U.S. Tax Compliance – Foreign Grantor Trusts – Foreign Gifts
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Although the estate tax is repealed in 2010, the gift tax remains in effect.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))
Penalties:
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.
FATCA – Penalty for Failure to Report
The minimum amount of penalty for failure to report information or file returns for foreign trusts is increased to $10,000.
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. 35% of the gross reportable amount (5% for U.S. Persons treated as owners of the trust) (IRC §6677(a), as amended by the 2010 HIRE Act).
Prior to these revisions, the penalty for failure to provide the required information or file a return with respect to certain foreign trusts was 35% of the gross reportable amount (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.
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).
FATCA: Reporting Requirements for U.S. 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 of the foreign trust include making a return for the year and providing certain 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 (IRC §6048(b)(1)(A) and (B)).
FATCA: Uncompensated Use of Foreign Trust Property
The uncompensated use of foreign trust property by a U.S. Grantor, a U.S. Beneficiary, or a U.S. Person related to either of them is treated as a distribution by the trust for non-grantor trust income tax purposes (which also includes the loan of cash or marketable securities by a foreign trust or the use of any other property of the trust).
The distribution treatment of foreign trust transaction has been expanded to include the uncompensated use of property by certain U.S. Persons. The treatment of foreign trusts as having U.S. beneficiaries for grantor trust purposes has been expanded to include loans of cash or marketable securities or the use of any other trust property to or by a U.S. Person.
If a foreign trust permits the use of any trust property by a U.S. Grantor, a U.S. Beneficiary, or any U.S. Person related to either of them, the fair market value of the use of such property is treated as a distribution by the trust to the Grantor or Beneficiary (IRC §643(i)(1), as amended by the 2010 HIRE Act).
This treatment does not apply to the extent that the trust is paid the fair market value of such use within a reasonable time (IRC §643(i)(2)(E), as added the 2010 HIRE Act). If distribution treatment does apply to the use of trust property, the subsequent return of such property is disregarded for federal tax purposes (IRC §643(i)(3), as amended by the 2010 HIRE Act).
FATCA – Foreign Trusts Treated as Having U.S. Beneficiaries
For purposes of treating a foreign trust as a grantor trust, there is a rebuttable presumption that the trust has a U.S. beneficiary if a U.S. Person transfers property to the trust. An amount is treated as accumulated for a U.S. Person even if that person has a contingent interest in the trust.
A foreign trust is treated as having a U.S. beneficiary if any person has discretion to make trust distributions, (unless none of the recipients are U.S. Persons). An amount will be treated as accumulated for the benefit of a U.S. Person even if that person’s interest in the trust is contingent on a future event (IRC §679(c)(1) as amended by the 2010 HIRE Act).
If any person has the discretion (by authority given in the trust agreement, by a power of appointment or otherwise, of making a distribution from the trust to or for the benefit of any person), the trust will be treated as having a beneficiary who is a U.S. Person, unless the trust terms specifically identify the class of person to whom such distribution may be made and none of those persons are U.S. Persons during the tax year (IRC §679(c)(4) as added by the 2010 HIRE Act).
If any U.S. Person who directly or indirectly transfers property to the trust is directly or indirectly involved in any agreement or understanding that may result in trust income or corpus being paid or accumulated to or for the benefit of a U.S. Person, that agreement or understanding will be treated as a term of the trust (IRC §679(c)(5) as added by the 2010 HIRE Act). The agreement or understanding may be written, oral or otherwise.
The provision creating a rebuttable presumption allowing the IRS to treat a foreign trust as having a U.S. beneficiary if a U.S. person directly or indirectly transfers property to the trust applies to transfers of property after March 18, 2010. (Act Section 532(b) 2010 HIRE Act.)
H.I.R.E. and the Foreign Account Tax Compliance Act
On Thursday, March 18, 2010 President Obama signed the Hiring Incentives to Restore Employment Act (H.R. 2847). Included in the bills’ provisions is the Foreign Account Tax Compliance Act.
This Act requires foreign entities to provide U.S. Tax Withholding Agents with the name, address and Tax Identification Number of any U.S. Individual who is an account holder or a substantial owner of a foreign entity, i.e., owns more than 10% of:
1. the foreign corporation’s stock;
2. the profits or capital interest of a foreign partnership; or
3. holds more than 10% of the beneficial interest in a foreign trust (or is the trust grantor).
U.S. Tax Withholding Agents are required to report foreign account tax compliance to the U.S. Treasury Department. Publicly held corporations are exempt from the reporting requirement.
Foreign entities, who fail to report the required information will be required to withhold tax at the rate of 30% on payments made to U.S. Taxpayers.
FBAR Filings: Foreign Trusts
Each US Trustee of a trust account must file a FBAR (even if the beneficiary of the trust is not a US Person). If the owner of an account gave someone the power of attorney over the account, both the owner and the attorney-in-fact must file a FBAR (if both are US Taxpayers).
If a trust that holds a foreign financial account provides for a Protector, whose powers include directing distributions if the Protector is a US Person, the Protector must file a FBAR.
If several members of the same family have accounts, the FBAR rules apply to each account holder individually. The IRC §318 attribution rules do not apply to filing the FBAR.
Under the grantor trust rules (IRC §679) any US Person who establishes a foreign trust (which holds the foreign financial account), established by a US Person for any US beneficiary, the US Settlor is responsible for filing a FBAR for the trust accounts (even if the US Settlor of the trust is not a beneficiary, has no authority over the trust or any of the trust accounts). Under US tax rules, he is treated as the owner of the trust (for US income tax purposes) because the trust is deemed a grantor trust which makes him responsible to file the FBAR form.
Financial interest may be present even if there is no signatory authority. If a trust holds an account and the US Taxpayer has a present beneficiary interest in more than 50% of the trust assets, receives more than 50% of the trust assets, or receives more than 50% of the current trust income, he must file a FBAR.
If a trust has 2 or more beneficiaries and none of the beneficiaries has more than a 50% interest in the income of principal, then none of them needs to file a FBAR (although each US Trustee who is a US Taxpayer must file the FBAR). Regarding the rules for a discretionary trust, if a US Taxpayer receives distributions of more than 50% of trust income or principal in any given year, it requires filing the FBAR.
International Tax Compliance – Foreign Trust (U.S. Person): Reportable Event
U.S. Persons who receive a distribution from a foreign trust must report the distribution on Form 3520.
These penalties are payable on notice and demand. The IRS is not required to issue a notice of deficiency. A pre-payment appeal of the penalty is not automatically available.
