Reporting Foreign Trusts (2019) – IRS Tax Filing Requirements Guide
Reporting Foreign Trusts (2019) – IRS Tax Filing Requirements Guide: A ForeignTrust 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)).
Reporting Foreign Trusts
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.
Common Questions About Trusts that are Foreign
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?
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 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.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.
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:
- Traditional (IRM) IRS Voluntary Disclosure Program
- Streamlined Domestic Offshore Procedures (SDOP)
- Streamlined Foreign Offshore Procedures (SFOP)
- Reasonable Cause (RC)