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Foreign Trust Reporting Requirements (2019) – IRS Tax & Filing Rules

Foreign Trust Reporting Requirements (2019) – IRS Tax & Filing Rules

Reporting Foreign Trusts (2019) - IRS Filing Requirements (Updated) - Golding & Golding, A PLC

Reporting Foreign Trusts (2019) – IRS Filing Requirements (Updated) – Golding & Golding

Reporting Foreign Trusts is an important aspect of IRS Offshore Compliance for international and foreign trusts.

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.

With a Foreign Trust, some common IRS International Tax and Reporting issues to consider are:

  • 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? 

Reporting Foreign Trusts (2019 Update)

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.

Some examples of Reporting Foreign Trusts, include:

  • 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?

How do I Report a Foreign Trust?

It is the reason why the IRS has made International Tax Enforcement a key priority, and it is why the penalties associated with non-filing of foreign informational returns and account reporting are so unnecessarily extreme.

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).

Trust Accounting

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.

Grantor Trust

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 trust, asset or account compliance obligations, your best options are either the traditional IRS Voluntary Disclosure Program, or one of the Streamlined Offshore Disclosure Programs.

What Type of Attorney Should I Hire?

IRS Voluntary Disclosure is a specialized area of law. An IRS Voluntary Disclosure is a complex undertaking. It requires the coordination of several moving parts, including strategy development, Tax Preparation, Legal Analysis, Negotiation and more.

You should hire a Tax Attorney who has the following credentials:

  • ~20 Years of Private Practice experience representing his/her own clients
  • Experienced in Criminal and Civil Tax Litigation
  • Experienced representing clients in Eggshell and Reverse Eggshell Audits.
  • Advanced Tax Degree (LL.M.)
  • EA (Enrolled Agent) or CPA (Certified Public Accountant)
  • Preferably a Board Certified Tax Law Specialist

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 (In over 65 countries!)

Whether it is a simple or complex case, safely getting clients into compliance is our passion, and we take it very seriously.

Examples of areas of tax we handle

Who Decides to Disclose Unreported Money?

What Types of Clients Do we Represent?

We represent Attorneys, CPAs, Doctors, Investors, Engineers, Business Owners, Entrepreneurs, Professors, Athletes, Actors, Entry-Level staff, Students, Former/Current IRS Agents and more.

You are not alone, and you are not the only one to find himself or herself in this situation.

Sean M. Golding, JD, LL.M., EA (Board Certified Tax Law Specialist)

Our Managing Partner, Sean M. Golding, JD, LLM, EA  earned an LL.M. (Master’s in Tax Law) from the University of Denver and is also an Enrolled Agent (the highest credential awarded by the IRS, and authorizes him to represent clients nationwide.)

Mr. Golding and his team have successfully handled several hundred IRS Offshore/Voluntary Disclosure Procedure cases. Whether it is a simple or complex case, safely getting clients into compliance is our passion, and we take it very seriously.

He is frequently called upon to lecture and write on issues involving IRS Voluntary Disclosure.

Less than 1% of Tax Attorneys Nationwide are Board Certified Tax Law Specialists 

The Board Certified Tax Law Specialist exam is offered in many states, and is widely regarded as one of (if not) the hardest tax exam given in the United States for practicing Attorneys. Certification also requires the completion of significant ethics and experience requirements.

In California alone, out of more than 200,000 practicing attorneys (with thousands of attorneys practicing in some area of tax law), less than 350 attorneys are Board Certified Tax Law Specialists.

Beware of Copycat Law Firms

Unlike other attorneys who call themselves specialists or experts in Voluntary Disclosure but are not “Board Certified,” handle 5-10 different areas of tax law, purchase multiple keyword specific domain names, and even practice outside of tax, we are absolutely dedicated to Offshore Voluntary Disclosure.

*Click here to learn the benefits of retaining a Board Certified Tax Law Specialist with advanced tax credentials.

IRS Penalty List

The following is a list of potential IRS penalties for unreported and undisclosed foreign accounts and assets:

Failure to File

If you do not file by the deadline, you might face a failure-to-file penalty. If you do not pay by the due date, you could face a failure-to-pay penalty. The failure-to-file penalty is generally more than the failure-to-pay penalty.

The penalty for filing late is usually 5 percent of the unpaid taxes for each month or part of a month that a return is late. This penalty will not exceed 25 percent of your unpaid taxes. If you file your return more than 60 days after the due date or extended due date, the minimum penalty is the smaller of $135 or 100 percent of the unpaid tax.

Failure to Pay

f you do not pay your taxes by the due date, you will generally have to pay a failure-to-pay penalty of ½ of 1 percent of your unpaid taxes for each month or part of a month after the due date that the taxes are not paid. This penalty can be as much as 25 percent of your unpaid taxes. If both the failure-to-file penalty and the failure-to-pay penalty apply in any month, the 5 percent failure-to-file penalty is reduced by the failure-to-pay penalty.

However, if you file your return more than 60 days after the due date or extended due date, the minimum penalty is the smaller of $135 or 100 percent of the unpaid tax. You will not have to pay a failure-to-file or failure-to-pay penalty if you can show that you failed to file or pay on time because of reasonable cause and not because of willful neglect.

Civil Tax Fraud

If any part of any underpayment of tax required to be shown on a return is due to fraud, there shall be added to the tax an amount equal to 75 percent of the portion of the underpayment which is attributable to fraud.

A Penalty for failing to file FBARs

The civil penalty for willfully failing to file an FBAR can be as high as the greater of $100,000 or 50 percent of the total balance of the foreign financial account per violation. See 31 U.S.C. § 5321(a)(5). Non-willful violations that the IRS determines were not due to reasonable cause are subject to a $10,000 penalty per violation.

A Penalty for failing to file Form 8938

The penalty for failing to file each one of these information returns is $10,000, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return.

A Penalty for failing to file Form 3520

The penalty for failing to file each one of these information returns, or for filing an incomplete return, is the greater of $10,000 or 35 percent of the gross reportable amount, except for returns reporting gifts, where the penalty is five percent of the gift per month, up to a maximum penalty of 25 percent of the gift.

A Penalty for failing to file Form 3520-A

The penalty for failing to file each one of these information returns or for filing an incomplete return, is the greater of $10,000 or 5 percent of the gross value of trust assets determined to be owned by the United States person.

A Penalty for failing to file Form 5471

The penalty for failing to file each one of these information returns is $10,000, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return.

A Penalty for failing to file Form 5472

The penalty for failing to file each one of these information returns, or to keep certain records regarding reportable transactions, is $10,000, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency.

A Penalty for failing to file Form 926

The penalty for failing to file each one of these information returns is ten percent of the value of the property transferred, up to a maximum of $100,000 per return, with no limit if the failure to report the transfer was intentional.

A Penalty for failing to file Form 8865

Penalties include $10,000 for failure to file each return, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return, and ten percent of the value of any transferred property that is not reported, subject to a $100,000 limit.

Fraud penalties imposed under IRC §§ 6651(f) or 6663

Where an underpayment of tax, or a failure to file a tax return, is due to fraud, the taxpayer is liable for penalties that, although calculated differently, essentially amount to 75 percent of the unpaid tax.

A Penalty for failing to file a tax return imposed under IRC § 6651(a)(1)

Generally, taxpayers are required to file income tax returns. If a taxpayer fails to do so, a penalty of 5 percent of the balance due, plus an additional 5 percent for each month or fraction thereof during which the failure continues may be imposed. The penalty shall not exceed 25 percent.

A Penalty for failing to pay the amount of tax shown on the return under IRC § 6651(a)(2)

If a taxpayer fails to pay the amount of tax shown on the return, he or she may be liable for a penalty of .5 percent of the amount of tax shown on the return, plus an additional .5 percent for each additional month or fraction thereof that the amount remains unpaid, not exceeding 25 percent.

An Accuracy-Related Penalty on underpayments imposed under IRC § 6662

Depending upon which component of the accuracy-related penalty is applicable, a taxpayer may be liable for a 20 percent or 40 percent penalty

Possible Criminal Charges related to tax matters include tax evasion (IRC § 7201)

Filing a false return (IRC § 7206(1)) and failure to file an income tax return (IRC § 7203). Willfully failing to file an FBAR and willfully filing a false FBAR are both violations that are subject to criminal penalties under 31 U.S.C. § 5322.  Additional possible criminal charges include conspiracy to defraud the government with respect to claims (18 U.S.C. § 286) and conspiracy to commit offense or to defraud the United States (18 U.S.C. § 371).

A person convicted of tax evasion

Filing a false return subjects a person to a prison term of up to three years and a fine of up to $250,000. A person who fails to file a tax return is subject to a prison term of up to one year and a fine of up to $100,000. Failing to file an FBAR subjects a person to a prison term of up to ten years and criminal penalties of up to $500,000.  A person convicted of conspiracy to defraud the government with respect to claims is subject to a prison term of up to not more than 10 years or a fine of up to $250,000.  A person convicted of conspiracy to commit offense or to defraud the United States is subject to a prison term of not more than five years and a fine of up to $250,000.

What Should You Do?

Everyone makes mistakes. If at some point that you should have been reporting your foreign income, accounts, assets or investments the prudent and least costly (but most effective) method for getting compliance is through one of the approved IRS offshore voluntary disclosure program.

Be Careful of the IRS

With the introduction and enforcement of FATCA for both Civil and Criminal Penalties, renewed interest in the IRS issuing FBAR Penalties, crackdown on Cryptocurrency (and IRS joining J5), the termination of OVDP, and recent foreign bank settlements with the IRS…there are not many places left to hide.

4 Types of IRS Voluntary Disclosure Programs

There are typically four types of IRS Voluntary Disclosure programs, and they include:

Contact Us Today; Let us Help You.