It is about this time every year when CPAs remind their clients that any foreign bank and financial accounts must be disclosed to the U.S. Department of Treasury by June 30th. My colleague Ray Polantz explains the foreign bank account reporting (FBAR) requirements in greater detail in his recent blog post. Trusts and estates considered U.S. persons are no exception and are required to file the FBAR if the trust has a financial interest in, or signature or other authority over, any foreign financial accounts with an aggregate value exceeding $10,000 at any time during the year. However, foreign trusts — those not considered U.S. persons — have other reporting responsibilities to consider in addition to filing the FBAR.
What is a foreign trust?
The IRS defines a foreign trust as one that is not treated as a U.S. person. Any trust failing either of the following two tests will not be considered a U.S. person and therefore will be classified as a foreign trust:
- Court Test. A U.S. court must exercise primary supervision over the administration of the trust.
- Control Test. One or more U.S. persons have the authority to control all substantial decisions of the trust.
Foreign Trust Reporting Requirements
Foreign trusts with a U.S. owner must file informational Form 3520 to:
- Report transfers to a foreign trust, including gifts;
- Report outstanding loans to a foreign trust;
- Report ownership of foreign grantor trusts;
- Report distributions from a foreign trust;
- Report receipts of greater than $100,000 from a nonresident alien individual or foreign estate that were treated as gifts or bequests; and to
- Report receipts of greater than $15,102 from foreign corporations or partnerships that were treated as gifts.
DEADLINE: Form 3520 is due with the trust’s income tax return, including extensions, i.e., generally April 15th or September 15th.
Foreign trusts with a U.S. owner must also file Form 3520-A to satisfy IRS annual information reporting requirements. Any U.S. person treated as an owner under the grantor trust rules (IRC Secs. 671-679) must file Form 3520-A to report the trust’s financial information as well as provide a foreign grantor trust beneficiary statement for each U.S. owner detailing the owner’s share of the trust’s income. The U.S. owner must attach Form 3520-A to Form 3520.
DEADLINE: File Form 3520-A and provide a copy of the foreign grantor trust beneficiary statement to each U.S. owner by the 15th day of the third month after the trust’s tax year closes (typically March 15th). A separate extension may be requested for Form 3520-A.
Nongrantor trust beneficiary statement (Schedule K-1 equivalent)
Distributions from foreign trusts may be treated as accumulation distributions and are thus subject to income tax unless the U.S. beneficiary can provide adequate records to the IRS to determine the appropriate treatment. While grantor trusts file Form 3520-A, including page four (Foreign Grantor Trust Beneficiary Statement), and provide to all U.S. owners, nongrantor trusts do not have a prescribed form. Instead, IRS Notice 97-34 details the information a trustee should include in a statement provided to all U.S. beneficiaries. The statement should include the following:
- Background information on the foreign trust;
- U.S. beneficiary information, including TIN and description of property distributed;
- Sufficient tax information similar to Schedule K-1 to allow the beneficiary to determine the correct treatment of any distributions; and
- Statement regarding the IRS and beneficiary’s right to inspect the trust’s books and records or the name, address, and EIN of the trust’s U.S. agent.
DEADLINE: There is no established filing deadline since there is no prescribed tax form. However, it is recommended that fiduciaries provide this statement by the same deadline as the foreign grantor trust beneficiary statement.
What are the penalties for not filing?
Failure to file or providing incomplete or incorrect information on Form 3520 or Form 3520-A can subject a U.S. person to penalties up to the greater of $10,000 or 5% of the value of the trust’s assets. Additionally, a penalty up to 35% of the value of property transferred to or received from the foreign trust can be assessed if such a reportable transaction is not reported on Form 3520. The IRS can waive these penalties for reasonable cause, but it also can assess additional penalties for continued noncompliance following an IRS notice.
There are no penalties for failure to provide a foreign nongrantor beneficiary statement, but failure to do so may subject the trust’s beneficiaries to the accumulation distribution default rules, which could lead to unnecessary income tax.
A Complex Scenario
This posting only scratches the surface of the many exceptions and substantial penalties related to foreign trust tax compliance. Consult with your accounting advisors early on to determine your particular requirements and options.
Contact a member of your service team for further discussion.
This communication is for information only, and any action should only be taken after a detailed review of the specific situation and appropriate consultation.