The Form 3520-A is no easy feat.
When a Foreign Trust has U.S. Owner, there is a requirement under Internal Revenue Service section 6048 to report the information on a Form 3520-A. This form is important, because the IRS has taken an aggressive approach on matters involving foreign accounts compliance and unreported offshore income (including foreign trust income).
IRC 6048 refers to information returns with respect to certain foreign trusts. The code section is dense, but here are some of the basics
(a) Notice of certain events
(1) General rule
On or before the 90th day (or such later day as the Secretary may prescribe) after any reportable event, the responsible party shall provide written notice of such event to the Secretary in accordance with paragraph (2).
(2) Contents of notice
The notice required by paragraph (1) shall contain such information as the Secretary may prescribe, including—
(A) the amount of money or other property (if any) transferred to the trust in connection with the reportable event, and
(B) the identity of the trust and of each trustee and beneficiary (or class of beneficiaries) of the trust.
(3) Reportable event
For purposes of this subsection—
(A) In general
The term “reportable event” means—
(i) the creation of any foreign trust by a United States person,
(ii) the transfer of any money or property (directly or indirectly) to a foreign trust by a United States person, including a transfer by reason of death, and
(iii) the death of a citizen or resident of the United States if—
(I) the decedent was treated as the owner of any portion of a foreign trust under the rules of subpart E of part I of subchapter J of chapter 1, or
(II) any portion of a foreign trust was included in the gross estate of the decedent.
(i) Fair market value sales Subparagraph (A)(ii) shall not apply to any transfer of property to a trust in exchange for consideration of at least the fair market value of the transferred property. For purposes of the preceding sentence, consideration other than cash shall be taken into account at its fair market value and the rules of section 679(a)(3) shall apply. (ii)Deferred compensation and charitable trustsSubparagraph
(A) shall not apply with respect to a trust which is—
(I)described in section 402(b), 404(a)(4), or 404A, or (II)determined by the Secretary to be described in section 501(c)(3).
(4) Responsible party
For purposes of this subsection, the term “responsible party” means—
(A)the grantor in the case of the creation of an inter vivos trust,
(B)the transferor in the case of a reportable event described in paragraph (3)(A)(ii) other than a transfer by reason of death, and
(C)the executor of the decedent’s estate in any other case.
(b) United States owner of foreign trust
(1) In general
If, at any time during any taxable year of a United States person, such person is treated as the owner of any portion of a foreign trust under the rules of subpart E of part I of subchapter J of chapter 1, such person shall submit such information as the Secretary may prescribe with respect to such trust for such year and shall be responsible to ensure that—
(A)such trust makes a return for such year which sets forth a full and complete accounting of all trust activities and operations for the year, the name of the United States agent for such trust, and such other information as the Secretary may prescribe, and
(B)such trust furnishes such information as the Secretary may prescribe to each United States person
(i) who is treated as the owner of any portion of such trust or
(ii) who receives (directly or indirectly) any distribution from the trust.
(2) Trusts not having United States Agent
(A) In general If the rules of this paragraph apply to any foreign trust, the determination of amounts required to be taken into account with respect to such trust by a United States person under the rules of subpart E of part I of subchapter J of chapter 1 shall be determined by the Secretary.
(B) United States agent requiredThe rules of this paragraph shall apply to any foreign trust to which paragraph (1) applies unless such trust agrees (in such manner, subject to such conditions, and at such time as the Secretary shall prescribe) to authorize a United States person to act as such trust’s limited agent solely for purposes of applying sections 7602, 7603, and 7604 with respect to—
(i)any request by the Secretary to examine records or produce testimony related to the proper treatment of amounts required to be taken into account under the rules referred to in subparagraph (A), or (ii)any summons by the Secretary for such records or testimony.
The appearance of persons or production of records by reason of a United States person being such an agent shall not subject such persons or records to legal process for any purpose other than determining the correct treatment under this title of the amounts required to be taken into account under the rules referred to in subparagraph (A).
A foreign trust which appoints an agent described in this subparagraph shall not be considered to have an office or a permanent establishment in the United States, or to be engaged in a trade or business in the United States, solely because of the activities of such agent pursuant to this subsection.
(C) Other rules to apply Rules similar to the rules of paragraphs (2) and (4) of section 6038A(e) shall apply for purposes of this paragraph. (c)Reporting by United States beneficiaries of foreign trusts
(1) In generalIf any United States person receives (directly or indirectly) during any taxable year of such person any distribution from a foreign trust, such person shall make a return with respect to such trust for such year which includes—
(A) the name of such trust,
(B) the aggregate amount of the distributions so received from such trust during such taxable year, and (C)such other information as the Secretary may prescribe.
(2) Inclusion in income if records not provided
(A) In general If adequate records are not provided to the Secretary to determine the proper treatment of any distribution from a foreign trust, such distribution shall be treated as an accumulation distribution includible in the gross income of the distributee under chapter 1. To the extent provided in regulations, the preceding sentence shall not apply if the foreign trust elects to be subject to rules similar to the rules of subsection (b)(2)(B).
(B) Application of accumulation distribution rules For purposes of applying section 668 in a case to which subparagraph (A) applies, the applicable number of years for purposes of section 668(a) shall be ½ of the number of years the trust has been in existence.
Common Questions we receive about Foreign Trusts
With a Foreign Trust, some common IRS International Tax and Reporting issues to consider are:
- What is a Foreign Trust?
- How do I report a Foreign Trust?
- What if I never received Foreign Trust distribution?
- Do I pay tax on Foreign Trust income?
- What if I am out of IRS compliance?
- Is it a Foreign “Grantor “Trust?”
- Is it a Foreign “Non-Grantor Trust?”
- It there are Foreign Trustee?
- Is there are Trust Protector?
- Is there a U.S. Agent?
What is Foreign Trust Reporting?
A Foreign Trust is a trust that is governed by a Foreign Jurisdiction, with a foreign Trustee(s). When the trust is “Foreign,” it is subject to different IRS Requirements and Reporting Rules by the IRS.
If the IRS considers you to be the owner of beneficiary (agent or trustee) of a foreign trust, there are additional U.S. Reporting Requirements on Form 3520 and 3520-A (Annual Information Return of Foreign Trust with a U.S. Owner) — as required by section 6048(b))
The Trustee of the Foreign Trust is tasked with the responsibility of filing these forms each year with the IRS.
We have worked with citizens and residents worldwide with Foreign Trusts (Form 3520 and 3520-A) filing requirements — along with related issues, such as FBAR, PFIC, Foreign vs. U.S. Residents, etc.
IRS offshore compliance (and reporting foreign trusts in particular) is an important aspect of international and offshore reporting and disclosure to the IRS.
There are specific foreign trust reporting requirements for grantors, non-grantors, trustees, U.S. agents, beneficiaries, which may impact internal revenue service reporting and tax requirements.
How do I Report a Foreign Trust?
Foreign Trusts (especially Foreign Grantor Trusts) are traps for the unwary.
Namely, this is because the Internal Revenue Service is a strong believer that anybody who has any money offshore or in a foreign country is doing so to avoid U.S. tax.
This is very common for our clients with an active New Zealand Foreign Trust.
Despite all the different types of reporting requirements for different types of accounts, the foreign trust is one of the most overbearing. There are particular rules involving foreign trusts, and while we were not going to go into all of those rules in this article, will provide a brief summary of some of the key issues to watch out for.
U.S. Citizens Abroad
In many countries, it is common to have a foreign trust to hold all of your assets (somewhat similar to a revocable trust is set it is more active during the lifetime of the trustee/beneficiary).
As a result, it is important to note that the United States does not really care where you live, insofar as if you reside abroad and are following foreign trust rules, you will still have to report a foreign trust to the United States. This is true, when there is a US person who serves as a member of the foreign trust.
What is a U.S. Owner?
Leave it to the Internal Revenue Service to keep the task somewhat esoteric and ambiguous. The reality is, anybody who is considered a U.S. person is most likely going to be considered a U.S. owner.
This includes U.S. Citizens, Legal Permanent Residents and other individuals who meet the Substantial Presence Test (at least during the time in which they meet the test). While IRS likes to build ambiguity into its definitions, it is usually preferred to error on the side of caution and report the Foreign Trust because you can better believe that the IRS is going to find any ambiguity to be in favor of the IRS and US government (Read: they are going to penalize you).
As provided by the IRS: “A foreign trust with a U.S. owner must file Form 3520-A in order for the U.S. owner to satisfy its annual information reporting requirements under section 6048(b). Each U.S. person treated as an owner of any portion of a foreign trust under the grantor trust rules (sections 671 through 679) is responsible for ensuring that the foreign trust files Form 3520-A and furnishes the required annual statements to its U.S. owners and U.S. beneficiaries.”
What is a Foreign Trust?
As we mentioned above, the IRS doesn’t like to nail down specifics – most likely because most solid tax attorneys would find a way around them. As such, the Internal Revenue Service defines a foreign trust as “A foreign trust is any trust other than a domestic trust.
A domestic trust is any trust if: 1. A court within the United States is able to exercise primary supervision over the administration of the trust, and 2. One or more U.S. persons have the authority to control all substantial decisions of the trust.”
In other words, to perform the analysis you would determine if it is a domestic trust. If it is not a domestic trust then by default it is a foreign trust. While there are definitely times in which you can argue semantics (and probably win) if not drag the matter out for a very long time through the court system, if the trust is located overseas, or the property is comprised of foreign property, and/or the owner is a non-US person, then most likely you will be required to report the trust.
Who has to Report The Foreign Trust?
If there is a trustee, then typically the trustee as part of his or her duties will prepare and file the form with the Internal Revenue Service. It is important to note, that if the trustee does not file the form, the U.S. owner must still file the form. An example we deal with often will be when we have a client based in the United States, who has a multi-million dollar funded foreign trust a broad, through a trust company that may have ‘baited’ the client into the investment by explaining that since it is a foreign trust it does not need to be reported in the United States.
Thereafter, the US owner learns of the reporting requirement (3520, 3520-A, FBAR, Form 8938, 8621) and realizes that the trustee never filed the form. This is a nonissue to the IRS, and the owner still must file the form(s).
Depending on how active or passive your foreign trust is, chances are there will be some accounting that needs to be handled in order for the trust to be properly reported. For example, assets, equity, and liabilities will need to be detailed in the form 3520-A.
The Internal Revenue Service will want to be aware of which Beneficiaries or Trustees received what distribution (if any), and especially, whether taxes have already been paid either abroad or in the United States.
Generally, trust distributions that are income will be reported by the grantor as income in a foreign trust scenario. The purpose is to avoid the deep pocket grantor from artificially reducing his or her tax liability by distributing money to his children or other family members which would presumably be taxed at a lower tax bracket than Mr. or Mrs. Deep Pockets.
Whether or not a trust is a grantor trust is well beyond the scope of this article. It is important to keep in mind that the IRS will default to a trust being a grantor trust because that will increase the amount of tax the IRS can recover. To be fair, most foreign trusts are most likely going to be grantor trusts.
A typical scenario would be the owner of the trust maintains control or at least the purse-strings of the trust. No matter how many layers of rhetoric the grantor will try to place between himself or herself and the beneficiaries, if in reality the grantor is making the final decision (even if through a conduit in which he or she has some control) it is probably going to be a grantor trust.
Foreign Trust Penalties
The IRS loves penalties — especially Offshore Penalties. And, due to the fact that the IRS is understaffed and under budget, they rely on these penalties to make it through the year. As such, if you are high-net worth individual with a substantial amount of money overseas in a foreign trust, it will behoove you to get into compliance. To better understand the penalties, the IRS provides the following:
The U.S. owner is subject to an initial penalty equal to the greater of $10,000 or 5% of the gross value of the portion of the trust’s assets treated as owned by the U.S. person at the close of that tax year, if the foreign trust (a) fails to file a timely Form 3520-A, or (b) does not furnish all of the information required by section 6048(b) or includes incorrect information. See section 6677(a) through (c).
The U.S. owner is subject to an additional separate penalty equal to the greater of $10,000 or 5% of the gross value of the portion of the trust’s assets treated as owned by the U.S. person at the close of that tax year, if the U.S. owner (a) fails to file a timely Form 3520 (Part II), or (b) fails to furnish all of the information required by section 6048(b) or includes incorrect information.
See section 6677(a) through (c). Additional penalties will be imposed if the noncompliance continues for more than 90 days after the IRS mails a notice of failure to comply with the required reporting. For more information, see section 6677. Criminal penalties may be imposed under sections 7203, 7206, and 7207 for failure to file on time and for filing a false or fraudulent return. Penalties may also be imposed under section 6662(j) for undisclosed foreign financial asset understatements. Reasonable cause. No penalties will be imposed if the taxpayer can demonstrate that the failure to comply was due to reasonable cause and not willful neglect.
What if I am Out of IRS Compliance?
When you have not met your prior year IRS foreign bank account compliance obligations, your best options are either the traditional IRS Voluntary Disclosure Program, or one of the Streamlined Offshore Disclosure Programs.
We Specialize in Safely Disclosing Foreign Money
We have successfully handled a diverse range of IRS Voluntary Disclosure and International Tax Investigation/Examination cases involving FBAR, FATCA, and high-stakes matters for clients around the globe.
Golding & Golding: About our International Tax Law Firm
Golding & Golding specializes exclusively in international tax, and specifically IRS offshore disclosure.
We are the “go-to” firm for other Attorneys, CPAs, Enrolled Agents, Accountants, and Financial Professionals across the globe. Our attorneys have worked with thousands of clients on offshore disclosure matters, including FATCA & FBAR.
Each case is led by a Board-Certified Tax Law Specialist with 20-years experience, and the entire matter (tax and legal) is handled by our team, in-house.
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Recent Golding & Golding Case Highlights
- We represented a client in an 8-figure disclosure that spanned 7 countries.
- We represented a high-net-worth client to facilitate a complex expatriation with offshore disclosure.
- We represented an overseas family with bringing multiple businesses & personal investments into U.S. tax and offshore compliance.
- We took over a case from a small firm that unsuccessfully submitted multiple clients to IRS Offshore Disclosure.
- We successfully completed several recent disclosures for clients with assets ranging from $50,000 – $7,000,000+.
How to Hire Experienced Offshore Counsel?
Generally, experienced attorneys in this field will have the following credentials/experience:
- Board Certified Tax Law Specialist credential
- Master’s of Tax Law (LL.M.)
- Dually Licensed as an EA (Enrolled Agent) or CPA
- 20-years experience as a practicing attorney
- Extensive litigation, high-stakes audit and trial experience
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