Are Trusts Created in Territories & Possession Foreign?

Are Trusts Created in Territories & Possession Foreign? 

As if international tax law was not already unnecessarily complicated for U.S. Persons, with the uptick in Form 3520/3520-A penalties being assessed against US taxpayers across the globe — it is important for taxpayers to be aware as to what their reporting requirements are — especially when foreign trusts are involved. In general, US persons who have foreign assets are required to report these assets on one or more IRS international information reporting forms each year such as the FBAR, Form 8938, Form 3520, Form 5471, etc. But, it can get even more complicated when the taxpayer has a trust formed in a U.S. possession or territory. That is because while possessions and territories are impacted by US tax law they are also considered tax-independent, to a degree. And, just determining whether a territory or possession is a mirror or non-mirror jurisdiction and how the IRC will apply to income and assets in that area can be very complex. Focusing specifically on foreign trusts and Form 3520, the general proposition is that if a trust is formed in a territory or possession it is still considered a foreign trust for Form 3520 purposes. Let’s briefly look at the analysis:

26 U.S.C. 7701 (30) and (31)

To begin the analysis, let’s look at the definition of US person and the definition of foreign trust as set forth in Title 26 of the U.S.C.

• • • (30) United States person

      • The term “United States person” means—

        • (A) a citizen or resident of the United States,

        • (B) a domestic partnership,

        • (C) a domestic corporation,

        • (D) any estate (other than a foreign estate, within the meaning of paragraph (31)), and

        • (E) any trust if—

          • (i) a court within the United States is able to exercise primary supervision over the administration of the trust, and

          • (ii)one or more United States persons have the authority to control all substantial decisions of the trust.

What does this mean?

Paragraph 30 refers specifically to how a US person is defined. And, when dealing with trusts, in order for the trust to be considered a US person it must meet the court and control tests.

• • • (31) Foreign estate or trust

      • (A) Foreign estate

        • The term “foreign estate” means an estate the income of which, from sources without the United States which is not effectively connected with the conduct of a trade or business within the United States, is not includible in gross income under subtitle A.

      • (B) Foreign trust

        • The term “foreign trust” means any trust other than a trust described in subparagraph (E) of paragraph (30).

What does this mean?

Conversely, when determining what is considered a foreign trust it refers to any trash that is not meet the requirements of (30)(E).

Definition of United States: 26 USC § 7701(a)(9)

Paragraphs 30 and 31 identified above use the term United States. But the term United States for purposes of this code section? The definition of United States for purposes of this code section is found in subparagraph (a)(9):

• • • (9) United States

      • The term “United States” when used in a geographical sense includes only the States and the District of Columbia.

What does this mean?

Since the definition of the term United States is limited to the States and the District of Columbia, this presumes that it does not include territories and possessions. As a result, a trust formed in the territory or possession would be considered a foreign trust for US tax purposes and reporting purposes. Likewise, since taxpayers reside in territories and possessions are considered US persons for tax purposes (although the impact of the filing requirements sermon by whether or not the territory possession utilizes a mirror or non-mirror code) – they are required to report a trust formed in one of these territories are possessions as a foreign trust on Form 3520/3520-A.

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