Reporting Foreign Trusts to the IRS

The taxation and reporting requirements associated with foreign trust management are complex and require specific expertise from knowledgeable parties. There are many U.S. tax consequences to a foreign trust and a beneficiary of a foreign trust who is or becomes a U.S. citizen or resident alien. This is a highly complex area of U.S. taxation. Contact our experienced lawyers for specific taxation and reporting requirements.

U.S. persons who create a foreign trust, or have transactions with a foreign trust, can have both U.S. income tax consequences, as well as information reporting requirements. Failure to satisfy the information reporting requirements can result in significant penalties, as well as an extended time to assess any tax imposed with respect to the period to which the information relates.

How Are Foreign Trusts Taxed?

Know that moving your assets into a foreign Trust will not exempt you from certain taxes. The Internal Revenue Service will enforce the taxation of foreign Trusts as either a grantor or non-grantor Trust. This is a highly complex area, set up a consultation with our experts in Offshore Shore taxes.

A foreign trust is considered a grantor trust for U.S. income tax purposes when a U.S. grantor makes a gratuitous transfer to a foreign trust that has one or more U.S. beneficiaries or potential beneficiaries of any portion of the trust.

A grantor Trust describes a Trust for which the grantor retains some ownership over the assets. In this case, any income and capital gains made by property held in a foreign Trust are taxed as if the property had never been transferred into the foreign Trust in the first place.

Foreign non-grantor trusts generally are not subject to U.S. income tax unless the trust earns U.S. source or effectively connected income. Such income is taxed at graduated rates applicable to domestic trusts. Depending upon the investments that the trust holds as well as treaty considerations, the trusts may be subject to non-resident withholding. Foreign information disclosures may be required as well.

If you are the owner, or what is called the grantor, of a foreign trust, all income and expenses of the trust flow directly to your personal tax return. Further, if you are a beneficiary of a foreign trust, you will need to report your share of the income of the trust. In addition to this, there may be additional reporting requirements if you transfer assets to a foreign trust.

The two main forms that are filed for foreign trusts are Form 3520 and Form 3520-A. Forms 3520 and 3520-A are not required to be filed for Canadian registered retirement savings plans (RRSPs) and Canadian registered retirement income funds (RRIFs).

Generally, Form 3520 is required to be filed under the following conditions:

A U.S. person creates or transfers money to a foreign trust, or he or she makes a loan to a foreign trust
Receives distributions from a foreign trust, or receives the uncompensated use of property of that foreign trust, or if they receive a loan from a foreign trust;
If they are treated as a U.S. owner of a foreign trust under the grantor trust rules;
And if they receive certain large gifts from foreign persons.

Also, as part of the reporting requirements for foreign trusts, U.S. persons that are treated as owners of a foreign trust under the grantor trust rules must also take steps to ensure that there is a timely and accurate filing of Form 3520-A.

Other Reporting Requirements

Form 3520 is also used to report annual gifts or bequests in excess of $100,000 received by U.S. persons from foreign persons or gifts received from foreign entities in excess of $16,076 annually.

The ownership of foreign trusts and foreign financial accounts by U.S. persons may require other reporting requirements such as FINCEN 114, Report of Foreign Bank and Financial Accounts, Form 8938, Statement of Specified Foreign Assets, and Form 8621, Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund.

Create Your Trust Today

Establishing a foreign trust can be a great tool for those who desire added protection. Given the complex nature and the series of steps involved when it comes to the reporting of foreign trusts, seek professional help to ensure that these foreign trust returns are filed accurately, and on a timely basis. Please note that there may be additional forms for you to fill out depending on your specific situation (such as Schedule B, Form 8938, Form FinCEN 114, and so on), and that this article does not provide an exhaustive list of tax obligations related to foreign trusts. Therefore, if you are the grantor of a foreign trust, or you have received distributions from or have transferred assets to a foreign trust, please get in touch with us today to determine your filing requirements.