Foreign Trusts & IRS Tax Penalties (Form 3520-A) – FAQ Summary Review
- 0.1 U.S. Taxation of Foreign Trusts
- 0.2 Form 3520-A – Foreign Trust Ownership
- 0.3 What is Included on the Form 3520-A
- 0.4 Be Careful with “Questionable” Deductions
- 0.5 What if I never Filed the Form 3520-A?
- 0.6 Reporting Foreign Income and Accounts – The Basics
- 0.7 Who Has to Report?
- 1 The Basics
The IRS hates foreign trusts; they are highly frowned upon by the U.S. government and if they are not reported properly and timely, the IRS may issue extensively high fines and penalties against you (Read: PFIC 8621)
The main reason the IRS hates Foreign Trusts, is because oftentimes people use them to shelter offshore funds, accounts and profits.
As a result, the United States is unable to obtain information about the funds which are sheltered abroad, and the Internal Revenue Service loses out on billions of dollars of tax liability that would be due for individuals with foreign trusts to pay each year.
U.S. Taxation of Foreign Trusts
It is important to remember that unlike other types of trusts, in a foreign trust (grantor trust) it is the owner of the trust was essentially liable for taxes due for income generated from the trust – and not the beneficiaries.
Thus, many trust owners are getting away tax-free simply by shifting their US money into a foreign trust and sheltering the income through a variety of means. Moreover, if the Grantor has”Deep Pockets” chances are he or she would be taxed at the higher U.S. Tax Rate of 33%, 35% or 39.6%
Form 3520-A – Foreign Trust Ownership
Form 3520-A is an “Annual Information Return of Foreign Trust With a U.S. Owner” and is required to be filed by the owner of a foreign trust if the owner is considered a US person (U.S. Citizen, Legal Permanent Resident, Foreign National who meets the Substantial Presence Test and possibly individuals who relinquished their Green Card but are considered Long-Term Green Card Holders). While there are some exceptions to filing the majority of individuals who are considered US owners of a foreign trust are going to have to file this form on an annual basis.
The penalties for failing to file this form are steep and amount 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.”
What is Included on the Form 3520-A
Form 3520-A is a comprehensive form that requires extensive reporting, such as Trust:
- Rents and Royalties
- Income Loss
- Capital Gain
- Ordinary Gains
- Other Income
Thus, the form is equivalent to having to file a 5471 or other type of business form detailing the income, assets and expenses of the trust.
Be Careful with “Questionable” Deductions
In order to offset profit, some trustees will pad the deductions in order to reduce the annual income. This is not a great strategy, especially when it involves a heavily scrutinized investment such as a foreign trust. For example, the following types of expenses must be detailed and parsed out individually on the form 3520-A:
- Interest Expense
- Foreign Taxes
- State and Local Taxes
- Amortization and Depreciation
- Trustee and Advisor Fees
- Charitable Contributions
- Other Expenses.
What if I never Filed the Form 3520-A?
If you have never filed a form 3520-A (and/or your foreign trustee never filed a form either), then you are out of compliance. It is important that you get back into compliance as quickly as possible to avoid fines and penalties. Beyond the mere failure to file the form 3520-A there may be other issues right around the bend such as:
- Does the trust have a foreign bank account(s)?
- What is the annual aggregate total of the foreign bank accounts?
- Does the owner of the trust reside in the United States?
- Where does the Trustee Reside?
- Does the owner of the trust file single, married or marry filing separate?
- Is the trust owned by foreign corporation? (5471 and 5472 issues)
- Is the trust part of a Passive Foreign Investment Company (PFIC and 8621 issues)?
- Does the trust own foreign mutual funds (PFIC and 8621 issues)
These are just some very basic/preliminary questions that may lead to additional reporting requirements that you should keep in mind when assessing your Foreign Tax situation. It is often a good idea to speak with an experienced offshore disclosure attorney involving these complex matters.
Reporting Foreign Income and Accounts – The Basics
Offshore disclosure is a complex area of law. To that end, many clients of ours have many of the same issues, questions, or concerns regarding their failure to report and/or be in compliance.
The following is a summary:
Golding & Golding is a flat-fee, full-service firm; we are lawyers who assist international clients in reporting their offshore accounts to the IRS. Most recently, many of our clients learned about Foreign Bank Account reporting requirements when they received a FATCA Letter from their Bank, asking them to certify their U.S. Status by submitting either a W-9 or W-8 BEN.
Who Has to Report?
We have represented numerous clients worldwide with issues similar to yours:
– Expats who relocated overseas and did not know they had to report their foreign accounts.
– U.S. Citizens who live overseas and may or may not earn significant income, but have accounts in a foreign country.
– Legal Permanent Residents of the United States who relocate back to a foreign country but are unaware that they are still required to report the foreign accounts.
– Non-Residents who meet the substantial presence test and therefore are required to report foreign bank and other accounts to the US government.
Please do not worry. We can assist you as we have assisted hundreds of clients in over 40 countries disclose upwards of $40 million in a single disclosure.
We are available seven days a week and provide flat-fee and full-service representation to our clients around the world.
These are the most basic rules when it comes to foreign accounts and foreign income:
If you are either a US Citizen, Legal Permanent Resident (aka Green Card holder or recently gave up your Green Card) or foreign resident who meets the substantial presence test, then you are required to report your worldwide income to the IRS. This means that even if you do not have any US-based income, you are still required to report your worldwide income (even if it is the type of income which is not taxed in your home country such as interest and dividend income in most Asian countries). And, if you have enough foreign income to meet the minimum threshold for having to file a US tax return, then you are required to do so even if it is based on your foreign income alone.
If you meet the requirement for being a U.S. “Taxpayer” (even if you do not meet the threshold for having to file a US tax return), you are still required to file an annual FBAR (Report of Foreign Bank and Financial Accounts). The threshold is as follows: if at any time during the year, you have more than $10,000 in foreign accounts (whether the money is in one account or spread over numerous accounts), you are required to file an FBAR.
In addition, if you have significant amounts of money overseas, then you may also have to file additional forms such as an 8938 (FATCA Form) or 8621 (Passive Foreign Investment Company, which includes Foreign Mutual Funds along with as many other passive investments). There are many other forms you may have to file, but we determine those on a case-by-case basis.
Fines & Penalties
Unless you are criminal, chances are the IRS or Department of Justice will not be banging down your door to come drag you to jail. With that said, the fines and penalties can be very steep and depending on your particular circumstances, may include penalties upwards of 100% of the value of your foreign account. If the IRS believes you were willful (aka intentional), then they may launch a criminal investigation against you and the penalties and fines can get much worse from here, including Liens, Levies, Seizures…and worse.
Customs Holds and Passport Revocation
With the implementation of FATCA (Foreign Account Tax Compliance Act), the United States is heavily cracking down on offshore tax evasion and unreported foreign accounts in general. The IRS and US government have the power to both revoke your passport as well as possibly hold you at the airport “customs hold” to question you on the spot (usually outside the presence of your attorney).
Getting Into Compliance
Getting into compliance should be mandatory on your “to-do” list. Even though our firm, Golding & Golding, is based in Newport Beach, we represent clients worldwide. A majority of our clients live overseas in over 40 countries. We have helped numerous clients get into compliance and are regarded as one of the top Offshore Disclosure Law Firms worldwide.
To that end, there are three main methods of compliance:
(1) Streamlined Compliance
This program is for individuals who were unaware of any requirement to file an FBAR and/or report their income on a US tax return. The penalties under the streamlined program are significantly reduced and may possibly be waived depending on whether a person qualifies under the strict definition of foreign resident for offshore disclosure purposes.
This program is mainly for individuals and businesses who were willful, aka were aware they were supposed to report their foreign accounts but intentionally hid or kept the account/income information secret.
(3) Reasonable Cause Statement
This is not a particular program; instead, it is a method for getting to compliance while attempting to avoid any penalty. There are many pros and cons to this method depending on your specific situation, which must be evaluated carefully with your attorney before making a decision.
Sean holds a Master's in Tax Law from one of the top Tax LL.M. programs in the country at the University of Denver, and has also earned the prestigious Enrolled Agent credential. Mr. Golding is also a Board Certified Tax Law Specialist Attorney (A designation earned by Less than 1% of Attorneys nationwide.)