Foreign Trust Reporting Requirements
Although there are a myriad of reasons why a U.S. person might create a foreign trust, or have transactions with a foreign trust, they can have tax consequences and result in filing responsibilities as well. Regardless of your motivation, failure to meet these reporting and filing requirements can result in very significant penalties. In addition, if a U.S. person has signature authority over a foreign bank account related to a foreign trust, he or she may have an FBAR filing requirement. Any delinquency associated with IRS form 3520A can usually be resolved through the Offshore Voluntary Disclosure Program or the Streamlined Filing Compliance Procedures. For further assistance, please contact a Los Angeles tax attorney to discuss your specific questions regarding foreign trust reporting requirements.
General Rules for Foreign Trust Reporting Requirements
In general, the reporting rules apply to a U.S. person who:
- Creates a foreign trust
- Transfers any money or property to a foreign trust
- Receives a distribution from a foreign trust
- Is treated as the U.S. owner of a foreign trust.
Tax consequences can apply to the U.S. owners and U.S. beneficiaries of foreign trust, and to the foreign trust itself.
Reporting Requirements and Tax Consequences
Form 3520-A – Annual Information Return of Foreign Trust with a U.S. Owner – provides information about the foreign trust, its U.S. beneficiaries, and any U.S. person who is treated as an owner of any portion of the foreign trust.
Who Must File Form 3520-A? Each U.S. person treated as an owner of any portion of a foreign trust under the grantor trust rules 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.
Other Possible Reporting Requirements
In addition to the form 3520, you may be required to fill out other IRS forms if you have a foreign trust, depending on your level of involvement with the foreign trust. If you have dealings with a foreign trust and have questions about compliance, you should contact a Los Angeles tax attorney to discuss your compliance obligations, which could include any of the following:
- Form 1040, Schedule B, Part III, Foreign Accounts and Trusts: this schedule must be completed if you receive a distribution from, or were grantor of, or a transferor to a foreign trust.
- FinCEN Report 114: Report of Foreign Bank and Financial Accounts must be filed if you have a financial interest in or signature authority over an account associated with a foreign trust.
- Form 709: A U.S. person who transfers money or property to a foreign trust may be required to file Form 709 United States Gift (Generation Skipping Transfer) Tax Return.
- Form 1040NR: A foreign trust, which is not taxed to a U.S. owner as a grantor trust, may be obligated to file a Form 1040NR to pay U.S. tax on certain U.S. sourced income.
Income Tax Consequences
The tax consequences arising from dealings with a foreign trust depending on whether you are considered an owner of the foreign trust, a beneficiary of the foreign trust, or a transferor to a foreign trust, as outlined below.
U.S. owner of a foreign trust – In general, the U.S. owner of a foreign trust is taxed on the income of that trust.
A U.S. person is treated as the owner of a foreign trust under the grantor trust rules of Internal Revenue Code sections 671-679, which includes someone who transfers assets to a foreign trust which has a U.S. beneficiary of any portion of the trust. Each U.S. owner should receive a Foreign Grantor Trust Owner Statement (Form 3520-A, page 3), which includes information about the foreign trust income they must report.
U.S. beneficiary of a foreign trust – In general, the U.S. beneficiary of a foreign trust will report their share of foreign trust income to the extent it is not reported by the transferors to the trust under the grantor trust rules. The U.S. beneficiary should receive a Foreign Grantor Trust Beneficiary Statement (Form 3520-A, or a Foreign Non Grantor Trust Beneficiary Statement which includes information about the taxability of distributions they have received and foreign trust income they must report.
U.S. transferor of assets to a non grantor foreign trust – Internal Revenue Code section 684 requires the recognition of gain on certain transfers of appreciated assets to a foreign trust.
Compliance Issues and Beneficial Owner of A foreign Trust
Citizens and residents of the United States are taxed on their worldwide income. Congress has enacted several specific provisions in the Internal Revenue Code that deal with foreign trusts. Some provisions trigger recognition of gains that would otherwise be deferred. Others deny deferral of tax on income moved offshore. Generally the IRS Special Enforcement Program unit of auditors is tasked with auditing foreign compliance by U.S. persons.
The IRS compliance responsibilities discussed in this post also apply to the “beneficial owners” of foreign trusts. The term beneficial ownership applies to the true owner of an entity, asset, or transaction as opposed to any stated ownership provided in documents or oral representations. In a sense this means substance will trump form in certain circumstances. The beneficial owner is the one that receives or has the right to receive proceeds or other advantages as a result of the ownership. It is common practice in offshore financial jurisdictions to interpose entities, individuals, or both as stated owners.
IRS FORM 3520-A Compliance Guidance
Taxpayers frequently ask their tax attorney for guidance pertaining to foreign trust report compliance on form 3520-A. A tax attorney can help you with the reporting and compliance issues involved with foreign trusts. In addition, to avoid penalties associated with noncompliance of filings and FBARs, the Voluntary Disclosure Program, and the Streamlined Filing Compliance Procedures may be an option for you. Contact a Los Angeles tax attorney at Disparte Tax Law for a free consultation today.