The Foreign Trust Reporting Requirements: When to Disclose

Foreign Trust Reporting

Foreign Trust Reporting

Foreign Trust Reporting: The U.S. government requires owners, trustees, and/or beneficiaries to complete annual foreign trust reporting to the IRS each year. The definition of foreign trust reporting is complicated — since the definition of a foreign trust is simply that the trust is not a U.S. trust. While reporting foreign trusts can be complex, with the recent 2020 release of Revenue Procedure 2020-17 (Rev. Proc. 2020-17), the IRS is working to ease the burden of reporting. Still, in light of the fact that the IRS takes an aggressive position on matters involving foreign accounts compliance and overseas trust disclosures, it is important to stay (or get into) offshore tax compliance. We will summarize foreign trust reporting, and how it is reported to the IRS.

What is a Foreign Trust?

At its most basic core, a Foreign Trust is an arrangement for the holding of money or assets.

Due to the secret nature of foreign trusts in general, the IRS has taken a keen interest in foreign trust reporting.

One very common scenario is a revocable trust.

For example, you may have been recommended to hold your personal residence in a revocable trust.

• • • With the revocable trust, the Grantor/Settlor creates the trust and transfers the home into the trust.

    • The Trustee administers the trust; and

    • The Beneficiary will receive the trust property

Therefore, the three (3) main components to a basic, revocable grantor trust.

• • • Grantor or Settlor

    • Trustee

    • Beneficiary

Report Overseas Holdings to the IRS

The reporting foreign trust rules vary based on the type of foreign trust and the extent of the income. When the IRS refers to foreign trusts and 3520-A, they are generally not referring to foreign retirement plans such as an Australian Super or CPF, or your child’s minor’s trust account in the U.K.  These are trusts by definition, but not the type of trust generally being referred to.

Generally, foreign pension/trust reporting is sufficient by using:

• • • FBAR

    • Form 8938 and

    • PFIC Form 8621 (if applicable).

Some clients preferred to report the 3520 and 3520-A as a safety precaution — which we completely understand — but the IRS has now brought some clarity with the recently introduced Rev. Proc. 2020-17. We prepared a separate analysis for U.S. persons with Australian Superannuation, who are considering filing form 3520-A/3520, 

Sham Trusts Used for Improper Purposes

As a quick aside, the IRS has a serious aversion to sham trusts, improper assigning of income, etc.

As provided by the IRS:

• • • “Where a trust exists solely for tax avoidance purposes, it is an “abusive trust arrangement” or “sham” whereby the IRS may ignore the purported form for U.S. tax purposes.

      • Factors you should consider in a sham analysis (not an exclusive list):

        • Lack of Change: The relationship between the grantor and property conveyed to the trust does not materially change after conveyance to the trust.

        • Retained Control: A grantor continues to use and/or exercise dominion and control over trust property as if it was his/her own.

        • Retained Benefit: Property and/or income of the trust are used to benefit the Grantor

• • • • • Lack of Independent Trustee: Trustee’s failure to exercise fiduciary responsibilities. The trustee merely approves actions directed by grantor, and is trustee “in name only”, often due to family relationships or grantor’s position of control over trustee.”

How to Report a Foreign Trust to IRS

The Foreign Trust is reported on Form 3520 and 3520-A. Form 3520 is the “Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts” Form 3520-A is the “Annual Information Return of Foreign Trust With a U.S. Owner. The reporting requirements can range extensively. Depending on the type of trusts, and assets involved, you have extensive reporting requirements. Noting, duplicative reporting may not be required, and there are certain exemptions for assets that may ordinarily be required on Form 8621, but if are part of the trust may escape duplicate reporting.

Exceptions to Foreign Trust Reporting (2020-17)

The new revenue procedure exempts certain foreign trust reporting.

Tax-Favored Foreign Non-Retirement Savings 

Here is what the Rev Procedure Says about the Tax-Favored Foreign Non-Retirement Savings Trust.

• • • “For purposes of this revenue procedure, a tax-favored foreign non-retirement savings trust means a foreign trust for U.S. tax purposes that is created, organized, or otherwise established under the laws of a foreign jurisdiction (the trust’s jurisdiction) as a trust, plan, fund, scheme, or other arrangement (collectively, a trust) to operate exclusively or almost exclusively to provide, or to earn income for the provision of, medical, disability, or educational benefits, and that meets the following requirements established by the laws of the trust’s jurisdiction.

    • “(1) The trust is generally exempt from income tax or is otherwise tax-favored under the laws of the trust’s jurisdiction as defined in section 5.03(1) of this revenue procedure.

    • (2) Annual information reporting with respect to the trust (or about the beneficiary or participant) is provided, or is otherwise available, to the relevant tax authorities in the trust’s jurisdiction.

    • (3) Contributions to the trust are limited to $10,000 or less annually or $200,000 or less on a lifetime basis, determined using the U.S. Treasury Bureau of Fiscal Service foreign currency conversion rate on the last day of the tax year (available at https://www.fiscal.treasury.gov/reports-statements/treasury-reporting-rates-exchange).

    • (4) Withdrawals, distributions, or payments from the trust are conditioned upon the provision of medical, disability, or educational benefits, or apply penalties to withdrawals, distributions, or payments made before such conditions are met. A trust that otherwise meets the requirements of this section 5.04 will not fail to be treated as a tax-favored foreign non-retirement savings trust within the meaning of this section 5.04 solely because it may receive a rollover of assets or funds transferred from another tax-favored foreign non-retirement savings trust established and operated under the laws of the same jurisdiction, provided that the trust transferring assets or funds also meets the requirements of this section 5.04.”

Tax-Favored Foreign Retirement 

• • • For purposes of this revenue procedure, a tax-favored foreign retirement trust means a foreign trust for U.S. tax purposes that is created, organized, or otherwise established under the laws of a foreign jurisdiction (the trust’s jurisdiction) as a trust, plan, fund, scheme, or other arrangement (collectively, a trust) to operate exclusively or almost exclusively to provide, or to earn income for the provision of, pension or retirement benefits and ancillary or incidental benefits, and that meets the following requirements established by the laws of the trust’s jurisdiction.

    • (1) The trust is generally exempt from income tax or is otherwise tax-favored under the laws of the trust’s jurisdiction.

    • For purposes of this revenue procedure, a trust is tax-favored if it meets any one or more of the following conditions:

    • (i) contributions to the trust that would otherwise be subject to tax are deductible or excluded from income, are taxed at a reduced rate, give rise to a tax credit, or are otherwise eligible for another tax benefit (such as a government subsidy or contribution); and

    • (ii) taxation of investment income earned by the trust is deferred until distribution or the investment income is taxed at a reduced rate.

    • (2) Annual information reporting with respect to the trust (or of its participants or beneficiaries) is provided, or is otherwise available, to the relevant tax authorities in the trust’s jurisdiction.

    • (3) Only contributions with respect to income earned from the performance of personal services are permitted.

    • (4) Contributions to the trust are limited by a percentage of earned income of the participant, are subject to an annual limit of $50,000 or less to the trust, or are subject to a lifetime limit of $1,000,000 or less to the trust. These contribution limits are determined using the U.S. Treasury Bureau of Fiscal Service foreign currency conversion rate on the last day of the tax year (available at https://www.fiscal.treasury.gov/reports-statements/treasury-reporting-rates-exchange).

    • (5) Withdrawals, distributions, or payments from the trust are conditioned upon reaching a specified retirement age, disability, or death, or penalties apply to withdrawals, distributions, or payments made before such conditions are met. A trust that otherwise meets the requirements of this section 5.03(5), but that allows withdrawals, distributions, or payments for in-service loans or for reasons such as hardship, educational purposes, or the purchase of a primary residence, will be treated as meeting the requirements of this section 5.03(5).

    • (6) In the case of an employer-maintained trust,

    • (i) the trust is nondiscriminatory insofar as a wide range of employees, including rank and file employees, must be eligible to make or receive contributions or accrue benefits under the terms of the trust (alone or in combination with other comparable plans),

    • (ii) the trust (alone or in combination with other comparable plans) actually provides significant benefits for a substantial majority of eligible employees, and

    • (iii) the benefits actually provided under the trust to eligible employees are nondiscriminatory.

    • A trust that otherwise meets the requirements of this section 5.03 will not fail to be treated as a tax-favored foreign retirement trust within the meaning of this section solely because it may receive a rollover of assets or funds transferred from another tax favored foreign retirement trust established and operated under the laws of the same jurisdiction, provided that the trust transferring assets or funds also meets the requirements of this section 5.03.”

 IRC 6677 Penalty Relief

If you were recently assessed penalties, and/or paid the penalty – you may be able to obtain relief, or abate the penalties.

As provided in the new Revenue Procedure 2020-17

• • • “Subject to the limitations of sections 6402 and 6511, eligible individuals who have been assessed a penalty under section 6677 for failing to comply with section 6048 with respect to an applicable tax-favored foreign trust (without regard to whether such failure was due to reasonable cause under section 6677(d)) and who wish to obtain relief under this revenue procedure may request an abatement of the penalty assessed, or a refund of the penalty paid, under section 6677 by filing Form 843, Claim for Refund and Request for Abatement.

    • Eligible individuals are not precluded from requesting relief under any other applicable relief provisions. Under section 6402(a), the Secretary is authorized to credit, within the applicable period of limitations, an overpayment against any liability in respect of an internal revenue tax of the person who made the overpayment, and must generally refund any balance to that person, subject to the requirements of section 6402(c), (d), (e), and (f) (providing for offset for past-due support and certain debts to federal and state governments). Section 6511(b)(1) provides that no credit or refund shall be allowed or made after the expiration of the period of limitation prescribed in section 6511(a), unless the taxpayer filed a claim for credit or refund within that period. .02 Where to File.

    • A Form 843 requesting relief under this revenue procedure should be mailed to Internal Revenue Service, Ogden, UT 84201-0027. .03 Filing Requirements for Form 843. Eligible individuals should complete the form and write the statement “Relief pursuant to Revenue Procedure 2020-17” on Line 7 of the form. In addition, Line 7 should include an explanation of how the eligible individual meets each relevant requirement under section 5.02 of this revenue procedure and how the foreign trust meets each relevant requirement under section 5.03 or 5.04 of this revenue procedure.”

The Full Text of the Revenue Procedure 2020-17 can be found here (subscription may be required).

Golding & Golding: About Our International Tax Law Firm

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

Contact our firm today for assistance.