November 2018 JD Supra
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Foreign Trusts and the IRS was published by JD Supra on 11/21/18.

A Foreign Trust can be a legitimate instrument for US Taxpayers that may have family members in foreign jurisdictions, have foreign business interests or are the beneficiaries of trusts created in other countries. Trusts are vehicles that can assist in the preservation of wealth and property for future generations, protect assets, or carry out a charitable purpose.  There are tax consequences that apply to the US owners and US beneficiaries of a Foreign Trust, and to the Foreign Trust itself.  Compliance with respect to the timely and accurate filing of information returns reporting ownership of and transactions with Foreign Trusts (IRS FORMS 3520 and 3520-A) was identified by IRS as one of the thirty-five (35) Compliance Campaigns announced in May 2018.  

 According to the Internal Revenue Code:

  • a “trust” is an arrangement created either by a will or by an inter vivos declaration whereby trustees take title to property for the purpose of protecting or conserving it for its beneficiaries.
  • the grantor transfers property to a trustee to hold and protect for the benefit of the trust beneficiaries, pursuant to the terms of a written trust agreement.
  • a trust is a separate legal entity or arrangement typically used for family and estate planning purposes. Trusts allow assets to be held by an entity, other than a natural person, with an indeterminate life.
  • trusts are often used to hold property and facilitate a transfer of such property to beneficiaries without the need for probate proceedings.

Foreign Trusts

A US Person may create a Foreign Trust and or execute transactions in a Foreign Trust which result in filing responsibilities and have tax reporting and paying consequences. Tax consequences can apply to the US owners, US beneficiaries of a Foreign Trust, and to the Foreign Trust itself.  IRS defines a Foreign Trust as any trust other than a domestic trust. A trust is domestic if:

  • A court within the United States is able to exercise primary supervision over the administration of the trust, and
  • One or more U.S. persons have the authority to control all substantial decisions of the trust.

IRS reporting rules apply to a US 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 US owner of a Foreign Trust.

IRS Form 3520 (Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts)

The purpose of Form 3520 is for US Persons (and executors of US decedents) to report certain transactions with Foreign Trusts, ownership of Foreign Trusts and receipt of certain large gifts or bequests from certain foreign persons.

Who must File Form 3520?

the responsible party for reporting a reportable event that occurred during the current tax year, or transferred property (including cash) to a Foreign Trust in exchange for an obligation.

  • a US person who, during the current tax year, is treated as the owner of any part of the assets of a Foreign Trust.
  • a US person (including a US owner) who received (directly or indirectly) a distribution from a foreign grantor or non-grantor trust during the current tax year or a US person (or a US person related to the US person) that received a loan (including an extension of credit) from a Foreign Trust or received the uncompensated use of trust property that could be treated as a distribution to a US person.
  • a U.S. person who, during the current tax year, received either:   More than $100,000 from a nonresident alien individual or a foreign estate (including foreign persons related to that nonresident alien individual or foreign estate) that the US person treated as gifts or bequests; or More than $15,797 from foreign corporations or foreign partnerships (including foreign persons related to such foreign corporations or foreign partnerships) that the US person treated as gifts.

IRS Form 3520-A (Annual Information Return of Foreign Trust With a US Owner)

Form 3520-A is the annual information return of a Foreign Trust with at least one US owner. The form provides information about the Foreign Trust, its US beneficiaries, and any US. person who is treated as an owner of any portion of the Foreign Trust under the grantor trust rules.  

Who must File Form 3520-A?

  • A Foreign Trust with a US owner must file Form 3520-A in order for the US owner to satisfy its annual information reporting requirements.
  • Each US 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 US owners and US beneficiaries.

Don’t be a victim of your own making

US Citizens and US Permanent Residents are taxed on their worldwide income. Foreign Trusts are sometimes used for tax avoidance or tax deferral.  Moreover, Foreign Trusts are a “product of choice” used by “promoters” of offshore non-legal schemes to conceal ultimate beneficial ownership, hide income and conceal assets.  

Taxpayers that are out of compliance with the timely and accurate filing of information returns reporting ownership of and transactions with Foreign Trusts face “apparent” IRS audit risk.  Taxpayers ought to consult their specialized tax representative and become IRS audit prepared.