Is Your Foreign Trust Out of US Tax or Reporting Compliance?

Is Your Foreign Trust Out of US Tax or Reporting Compliance?

The international tax reporting obligations for foreign trusts are complicated. In general, the Internal Revenue Service does not like foreign trusts because it is not uncommon for a foreign trust to be used for improper purposes such as hiding income offshore or keeping foreign accounts secret — and outside of the reach of the IRS.  When a US person has an ownership or interest in a foreign trust, they have to be careful to remain in compliance. That is because the penalties for failing to properly report information involving a foreign trust can be substantial. The two main forms taxpayers have to file with respect to a foreign trust are Form 3520 and Form 3520-A. But, these are not the only two international information reporting forms that a taxpayer may have to file to report aspects of their foreign trust. They may also have to file other forms such as the FBAR, Form 8938 (FATCA) — and even Form 8621 (PFIC) if the foreign trust holds foreign trust funds such as mutual funds – or if the trust itself is deemed a PFIC. Let’s take a brief look at three of the key issues involving foreign trust reporting and tax compliance.

First, is it a Foreign Trust?

Whether or not the foreign entity is considered a foreign trust for US tax purposes is much more complicated than one would think. Presuming for the moment that there is no issue as to whether the entity itself meets the court and control tests – a key preliminary question is whether the entity is a trust in the first place. For example, in Liechtenstein and a few other countries the Stiftung is a common entity — and while it may not have been expressly formed as a trust, for US tax purposes it may be considered a foreign trust. Likewise, if a person has a foundation in Panama or a Sociedad Anonima in other countries, it may have other reporting requirements in the US beyond foreign trust reporting, even if the structure was developed solely for foreign trust purposes. Stated another way, just determining whether or not the foreign structure is a foreign trust may require a detailed analysis.

Foreign Trust Taxation

Depending on whether the foreign trust is a grantor trust or non-grantor trust will impact the tax implications from a US tax perspective. From a baseline perspective, a grantor’s trust is taxed to the owner. So if the owner is a US person then they will be taxed on the income. If the person is a non-US person, then it will depend on whether or not any portion of the foreign trust contains US-generating assets. Conversely, if the foreign trust is a non-grantor trust with US beneficiaries, then it is the US beneficiaries who are taxed on the income. US beneficiaries will want to receive a foreign non-grantor trust beneficiary statement in order to help them delineate UNI vs. DNI vs Corpus for US tax purposes.

Reporting the Foreign Trust

When it comes to reporting the foreign trust for US tax purposes, the two primary forms are Form 3520 and Form 3520-A. Even if a foreign trust only has one owner, they are generally required to file both forms — and the failure to do so may result in multiple foreign trust penalties even in a case where there is only 1 trust owner/beneficiary, as was the case in Wilson. In addition to filing these two forms, depending on whether the trust has foreign financial accounts and/or other foreign assets, it may require additional reporting such as the FBAR, Form 8938, and Form 8621.

Current Year vs Prior Year Non-Compliance

Once a taxpayer missed the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, taxpayers should consider speaking with a Board-Certified Tax Law Specialist that specializes exclusively in these types of offshore disclosure matters.

Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)

In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to streamlined procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead of the Streamlined Procedures. But, if a willful Taxpayer submits an intentionally false narrative under the streamlined procedures (and gets caught), they may become subject to significant fines and penalties. 

Golding & Golding: About Our International Tax Law Firm

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

Contact our firm today for assistance.