A Multi-Million Penalty Dispute with IRS of a Foreign Grantor Trust

A Multi-Million Penalty Dispute with IRS of a Foreign Grantor Trust

~$15,000,000 Dispute with the IRS of a Foreign Grantor Trust Penalty

Recently, a U.S. taxpayer filed a lawsuit in Florida District Court challenging the Internal Revenue Service’s claim that a certain foreign trust is a foreign grantor trust. Rather, the taxpayer takes the position that the trust was a non-grantor trust — and a potential $15 million jeopardy assessment hangs in the balance. Our international tax law specialist team has written several articles on issues involving foreign trusts, and most recently an article explaining the difference between grantor and non-grantor trusts as well as a summary of the new proposed regulations that came out earlier this week. To understand the importance of this distinction between foreign trust types and how it can impact a penalty come and let’s walk through the Verified Complaint filed in the case of Geiger vs United States of America.

First, What is a Jeopardy Assessment?

Typically, there are specific processes and procedures that the IRS must follow to assess and collect taxes and penalties. This process can be very long and involves various notices to the taxpayers such as CP504 notices and CP71 notices. With a jeopardy assessment, the IRS gets the opportunity to pursue assessment and collection of penalties without having to follow these procedures. The idea behind the jeopardy assessment is that if the IRS has to go the long route to assess and collect the penalties, then the ability to collect the penalty is at risk.

26 U.S.C. 7429  (Review of jeopardy levy or assessment procedures)

      • (2) Request for review

          • Within 30 days after the day on which the taxpayer is furnished the written statement described in paragraph (1), or within 30 days after the last day of the period within which such statement is required to be furnished, the taxpayer may request the Secretary to review the action taken.

      • (3) Redetermination by Secretary

          • After a request for review is made under paragraph (2), the Secretary shall determine—

            • (A) whether or not—

              • (i)the making of the assessment under section 6851, 6861, or 6862, as the case may be, is reasonable under the circumstances, and

              • (ii)the amount so assessed or demanded as a result of the action taken under section 6851, 6861, or 6862 is appropriate under the circumstances, or

            • (B) whether or not the levy described in subsection (a)(1) is reasonable under the circumstances.

Case Background

The taxpayer had created a Lichtenstein foundation (aka Stiftung) which had not been timely reported to the IRS. This led taxpayers to submit to the offshore voluntary disclosure program (OVDP), submit late Forms 3520 and 3520-A, and pay a large penalty. When the forms were submitted for the trust, they mistakenly represented that the trust (WCF) was a grantor trust for federal income tax purposes. If this is the case, then the taxpayer would be considered the owner of the Grantor Trust and thus would be subject to the income associated with the trust along with certain reporting requirements specifically, as being a U.S. person owner of a foreign trust.

Tax Treatment As a Non-Grantor Trust

With a non-grantor trust, the taxpayer would not be considered the owner of the trust, and would only report income associated with the distributions. In other words, when a person is a beneficiary of a non-grantor trust they only have to report the distributions they receive as taxable income and they do not have to report the trust as a trust that they are the owner of. In this case, as in nearly all foreign trust cases, it would benefit the taxpayer greatly to be considered a beneficiary of a non-grantor foreign trust as opposed to the owner of a foreign grantor trust. In addition, this case also presents certain expatriation and exit tax issues, and depending on whether the trust is a non-grantor trust or grantor trust may impact the amount of exit taxes due.

Why Foreign Trust Classification is Important

This case gives great insight into the importance of classifying a trust as a non-grantor trust as opposed to a grantor trust. If the taxpayer is deemed the owner of a grant or trust, then they may have a significant tax liability and imputed annual income based on the percentage of assets in the trust that the taxpayer is deemed the owner of. Conversely, if it is a non-grantor trust then the taxpayer only pays tax on the income that is distributed to him because he is not the owner of the trust. Moreover, ancillary issues flow from this type of analysis, especially for wealthy taxpayers who may be considering expatriating from the United States because it could impact any exit tax that they may owe since if they’re deemed an owner of the trust then their exit tax would be greater than if they were a beneficiary with no ownership of the foreign trust.

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