Question: Melinda asks, “Do I need to file any forms with the IRS for an offshore trust, and if so, what are the requirements?”
Great question Melinda. Some people mistakenly think that if you have an offshore trust then you don’t need to file anything on it with the IRS. That is incorrect and can get you into a lot of trouble.
So let’s talk about what is needed to satisfy the IRS with an offshore trust.
The most important filing requirement for an offshore trust with a U.S. owner is Form 3520-A.
An offshore trust treated as a grantor trust for U.S. tax purposes must file IRS Form 3520-A each year. Gains, losses and ownership are reported to the IRS on this form.
It doesn’t matter whether there were transactions or gains in the trust, Form 3520-A must be filed each and every year.
Failure to Compy with Tax Filing Requirements Can Result in Costly Penalties
Failure to file Form 3520-A, or filing an incomplete or inaccurate Form 3520-A can result in a penalty of the greater of $10,000 per year or 5% of the gross value of the trust assets owned by U.S. persons. That means that the minimum penalty for failing to file this form is $10,000 per year.
The penalty for failing to file Form 3520-A for an offshore trust where the settlor is alive, is a U.S. person, and the trust is 100% owned by a U.S. person, is 5% of 100% of the trust assets. In the situation where the settlor has passed away and one or more of the beneficiaries are not U.S. persons, the penalty will apply only to the portion of the assets owned by U.S. persons.
Note that an offshore trust with U.S. owners must also file Form 3520 to report changes in ownership and certain transactions involving the trust. Failure to file this subform will result in an additional penalty of the greater of $10,000 per year or 5% of the gross value of the trust assets owned by U.S. persons.
So, failure to report an offshore trust in a year where both Form 3520-A and Form 3520 are required can result in a total penalty of $20,000 or 10% of the gross assets.
Miss these forms or file them incorrectly for a few years and the penalties add up quickly!
Foreign Bank Account Report (FBAR)
So while we are on the subject of IRS requirements for offshore accounts, let’s cover a few more situations that may pertain to you.
Let’s say you have an offshore bank and/or brokerage account. The IRS has reporting forms for that as well.
The most basic offshore form is the Report of Foreign Bank and Financial Accounts, Form FinCEN 114, generally referred to as the FBAR. Anyone who is a signor or beneficial owner of a foreign bank or brokerage account with a value of more than $10,000 must disclose their account(s) to the U.S. Treasury.
The $10,000 amount is the value of all offshore bank and brokerage accounts combined. If you have 4 offshore accounts, each with $4,000, your total offshore balance is $16,000 and an FBAR report is due each year.
The penalty for failing to disclose an offshore bank account is $10,000 for each non-willful violation. If the violation is intentional, the penalty is the greater of $100,000 or 50% of the amount in the account for each violation.
A separate penalty will be imposed for each year you failed to report the international bank and/or brokerage account associated with your offshore trust.
In addition to filing the Foreign Bank Account Report, your offshore account must be disclosed on Form 1040, Schedule B of your personal tax return.
Other Tax Forms for Offshore Trusts
Of course, we’re talking about the IRS, so more forms are sometimes in order. Here are some that may apply in your situation.
Form 5471 – Information Return of U.S. Persons with Respect to Certain Foreign Corporations. If your trust owns a foreign corporation, Form 5471 will be required.
A foreign corporation or limited liability company owned by an offshore trust should review the default classifications in Form 8832, Entity Classification Election and decide whether to make an election to be treated as a corporation, partnership, or disregarded entity.
Form 8858 – Information Return of U.S. Persons with Respect to Foreign Disregarded Entities. If your foreign trust owns an offshore Limited Liability Company, you might need to file Form 8858. If not this form, then Form 5471. Which form is required is determined using the instructions to Form 8832.
Form 5472 – Information Return of a 25% Foreign-Owned U.S. Corporation. If your offshore trust invests in a U.S. business, or in an offshore corporation that does business in the United States, you may need to file Form 5472 to report U.S. source income.
Form 926 – Return by a U.S. Transferor of Property to a Foreign Corporation. Form 3520 is generally used to report transfers to an offshore trust. Form 926 can be required if you transfer property into a foreign corporation owned by your trust.
Form 8938 – Statement of Foreign Financial Assets was introduced in 2011 and must be filed by anyone with significant assets outside of the United States. Whether this Form 8938 is required will depend on many factors, such as the value of your foreign assets and whether you’re living in the United States or abroad.
I won’t go into the details here. Suffice it to say that most offshore trusts are large enough that Form 8938 is required.
Why You Should Hire a U.S. Expert to Form Your Structure
Because of the complex web of tax forms and rules that apply to offshore trusts, the severe penalties for getting it wrong, and the potential to use an offshore trust as a tax planning tool (when combined with an insurance wrapper) or as a way to minimize estate tax, I strongly suggest you hire a U.S. expert to form your structure for the following reasons:
- A U.S. tax and asset protection lawyer is qualified to design and implement an offshore trust for an American citizen or resident.
- A Professional with years of experience in the field should be hired to quarterback your asset protection team.
- A U.S. lawyer can build an asset protection trust to protect you from U.S. creditors. If your risks are in the United States, so must be your legal counsel.
- A U.S. tax expert is qualified to keep your offshore trust in compliance.
- An attorney experienced in both offshore planning and U.S. taxation can assist you with pre-immigration planning using offshore trusts.
Sure, it’s Cheaper to Hire an Offshore Trust Agent
Take a read through the penalties for failure to file or report again, and then consider whether the savings are worth the risk.
Here’s the bottom line: If you can’t afford to do it right, don’t do it at all. If the amount of assets you want to transfer offshore don’t warrant hiring a U.S. lawyer, then don’t go with a trust. Plant your first flags offshore in a less costly and less complex structure.
I hope you’ve found this article on the U.S. tax status and IRS filing obligations of offshore trusts to be helpful. For more information on building an international asset protection structure, please contact me at www.NagelLaw.com.
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