The IRS Prioritizes Foreign Trust Reporting (Form 3520-A)

Whether a foreign trust is subject to U.S. tax depends on several different factors. If there are no US beneficiaries and no US situs in the foreign trust, then generally there is no U.S. tax or reporting requirement for the trust. In other words, if a foreign person owns a foreign trust that generates foreign income with no US beneficiaries, then there is typically no reason for the trust owners or beneficiaries to have to report anything in the United States for IRS tax purposes. However, it is not uncommon for a foreign Oftentimes, what starts as a foreign trust with foreign persons can morph into a foreign trust with US beneficiaries, owners, and trustees (especially when a foreign person trust owner becomes a US person) — which can then significantly impact the tax and reporting of the trust — as well as the owners of the trust and the beneficiaries of the trust. Let’s look at some of the basics of foreign-owned trusts and U.S. tax and reporting:

Foreign-Owned Grantor Trust

A foreign-owned grantor trust typically does not have any U.S. tax reporting requirements unless there are US assets in the trust or distributions made to US beneficiaries. In a common situation, a foreign-owned non-grantor trust may have an owner who later becomes a US person. In this type of situation, the US owner of the foreign trust is then required to report the income on their U.S. tax return and report their ownership in the foreign grant or trust on Forms 3520 and 3520-A.

What if there are U.S. Beneficiaries in the Foreign-Owned Grantor Trust?

If there are US beneficiaries to a foreign-owned grant or trust, the general rule is that beneficiaries do not pay tax on the income they receive. That is because it is the owner of a grantor trust who is taxed on the income in the foreign grantor trust and not the beneficiaries (under U.S. tax law). But that does not mean that the US beneficiaries get away scot-free. The US person beneficiaries of a foreign grantor trust are required to report the distribution on Form 3520 and depending on the underlying specifics of the distribution will impact whether it is reported as a gift or whether it is reported as a trust distribution — this is important because the reporting threshold requirements will vary depending on whether it is a gift from an individual, foreign entity, or trust distribution.

Foreign-Owned Non-Grantor Trust

With a foreign-owned non-grantor trust, the general rule again will be that the foreign owner of a foreign non-grantor trust is not required to report this information on the US tax return. That is because, unless there are US assets in the foreign-owned non-grantor trust, generally the US has no jurisdiction over a foreign non-grantor trust owned by a foreign person.

What if there are U.S. Beneficiaries?

In this type of scenario, where the US beneficiaries receive a distribution from a foreign non-grantor trust, the distribution is reported as income on their U.S. tax return. In addition, the US beneficiary is required to report the distribution on Form 3520. As provided by the IRS:

The Internal Revenue Service would like to remind all U.S. owners of a foreign trust and their return preparers of the filing requirements for Form 3520-A, Annual Information Return of Foreign Trust with a U.S. Owner (Under section 6048(b)). See the Instructions for Form 3520-A for more information.
- - Who must file. A foreign trust with a U.S. owner must timely file a complete and accurate Form 3520-A and furnish the required annual statements to its U.S. owners and U.S. beneficiaries in order for the U.S. owner to avoid penalties for the foreign trust’s failure to file a Form 3520-A. If a foreign trust fails to timely file Form 3520-A, the U.S. owner must complete and attach a substitute Form 3520-A to Part II of Form 3520, Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts, and furnish the required annual statements by the due date of the U.S. owner’s Form 3520.
  - When to file. A Form 3520-A must be filed by the 15th day of the third month after the end of the trust’s tax year. For example, a foreign trust with a tax year ending December 31, 2023, must file a Form 3520-A by March 15, 2024. However, if the U.S. owner files a substitute Form 3520-A with the U.S. owner’s Form 3520, then the substitute Form 3520-A is due by the due date of the U.S. owner’s Form 3520 and not the due date of the Form 3520-A. A Form 3520 is due by the 15th day of the fourth month following the end of the U.S. owner’s tax year (April 15), or October 15 for calendar year taxpayers filing with extensions. See the Instructions for Form 3520 for more information about when to file Form 3520.
  - Extension of time to file. An automatic 6-month extension of time to file Form 3520-A may be granted by filing Form 7004, Application for Automatic Extension of Time To File Certain Business Income Tax, Information, and Other Returns, with the foreign trust’s Employer Identification Number (EIN) by the 15th day of the third month after the end of the trust’s tax year. For example, a foreign trust with a tax year ending December 31, 2023 must file a Form 3520-A by March 15, 2024. If a properly completed Form 7004 was received by March 15, 2024, then the deadline to file Form 3520-A is now September 15, 2024. Please be aware that an extension of time to file an income tax return will not provide an extension of time to file Form 3520-A. Caution: Form 7004 with the foreign trust’s EIN must be filed in order to request an extension of time to file Form 3520-A. A Form 7004 for a foreign trust cannot be processed if it has the U.S. owner’s Social Security number (SSN).
  - Use EINs to identify the foreign trust. Only an EIN should be used to identify the foreign trust in Part I, Line 1b of Form 3520-A. If the foreign trust does not have an EIN, refer to Get an employer identification number. Caution: Do not enter the U.S. owner’s SSN or individual taxpayer identification number (ITIN) in line 1b.
  - Where to file. File Form 3520-A and Form 7004 with Internal Revenue Service Center, P.O. Box 409101, Ogden, UT 84409. Form 7004 can also be filed electronically to extend the due date of Form 3520-A. For details on electronic filing, visit IRS.gov/efile7004.
  - Exceptions from Form 3520-A filing requirements. A Form 3520-A is not required to be filed for Canadian registered retirement savings plans (RRSPs) and Canadian registered retirement income funds (RRIFs). See Rev. Proc. 2014-55. In addition, a Form 3520-A is not required to be filed for certain tax-favored foreign retirement trusts or tax-favored foreign non-retirement savings trusts, provided that the U.S. owner is an “eligible individual” and the tax-favored foreign trust meets certain requirements. See Rev. Proc. 2020-17.
    - Caution: These exceptions do not affect any reporting obligations that the U.S. owner may have to report specified foreign financial assets on Form 8938 or any other reporting requirement, including the requirement to file FinCEN Form 114, Report of Foreign Bank and Financial Accounts (FBAR).
  - Form 3520 filing requirements. In addition to ensuring that the foreign trust files Form 3520-A, a U.S. owner may be required to file a Form 3520, Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts. See the Instructions for Form 3520 for more information.

Form 3520-A filing tips to avoid penalties

- - File Form 3520-A using an EIN for the foreign trust on Line 1b of the form rather than the U.S. owner’s SSN or ITIN. If the foreign trust does not have an EIN, refer to Get an employer identification number.
  - File by the 15th day of the 3rd month after the end of the trust’s tax year. An automatic 6-month extension may be granted by filing Form 7004, Application for Automatic Extension of Time to File Certain Business Income Tax, Information and Other Returns. Form 7004 must be filed with the foreign trust’s EIN.
  - If the foreign trust will not file a Form 3520-A, the U.S. owner of the foreign trust must file a substitute Form 3520-A by completing a Form 3520-A to the best of their ability and attaching it to the U.S. owner’s timely filed Form 3520, including extensions (see Form 3520-A and Form 3520 instructions for more information on filing a substitute Form 3520-A). Do not separately file a duplicate Form 3520-A if you are filing a substitute 3520-A.
  - For additional information regarding penalties, refer to Penalties.

Late Filing Penalties May be Reduced or Avoided

For Taxpayers who did not timely file their FBAR and/or 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.

Late-Filing Disclosure Options

If a Taxpayer is out of compliance, there are various international offshore tax amnesty programs that they can apply to safely get into compliance. Depending on the specific facts and circumstances of the Taxpayers’ noncompliance, they can determine which program will work best for them.

*Below please find separate links to each program with extensive details about the reporting requirements and examples.

Streamlined Filing Compliance Procedures (SFCP, Non-Willful)

The Streamlined Filing Compliance Procedures is one of the most common programs used by Taxpayers who are non-willful and qualify for either the Streamlined Domestic Offshore Procedures or Streamlined Foreign Offshore Procedures.

Streamlined Domestic Offshore Procedures (SDOP, Non-Willful)

Taxpayers who are considered U.S. residents and file timely tax returns each year but fail to report foreign income and/or assets may consider the Streamlined Domestic Offshore Procedures.

Streamlined Foreign Offshore Procedures (SFOP, Non-Willful)

Taxpayers who are foreign residents may consider the Streamlined Foreign Offshore Procedures which is typically the preferred program of the two streamlined procedures. That is because under this program Taxpayers can file original returns and the 5% title 26 miscellaneous offshore penalty is waived.

Delinquent FBAR Submission Procedures (DFSP, Non-Willful/Reasonable Cause)

Taxpayers who only missed the FBAR reporting and do not have any unreported income or other international information reporting forms to file may consider the Delinquent FBAR Submission Procedures — which may include a penalty waiver.

Delinquent International Information Returns Submission Procedures (DIIRSP, Reasonable Cause)

Taxpayers who have undisclosed foreign accounts and assets beyond just the FBAR — but have no unreported income — may consider the Delinquent International Information Return Submission Procedures. Before November 2020, the IRS was more inclined to issue a penalty waiver, but since then this type of delinquency procedure submission has morphed into a reasonable cause request to waive or abate penalties.

IRS Voluntary Disclosure Procedures (VDP, Willful)

For Taxpayers who are considered willful, the IRS offers a separate program referred to as the IRS Voluntary Disclosure Program (VDP). This program is used by Taxpayers to disclose both unreported domestic and offshore assets and income (before 2018, there was a separate program that only dealt with offshore assets (OVDP), but that program merged back into the traditional voluntary disclosure program (VDP).

Quiet Disclosure

Quiet disclosure is when a Taxpayer submits information to the IRS regarding the undisclosed foreign accounts, assets, and income but they do not go through one of the approved offshore disclosure programs. This is illegal and the IRS has indicated they have every intention of investigating Taxpayers who they discover intentionally sought to file delinquent forms to avoid the penalty instead of submitting to one of the approved methods identified above.

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.

*This resource may help Taxpayers seeking to hire offshore tax counsel: How to Hire an Offshore Disclosure Lawyer.

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

Contact our firm today for assistance.