A person doesn't know how much he has to be thankful for until he has to pay taxes on it.” - Ann Landers
Americans with foreign trusts have to report them to the IRS. Foreign trusts are often set up by expats to protect an investment, gift, or bequest overseas. Furthermore, some foreign retirement accounts qualify as foreign trusts and have to be reported, and some direct gifts and bequests from non-US persons also have to be reported on the IRS foreign trust reporting form.
In this article, you’ll learn about:
• What is a foreign trust?
• When do expats have to report a foreign trust?
• How to file Forms 3520 and 3520-A
• Reporting receipt of a foreign gift
• What happens if you don’t file Form 3520 and Form 3520-A?
What is a foreign trust?
A US trust is a trust that US courts have primary jurisdiction over and which is controlled by US persons. (Note that ‘US persons’ refers to US entities such as companies as well as American individuals).
Any other trust is considered to be a foreign trust, so trusts registered outside the US are normally foreign trusts, as US courts don’t have jurisdiction over them, even if the trust is owned by an American. Similarly, a US-registered trust controlled by non-US persons has to be reported, too.
Some foreign retirement plans are considered to be foreign trusts by the IRS, such as many Australian and New Zealand Superannuation funds, if they are set up in the name of the saver but with a fiduciary controlling them for the saver’s benefit.
Understanding the US reporting requirements relating to foreign trusts is important, as expats can incur heavy fines if they don’t file the right forms both on time and correctly.
When do expats have to report a foreign trust?
There are several scenarios in which expats may have to report a foreign trust.
Firstly, income received from distributions from foreign trusts should be reported on Form 1040, along with income a trust makes if you’re the owner of the trust.
Secondly, some foreign trust accounts will need to be reported on an FBAR (Foreign Bank Account Report), while assets in foreign trusts may have to be reported on Form 8938 under FATCA reporting rules. In both cases, it will depend on whether the total value of your foreign account balances and assets exceeds the minimum reporting thresholds.
Thirdly, any US individual who is considered an owner of a foreign trust must file Form 3520-A annually to confirm their status with regard to the trust.
Lastly, any American who either receives a distribution from a foreign trust, or who transfers assets (e.g. property, stocks, or money) to a foreign trust, should file Form 3520.
Both Form 3520 and 3520-A are typically required to be filed on an annual basis. Form 3520 is required annually for US persons who, during the current tax year, are treated as the owner of any part of the assets of a foreign trust under the rules of Sections 671 through 678. US owners are required to complete Form 3520 Part II even if there have been no transactions involving the trust during the tax year.” - Shannon Meyer, Aspyr Group
How to file Forms 3520 and 3520-A
Many expats with foreign trusts have to file both Form 3520 and Form 3520-A annually.
Both forms are complex, and it’s highly advisable to ask an expat tax professional with experience filing these forms to help you out.
Form 3520-A is for reporting American trustees and beneficiaries, and to provide a financial statement for the trust’s assets and income. Form 3520 is for reporting distributions and other financial information.
Forms 3520 should be filed with your annual federal tax return, by June 15th for Americans residing abroad, or April 15th for those resident in the US, unless you request an extension until October 15th.
Form 3520-A has a different filing date: it is due on the 15th day of the third calendar month after the end of the trust’s tax year. So, for a trust that uses a calendar year, Form 3520 would be due by March 15th.
Reporting a foreign gift
Expats who receive a gift or bequest from a foreign individual or estate may also have to file Form 3520, depending on the size of the gift or bequest.
Recipients of gifts from a foreign individual or estate of amounts of less than $100,000 annually don’t have to report them. If gifts or bequests do exceed $100,000 on the other hand, the IRS requires that you report the total you received, and also separately identify each gift in excess of $5,000 on Form 3520.
The threshold for reporting gifts from foreign companies, partnerships or corporations is much lower: Americans must report any gift over the amount of $16,815 (in 2022). You must also report each gift separately, and identify who gave them to you.
What happens if you don’t file Form 3520 or Form 3520-A?
Filing the right forms on time is important to avoid fines.
Penalties for not filing Form 3520-A are the higher amount of either $10,000 or 5% of the trust’s assets owned by the American owner in question. An additional 5% penalty can be levied if you don’t also provide statements to the trust’s US owners each year, or for incorrect reporting.
Penalties for not filing Form 3520 are similar: failing to submit all information required or filing incorrectly can result in a penalty of $10,000 or 5% of the gross value of the trust’s property, assets, and distributions that weren’t reported.
The fines don’t stop there though, as failing to report creation of a trust or transfer to a foreign trust may result in a whopping 35% fee of the gross amount of the value of the amount transferred. Similarly, failing to report distributions from a foreign trust can result in another 35% fee of the gross amount of what was distributed.
These are worst case scenarios, and if there’s a genuine reason why you haven’t filed, leniency is at the IRS’ discretion.
As with all financial reporting, if you keep your account records and related paperwork and provide the relevant info to your tax professional, keeping up with your obligations needn’t be too strenuous.
Whether or not you establish a foreign trust will be part of your wider financial planning. Doing so doesn’t open you up to any new US taxation (you’re never taxed on ownership, only on income), but it does create new US reporting requirements, and not reporting can have significant consequences due to possible penalties.
If you have any questions, don't hesitate to contact us.
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