The 1996 Small Business Job Protection Act (“1996 Act”) established new reporting requirements for Foreign Gifts and Foreign Grantor Trusts. The 2010 HIRE Act included the Foreign Account Tax Compliance Act which imposed new foreign grantor trust reporting obligations on U.S. owners (i.e., U.S. Settlor) of Foreign Grantor Trusts.
The 1996 Act, under IRC §6048(b)(1) made U.S. owners of foreign grantor trusts responsible to ensure that the foreign grantor trust (Trustee) file the annual trust tax return (From 3520-A).
Under the 2010 HIRE Act, the U.S. government imposed a new reporting obligation on the U.S. owners (of foreign grantor trusts) so the IRS could obtain information about the foreign grantor trust, if the trustee was not cooperative and refused to file the annual Form 3520-A tax return for the Trust. Since the U.S. grantor has neither the legal authority nor the ability to force foreign trustees to file the Form 3520-A, the 2010 HIRE Act makes the grantor responsible to submit information to the IRS with respect to the Trust.
(1) “1996 Act” – Prior Law
Prior to the Small Business Job Protection Act of 1996 (the “Act”), there was no requirement that a recipient of a gift made by a person other than a U.S. person, report the gift.
Under the “Act”, if the value of the aggregate “foreign gifts” received by a U.S. person during any tax year exceeds $10,000, the U.S. person must report each foreign gift to the IRS. A “foreign gift” is any amount received from a non-U.S. person which the recipient treats as a gift or bequest.
The term “foreign gift” does not include qualified tuition or medical payments made on behalf of a U.S. person or any distribution properly disclosed on a return.
If a U.S. person fails, without reasonable cause to report the foreign gift within designated time, the IRS is authorized to determine the treatment of the unreported gifts. The IRS’s authority to make a determination of reasonableness will be subject to judicial review under an arbitrary or capricious standard, which provides a high degree of deference to its determination. In addition, the U.S. person is subject to a penalty of 5% of the amount of the gift for each month that the failure continues, limited to a total penalty of 25% of the amount.
Amounts received after date of enactment of the 1996 Act in tax years ending after date of enactment of the 1996 Act. Small Business Job Protection Act of 1996, Sec. 1905. IRC §6939F.
Information Reporting Requirement and Penalties – Prior Law
Prior to the Act, any U.S. person who created a foreign trust or transferred money or property to a foreign trust was required to report that event to the IRS without regard to whether the trust was a grantor or a nongrantor trust. Such persons were required to report, among other things, the name, address and identification number of the transferor, the trust, the fiduciary and trust beneficiaries; the interest of each beneficiary; the location of the trust records; and the value of each item transferred. Similarly, any U.S. person who transferred property-to a foreign trust that had one or more U.S. beneficiaries was required to report annually to the Service. In addition, if the transfer of any appreciated property by a U.S. person was subject to the excise tax of Section 1491, the transferor was required to report the transfer to the Service.
Any person who failed to file a required report with respect to the creation of, or a transfer to, a foreign trust could be subjected to a penalty of 5% of the amount transferred to the foreign trust. Similarly, any person who failed to file a required annual report with respect to a foreign trust with U.S. beneficiaries could be subjected to a penalty of 5% of the value of the corpus of the trust at the close of the tax year. The maximum amount of the penalty imposed under either case could not exceed $1,000. A reasonable cause exception was available. These civil penalties were determined separately from any applicable criminal penalties.
The information reporting requirements relating to foreign trusts, and the associated penalties, are expanded.
On or before the 90th day after any “reportable event,” the “responsible party” must provide written notice of the event to the Service. The notice must include the following information: (1) the amount of money or other property transferred to the trust in connection with the reportable event, and (2) the identity of the trust and each trustee and beneficiary of the trust.
A “reportable event” means the creation of any foreign trust by a U.S. person, the direct or indirect transfer of money or property to a foreign trust, and the death of a U.S. resident or citizen who was treated as the owner of any portion of a foreign trust under the grantor trust rules or whose gross estate includes any portion of a foreign trust. A reportable event does not include property transfers to a foreign trust in exchange for consideration of at least the property’s fair market value (FMV). Consideration other than cash is taken into account at its FMV. Also excluded from reportable events are transfers to pension trusts and charitable trusts.
A “responsible party” includes a grantor of an inter vivos trust, a transferor of a foreign trust, and the executor of a decedent’s estates.
A U.S. person that is treated as the owner of any portion of a foreign trust, the Service is entitled to determine the amount to be taken into account by a U.S. person under the grantor trust rules of Section 671 through Section 679, unless a U.S. person is authorized by the foreign trust to accept service of process. The U.S. person must be authorized to act as the trust’s limited agent with respect to any request by the Service to examine records or testimony in connection with the tax treatment of any items related to the trust. The appearance of persons or production of records by a U.S. person acting as the limited agent will not subject that person or records to legal process for any purpose other than determining the correct tax treatment of the amounts required to be taken into account. A foreign trust which appoint such an agent will not be considered to have an office or a permanent establishment in the U.S. or to be engaged in a U.S. trade or business solely because of the agent’s activities.
Any U.S. person who receives any distribution from a foreign trust is required to file a notice to report the name for the trust, the aggregate amount of the distributions received during the tax year and other information that the Service prescribes. If adequate records are not provided to the Service, the distribution includible in the distributee’s gross income will be treated as an accumulation distribution subject to the throwback rules applicable to U.S. beneficiaries of foreign trusts, unless the foreign trust elects, under the Regulations, to have a U.S. agent for the limited purpose of accepting service of process. In applying the accumulation distribution rules, the applicable number of years is ½ the number of years the trust has been in existence.
In determining whether a U.S. person receives a distribution from, or makes a transfer to, a foreign trust, the fact that a portion of the trust is treated as owned by another person under the grantor trust rules is disregarded, to the extent provided in the Regulations, a trust which is a U.S. person is treated as a foreign trust for purposes of the information reporting requirements if the trust has substantial activities, or hold substantial property, outside the U.S. In applying this rule, the service is expected to take into account information provided by a trust under the domestic trust reporting rules.
Any notice or return required must be made at the time and in the manner as the Service prescribes. The Service can suspend any of the above information reporting requirements if it determines the U.S. has no significant tax interest in obtaining the required information.
A person who fails to comply with the above notification requirements in cases involving the transfer of property to a new or existing foreign trust, or a distribution by a foreign trust to a U.S. person, is subject to an initial penalty equal to 35% of the gross reportable amount. A failure to provide an annual reporting of trust activities results in an initial penalty equal to 5% of the gross reportable amount.
The gross reportable amount is the gross value of the property transferred as of the date of the event. In cases where annual reporting of trust activities is required, the gross reportable amount is the gross value of the portion of the foreign trust’s assets treated as owned by the U.S. grantor at the close of the year. In cases involving a distribution to a U.S. beneficiary of a foreign trust, the gross reportable amount is the amount of the distribution to the beneficiary.
An additional $10,000 penalty is imposed for the continued failure for each 30-day period beginning 90 days after the Service notifies the responsible party of the failure. However, the total amount of penalties is limited to the gross reportable amount.
The above penalties are subject to a reasonable cause exception. However, the fact that a foreign jurisdiction would impose a civil or criminal penalty on the taxpayer or any other person for disclosing the required information is not treated as a reasonable cause.
The deficiency procedures that apply to income, estate, gift and certain excise taxes will not apply with respect to the assessment or collection of the increased penalty provisions.
The reporting requirements and applicable penalties generally apply to reportable events occurring or distributions received after the date of enactment of the 1996 Act. The annual reporting requirement and penalties applicable to U.S. grantors apply to tax years of U.S. persons beginning after December 31, 1995. Small Business Job Protection Act of 1996, Sec. 1901. IRC §§6048, 6677.
(2) “2010 HIRE Act”
HIRE Foreign Account Tax Compliance: Reporting Requirements for U.S. Persons Treated as Owners of a Foreign Trust
A U.S. Person who is treated as the owner of any portion of a foreign trust under the grantor trust rules, must submit any information required by the IRS with respect to the foreign trust (in addition to the current requirement that such U.S. Persons are responsible for insuring that a foreign trust complies with his own reporting obligations) (see IRC §6048(b)(1), as amended by the 2010 HIRE Act). This requirement to supply information about the trust applies to tax years beginning after March 18, 2010 (Act §534(b) of the 2010 HIRE Act).
The current reporting obligations for U.S. owners of foreign trust include filing a tax return for the year and providing certain information to each U.S. Person who is either treated as the owner of any portion of the trust, or who receives a direct or indirect distribution from the trust (IRC §6048(b)(1)(A) and (B)).
HIRE Foreign Account Tax Compliance: Penalty for Failure to Report Information or File Return Concerning Certain Foreign Trusts
The minimum amount of penalty for failure to report information or file returns for foreign trusts is increased to $10,000.
The maximum amount of the penalty has changed. The penalty for failure to report information or file a return with respect to certain foreign trusts cannot exceed the gross reportable amount (IRC §6677(a)).
To the extent that the aggregate amount of penalties exceeds the gross reportable amount, the IRS must refund the excess to the Taxpayer (IRC §6677(a), as amended by the 2010 HIRE Act).
If any notice or return required to be filed under IRC §6048 is not filed on or before the due date, or does not include all the information that is required, or includes incorrect information, then the person required to file such notice or return must pay a penalty equal to the greater of:
1. $10,000, or
2. Form 3520 Filings: 35% of the gross reportable amount (or Form 3520-A filings: 5% for U.S. Persons treated as owners of the trust)(IRC §6677(a), as amended by the 2010 HIRE Act).
Previously, the penalty for failure to provide the required information or file a return with respect to certain foreign trusts, Form 3520 Filings: 35% of the gross reportable amount (Form 3520-A filings: 5% for U.S. Persons treated as owners of the trust).
With the new minimum amount, the IRS will be able to impose a $10,000 penalty even when there is not enough information to determine the gross reportable amount.
If the failure to report persists for more than 90 days after the IRS has mailed notice of such failure to the person required to pay such penalty, an additional penalty is imposed that is equal to $10,000 for each 30 day period during which such failure continues after the 90-day period expires.
The penalty imposed cannot exceed the gross reportable amount (IRC §6677(a)). No penalty will be imposed if the failure to report is due to reasonable cause and not willful neglect (IRC §6677(d)).
If a Foreign Trust has a U.S. grantor, and one or more U.S. beneficiaries, under IRC §679 the Trust is classified as a foreign grantor trust and all Trust income, deductions and credits must be reported on the U.S. Grantor’s personal tax returns (Federal tax return/Form 1040).
The 2010 Hiring Incentives to Restore Employment Act (“2010 HIRE Act”) included the Foreign Account Tax Compliance Act which imposed new foreign grantor trust reporting obligations on Responsible Parties (i.e., U.S. Owners/ U.S. Settlor) of foreign grantor Trust (effective 3/18/10).
Since a U.S. grantor has neither the legal authority or the ability to force Foreign Trustees to file the Form 3520-A, the 2010 HIRE Act makes the grantor responsible to submit information to the IRS with respect to the Trust.
When a U.S. taxpayer forms a Foreign Grantor Trust, the following mandatory U.S. tax filings are required:
(1) Form SS-4 is to be filed immediately upon formation (this form is used to obtain the federal tax identification number for the Trust);
(2) Form 56 for reporting creation of fiduciary relationship (this form is filed upon the creation of the Trust, or is due with the first tax return filed for the Trust);
(3) Form 709
A transfer of Assets to a Foreign Trust may create a gift tax liability, dependent on whether or not there is a completed gift.
If the transfer is to an irrevocable, non-amendable trust there is a completed gift. In 2010, $1M in gifts are exempt from tax (Husband and Wife: $2M). The top gift tax rate of 35%, will be applicable to transfers over $500,000.
Although the estate tax is repealed in 2010, the gift tax remains in effect.
In 2010, there is an annual exclusion of $13,000 per donee for gifts ($26,000 for husband and wife, gift-splitting). There is an unlimited exclusion for payments of tuition and medical expenses.
Gifts to a non-citizen spouse are eligible for a gift tax annual exclusion of up to $134,000 (in 2010).
(4) Form 3520
This form is used to report transactions with foreign Trusts (and to report receipts of foreign gifts).
Form 3520 is sent to the IRS, P.O. Box 409101, Ogden, Utah 84409.
The U.S. Grantor of a Foreign Trust (as a responsible party) must notify the IRS of a reportable event: i.e., the creation of a foreign trust by a U.S. person, the transfer of money to a foreign trust by a U.S. person (including a transfer by reason of death), the death of a U.S. citizen or resident (if the decedent was treated as the owner of any portion of a foreign trust under the grantor trust rules or if any portion of the trust estate was included in the gross estate of the decedent).
The notice of “reportable event” is due on or before the 90th day after the reportable event and is satisfied by the Responsible Party filing Form 3520 (Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts).
Responsible parties include: the grantor of an inter vivos trust, the transferor in a reportable event (other than by death), and the executor of a decedent’s estate.
U.S. beneficiaries of foreign trusts are subject to IRS reporting requirements, if they receive a distribution from the trust. IRS reporting includes: the name of the trust, the aggregate amount of the distributions received from the trust during the trust year (satisfied by filing Form 3520 with the IRS).
If a complete Form 3520 is not filed by the due date (including extensions), the time for assessment of any tax imposed, with respect to any event or period to which the information required to be reported, will not expire before the date that is three (3) years after the date on which the required information is reported.
Penalties (Form 3520 Filing)
If Form 3520 is not timely filed, or the information is incomplete or incorrect, the penalties imposed:
A penalty generally applies if Form 3520 is not timely filed or if the information is incomplete or incorrect. Generally, the penalty is:
• 35% of the gross value of any property transferred to a foreign trust for failure by a U.S. transferor to report the transfer,
• 35% of the gross value of the distributions received from a foreign trust for failure by a U.S. person to report receipt of the distribution, or
• 5% of the amount of foreign gifts for each month the report is not filed (not to exceed 25%)
(5) Form 3520-A
Form 3520-A is the annual information return of a foreign trust with at least on U.S. owner, which includes:
1. Annual tax Information about the Foreign Trust
2. Annual Tax Information about its U.S. Beneficiaries
3. Annual Tax Information about any U.S. person who is treated as an owner of any portion of the foreign trust
Form 3520-A is filed with the Internal Revenue Service Center P.O Box 409101, Ogden, Utah 84405 and is due by the 15th day of the 3rd month after the end of the trust’s tax year.
Any U.S. person that is treated as the owner of any portion of a foreign trust (under the grantor trust rules) is responsible to ensure that the trust satisfies IRS reporting requirements, annually, which include: a complete accounting of trust activities and operations for the year, the name of the U.S. agent for the trust, and provides information to each U.S. person who is treated as the owner of any portion of the trust or who receives a direct or indirect distribution from the trust. IRS reporting is satisfied by the filing of Form 3520-A and providing copies of the Foreign Grantor Trust Owner Statement and the Foreign Grantor Trust Beneficiary Statement to the U.S. owners and beneficiaries.
Copies of the Foreign Grantor Trust Owner Statement and Foreign Grantor Trust Beneficiary Statement must be sent to the U.S. owners and U.S. beneficiaries by the 15th day of the 3rd month after the end of the Trust’s tax year.
The U.S. owner is subject to a penalty equal to 5% of the gross value of the Trust’s assets treated as owned by the U.S. person at the close of that year if the foreign trust:
1. Fails to timely file Form 3520-A
2. Does not furnish all of the information required by IRC §6048(b) or includes incorrect information (IRC §6677(b))
The U.S. owner of a foreign trust is subject to a penalty of 5% of the gross value of the portion of the foreign trust’s assets treated as owned by that person at the close of that year if the foreign trust fails to timely file Form 3520-A or does not furnish certain required information. Additional penalties may be imposed if the failure to file or furnish information continues after the IRS mails a notice to the U.S. owner.
No penalties will be imposed if the U.S. owner can demonstrate that the failure to comply was due to reasonable cause and not willful neglect. The fact that a foreign country would impose penalties for disclosing the required information is not reasonable cause. Similarly, reluctance on the part of the foreign fiduciary or provisions in the trust instrument that prevent the disclosure of required information is to reasonable cause either.
Additional penalties may be imposed if noncompliance continues after the IRS mails a notice of failure to comply with required reporting.
Criminal penalties may be imposed under IRC §7203, 7206 and 7207 for failure to file on time and for filing a false or fraudulent return.
5. Appointment of U.S. Agent
Foreign Trust (U.S. Agent)
Under IRC §6048(b), any person who is treated as a grantor of all or any portion of a foreign trust must appoint a U.S. Agent for the Trust.
Failure to execute an authorization of Agent, binding upon the trust and the agent allows the IRS to make its own determination as to the amounts to be included by U.S. transferors under the grantor trust rules (IRC §6048(b)(2), Notice 97-34, Section IV (B)). The designation of a U.S. agent will not otherwise subject the agent to legal process and will not alone cause the foreign trust to have an office in the United States (IRC §6048(b)(2)).
If the Foreign Trust does not appoint a limited U.S. agent, for purposes of examination of books and witnesses, service of summons and enforcement of summons (IRC 7602 – 7604), the IRS may include in the grantor’s income anything it wants to include (IRC §6048(b)(2)(C)). The IRS can make whatever determination it wishes based on its own knowledge or information obtained through testimony or otherwise (IRC §6038A(e)(4) rules regarding judicial proceedings to quash a summons will apply).
6. Foreign Gifts
U.S. Persons that receive gifts from foreign individuals or entities must report such transfers on Form 3520 (Part IV Lines 62-64).
Generally, a U.S. Person must report on a Form 3520 (1) any gifts from a non-resident individual or foreign estate that collectively exceed $ 100,000, (2) any gifts from foreign corporations and foreign partnerships that collectively exceed $10,000 (adjusted for inflation). IRC §6039F.
In calculating the $100,000 threshold, the U.S. Person must aggregate gifts from different, foreign nonresident aliens and foreign estates if he or she knows (or has reason to know) that one of those person is acting as the nominee for the other person.
For tax years beginning in 2010, the reporting threshold amount for gifts from foreign corporations or partnerships is $14,165.
A gift to a U.S. donee does not include any amounts paid for qualified tuition or medical payments made on behalf of the U.S. donee.
The Form 3520 is due at the same time as the U.S. Person’s federal tax return, including extensions. But the Form is filed separately from that tax return (a copy should be attached to the Federal Tax Return).
If the U.S. Person, without reasonable cause, fails to disclose a foreign gift, the IRS has the right to determine the “proper” tax treatment of the gift, and the IRS’s determination (although reviewable) is subject to an arbitrary and capricious standard.
For each month that the failure continues, the U.S. Person is subject to a penalty of five percent of the gift for each month, up to a 25 percent maximum.
The IRS must issue a notice of deficiency and follow deficiency procedures in making any determination regarding the proper tax treatment of the gift, but it may summarily assess the five percent additional penalty.
7. Summary U.S. Tax Compliance Foreign Grantor Trusts (Foreign Gifts)
When a U.S. person receives a foreign gift, or establishes a foreign grantor trust, the following U.S. tax compliance is required:
1. Form 56 (upon trust formation)
2. Form SS-4 (for trust formation)
3. Form 3520 (on both trust formation within 90 days of the reportable event, or annually upon receipt of foreign gifts)
4. Form 3520-A (annually)
5. Form 709 (Gift Tax Returns) for transfer of Assets to fund a Foreign Trust
A copy of both Form 3520 and 3520-A is to be attached to the U.S. person’s tax return, with separate copies filed with the IRS in Ogden, Utah.