Can I Hide Foreign or Income Accounts in a Trust for Protection?

Can I Hide Foreign or Income Accounts in a Trust for Protection?

Can I Hide Foreign or Income Accounts?

One of the most complicated and misunderstood aspects of international tax law is the U.S. taxation and reporting of foreign trusts. That is because the definition of a trust can vary depending on which particular country the trust is created in and what the purpose of the trust is. Likewise, U.S. courts can independently determine that a certain type of entity or structure is a trust, even if the Taxpayer has never intended for a trust to be formed.

For many years, ‘tax promoters’ and the IRS have been playing cat and mouse games, with the promoters seeking to sell U.S. persons on all types of different tax-advantaged foreign trusts, such as the 643(b) trust. Not only does this attract unwanted attention from the IRS, but this may also lead some taxpayers to believe that they can hide their foreign accounts through ownership in a trust in order to avoid having to report the account and corresponding income to the IRS on various international information reporting forms such as the FBAR and Form 8938. This may also lead to significant fines and penalties, especially if the government believes that the taxpayer acted willfully or with the intent to defraud. Let’s walk through some of the common pitfalls that present themselves when a taxpayer tries to hide foreign accounts in a trust.

FATCA Reporting by Foreign Financial Institutions (FFIs)

The first thing to keep in mind is that many FFIs voluntarily comply with FATCA (Foreign Account Tax Compliance Act). Even if a taxpayer opens up a foreign account using a foreign trust, chances are that the foreign bank is aware that the taxpayer has a US person status. And, even if the bank is not initially aware, most Foreign Financial Institutions require taxpayers to confirm in writing that they are a non-us person through KYC letters and self-certification requirements. If the U.S. taxpayer intentionally identifies himself as a non-U.S. person when the taxpayer really is a U.S. person, the IRS could pursue criminal fraud charges — which is something that U.S. taxpayers should be mindful of.

Domestic Trust is a US Person for FBAR

A Domestic Trust is considered a U.S. Person for FBAR. Likewise, a Foreign trust owned by a U.S. person can also require the U.S. person to report the FBAR.

As provided by the IRS:

Who Must File the FBAR?

      • “A U.S. person must file an FBAR if they have a financial interest in or signature or other authority over any financial account(s) outside the U.S. and the aggregate amount(s) in the account(s) exceeds $10,000 at any time during the calendar year. Who is a U.S. Person? A “U.S. person” means:

          • A citizen or resident of the United States;

          • An entity created, organized, or formed in the United States or under the laws of the United States, any State, the District of Columbia, the Territories and Insular Possessions of the United States, or the Indian Tribes. An “entity” includes but is not limited to, a corporation, partnership, trust, and limited liability company; or

          • An estate formed under the laws of the United States.

      • A domestic trust is considered a US person for tax purposes and FBAR reporting purposes. Therefore, taxpayers who have ownership of a foreign trust may be required to file the FBAR, along with the trust itself.”

1041 Forms and Form 8938 and/or FBAR

While the most common type of situation in which a U.S. taxpayer files a Form 8938 is when they file a 1040 U.S. tax return, other tax returns may require a Form 8938 as well. For example, if a Form 1041 is being filed and the trust owns foreign assets that qualify as foreign assets under FATCA or FBAR, the FBAR and/or Form 8938 may be required as well.

As provided by the Form 1041 Instructions for Form 8938

      • “A domestic trust that is a specified domestic entity must file Form 8938 along with Form 1041 for the tax year. Form 8938 must be filed each year the value of the trust’s specified foreign financial assets meets or exceeds the reporting threshold. A trust exceeds the threshold amount if the total value of the specified foreign financial assets is more than $50,000 on the last day of the tax year or more than $75,000 at any time during the tax year.

      • For more information on domestic trusts that are specified domestic entities, the filing threshold, and the types of foreign financial assets that must be reported, see the Instructions for Form 8938.”

Form 3520/3520-A Foreign Trust

If the Taxpayer has other international information reporting forms such as Form 3520 to file, they have to be careful of certain hidden traps that can be used to help the IRS determine if the taxpayer has foreign accounts in their trust. For example, Form 3520 specifically requires the Taxpayer to identify whether they have Form 8938 filing requirements as well.  Thus, if a Taxpayer intentionally fails to file Form 8938 — because they think the account is hidden from the IRS — and then doubles down with intentional non-disclosure on other IRS reporting forms as well, they may be setting themselves up for big problems with the IRS down the line if they are ever audited or investigated.

Form 3520

      • “Check if any excepted specified foreign financial assets are reported on this form. 

          • Check the box in item C only if the Form 3520 filer also files Form 8938 for the tax year and includes this form in the total number of Forms 3520 reported on line 15 of Part IV, Excepted Specified Foreign Financial Assets, of Form 8938. For more information, see the Instructions for Form 8938, generally, and in particular, Duplicative reporting and the specific instructions for Part IV.”

Form 3520-A

      • “Check if any excepted specified foreign financial assets are reported on this form.  

          • Excepted Specified Foreign Financial Assets Reported Check the box only if a U.S. person treated as the owner of any portion of the trust under the grantor trust rules also files Form 8938, Statement of Specified Foreign Financial Assets, for the tax year and includes this form in the total number of Forms 3520-A reported on line 16 of Part IV, Excepted Specified Foreign Financial Assets, of Form 8938. For more information, see the Instructions for Form 8938, generally, and in particular, Duplicative reporting and the specific instructions for Part IV.”

Subsequent Deferred Prosecution Agreements and FATCA Agreement 

Even if the current FFI where the trust maintains foreign accounts is not currently reporting U.S. account holders to the US government, that may not always be the case in the future. For example, there are now more than 110 FATCA agreements with foreign countries — while there are less than 60 tax treaty countries. This reflects the fact that many countries across the globe have become interested in reciprocal reporting between that foreign country and the United States.

Likewise, when some foreign banks and financial investment firms find themselves getting their hand caught in the cookie jar, oftentimes, they will negotiate with the Department of Justice to avoid criminal repercussions — even though the FFI may have told the US person client that they would never do so. This happened about 20 years ago when several Swiss banks had agreed to keep U.S. persons’ financial information private and protected with numbered accounts, but then relinquished thousands of U.S. taxpayer names to the DOJ as part of the deferred prosecution agreements they entered into with the Department of Justice.

Late Filing Penalties May be Reduced or Avoided

For Taxpayers who did not timely file their FBAR and other international information-related reporting forms, the IRS has developed many different offshore amnesty programs to assist taxpayers with safely getting into compliance. These programs may reduce or even eliminate international reporting penalties.

Current Year vs. Prior Year Non-Compliance

Once a taxpayer missed the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, taxpayers should consider speaking with a Board-Certified Tax Law Specialist who specializes exclusively in these types of offshore disclosure matters.

Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)

In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful Taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties

Need Help Finding an Experienced Offshore Tax Attorney?

When it comes to hiring an experienced international tax attorney to represent you for unreported foreign and offshore account reporting, it can become overwhelming for taxpayers trying to trek through all the false information and nonsense they will find in their online research. There are only a handful of attorneys worldwide who are Board-Certified Tax Specialists and who specialize exclusively in offshore disclosure and international tax amnesty reporting. 

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure

Contact our firm today for assistance.