There is so much to know about Foreign Trusts, Estate and Gift Taxation that we can barely scratch the surface on a web page.
The rules governing the legal structure of trusts and their associated obligations are complex, and some of these rules aren’t fully defined in the tax law. Many clients and even their trusted legal advisors, are simply unaware of the severity of noncompliance and the effects that foreign entities may have on reporting foreign trust activities.
Failing to understand the rules results in significant penalties. IWTA is here to help you navigate the rules and regulations to not only avoid the penalties, but reap the fullest rewards possible from playing by the rules.
Foreign Trust Reporting Requirements
The reporting requirements of foreign trusts created by U.S. persons and those with U.S. beneficiaries are complicated, but important to understand. Internal Revenue Code (IRC) Section 6048(a) and Treasury Regulation 404.6048-1 state that written notice must be provided, by filing Form 3520-A, within 90 days if a US person:
- Creates a foreign trust;
- Transfers money or property to a foreign trust, including a transfer by reason of death;
- Owns a portion of a foreign trust at death. If the decedent was treated as the owner under the grantor trust rules of IRC Sections 672 through 679 or;
- Has any part of a foreign trust included in their gross estate.
Furthermore, if U.S. persons have financial interests in or signature authority over a foreign financial account—including a bank account, brokerage account, mutual fund, foreign grantor trust (and some foreign non-grantors as a beneficial owner), or other type of foreign financial account—the Bank IRS by filing FinCEN Form 114, formerly known as FBAR.
What is FBAR?
Pursuant to IRC Section 6048(b) and Reg. 404.6048-1(c)(1), any U.S. person who owns any part of a foreign trust during any taxable year must file an annual return (Form 3520-A) by March 15. IRC Section 6048(c) and Section III of Notice 97-34 require U.S. persons who receive distributions (directly or indirectly) to report these transactions on IRS Form 3520 by the due date of the individual’s income tax return (including extensions).
Classifying Your Foreign Trust or Holding Company for Proper IRS Reporting
To avoid penalties and sanctions, it’s important to understand just what kind of trust you’re dealing with— particularly, whether the U.S. Tax Code does in fact classify a taxpayer’s trust as a foreign trust. To do that, IWTA helps clients assess whether their entity meets both the “court test” and the “control test” in the U.S. Tax Code and U.S. Treasury Regulations (Section 301.7701-7).
What is a Foreign Trust? Part I: Foreign Grantor Trusts
A foreign grantor trust is defined by the U.S. Tax Code as a trust in which the grantor retains certain control and/or economic benefits over the assets of the trust and is thereby treated as the owner of the assets. In this case, the trustee of a foreign grantor trust is supposed to file IRS Form 3520-A.
In the case of a nonresident alien (NRA) being the economic grantor, the grantor trust rules substantially limit the ability of the trust to be treated as a grantor trust. It must be a foreign revocable trust; or the NRA and/or their spouse are the only persons who are able and do receive distributions during the grantor’s lifetime.
If a U.S citizen receives a distribution from a foreign revocable grantor trust, they must file IRS Form 3520 PDF by the due date of the individual’s Form 1040. If a U.S. beneficiary receives a Foreign Grantor Trust Beneficiary Statement (FGTBS) additional filing is required.
What is a Foreign Trust? Part II: Foreign Non-Grantor Trusts
A foreign non- grantor trust (FNGT) is a foreign irrevocable trust in which persons other than, or in addition to, the settlor and/or their spouse receive distributions.
Non-grantor trusts are not generally subject to U.S. tax, unless the trust earns U.S. income. In this case, the trustee is obligated to provide a Foreign Non-Grantor Trust Beneficiary Statement to the U.S. recipient of any distribution, which should include a breakdown of the current income received, which is known as distributable net income (DNI) and distributions of accumulated income and principal (if any).
The U.S. 2017 Tax Act dictates the scope of certain deductions for non-grantor trusts. As these new regulations take shape, IWTA’s tax advisors continue to help clients navigate the tax laws and understand how best to position themselves to avoid unnecessarily steep penalties.
We hope this information has given you a rudimentary overview of U.S. tax compliance when reporting Foreign Trust ownership or distribution. For an in-depth analysis and wealth retention strategy of your foreign trust, read our blog regularly, or book an appointment with IWTA’s Founder, Jack Brister.
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