US Expat Taxes: IRS Tax and Reporting Obligations of Foreign Trusts
As with all of your worldwide income and assets, any involvement of a US Citizen or Green Card Holder with one or more foreign trust accounts must be reported to the IRS with your annual US income tax return. Whether you are a stateside American Citizen or a US Expat living and working overseas, the rules of reporting and paying taxes on income from your foreign trust are the same. Like many reporting obligations, divulging information to the Internal Revenue Service about your foreign trust(s) requires you to file additional forms. Furthermore, failure to comply with your foreign trust reporting obligations can prove to be a costly move – whether by mistake or design.
What is a (Foreign) Trust?
Trust is a legal entity created by a party (the trustor) through which a second party (the trustee) holds the right to manage the trustor's assets or property for the benefit of a third party (the beneficiary).
However - often what is considered a foreign trust is not simply a trust that is located overseas but an entity that would otherwise not be treated as a trust if it was not foreign.
A great deal of foreign pension funds are considered foreign trusts. Whereas U.S. pension accounts are also trusts by nature are not treated as trusts for tax reporting purposes.
Who is considered an owner of a foreign trust?
A U.S. person is treated as the owner of a foreign trust under the grantor trust rules if he transfers assets to a foreign trust with a U.S. beneficiary of any portion of the trust.
That beneficiary may be another U.S. person or the same U.S. person who contributed to the trust.
Foreign Trusts and the IRS
Foreign trusts with full or partial US Ownership are required to report trust account information annually to the IRS and US Account Holders. Around the time you receive your W-2s, 1099s, and other tax forms you should receive Form 3520-A. Form 3520-A is a report containing information about your foreign trust account provided to you by the institution in which it’s held. The information on Form 3520-A includes information that will be required when you file your US expat tax return (or US income tax return for stateside residents). The majority of foreign trusts are required to file Form 3520-A no later than March 15 of the year following the taxable year in which your foreign trust was held.
International agreements guarantee that the information you receive from your foreign trust is also received by the IRS. At some point in time the Internal Revenue Service receives electronic or written notification of your worldwide taxable income – including foreign trusts. As such, it’s imperative that you report your foreign trust account(s) accurately to avoid failure to file penalties and other forms of penalties and interest.
Information about Reporting Foreign Trust Accounts
To report a foreign trust account, you will minimally be required to file Form 3520. If you meet any of the Form 3520 filing requirements that result in your earning interest, dividends or other income from a foreign trust account, you will also be obligated to file Schedule B.
It is a mandatory requirement by the IRS for you to file Form 3520 if:
● You earned more than $1,500 in taxable interest or ordinary dividends from a foreign trust,
● You received a financial distribution from a foreign trust,
● You transferred financial assets to a foreign trust,
● You received property or other physical assets from a foreign trust,
● You transferred ownership of property or other physical assets to a foreign trust
● You were the grantor of a foreign trust,
● You were the transferor of a foreign trust,
● You had financial interest in a foreign trust,
● You held signature authority over a foreign trust,
● You had an outstanding obligation to a foreign trust, or
● You were owed a qualified obligation by a foreign trust.
In addition to the aforementioned requirements pertaining to a foreign trust, you will also be required to file Form 3520 if:
● You received a gift or bequest from a Non-US Resident or foreign estate valued at $100K or more, or
● You received a gift or bequest from a foreign corporation or partnership exceeding the taxable year’s allowance established by the IRS (currently $14,375).
If the value of your foreign trust account (either alone or when combined with other foreign accounts) exceeds $10K, you will also be obligated to satisfy FATCA (Foreign Accounts Tax Compliance Act) requirements by filing an FBAR (Foreign Bank Accounts Report), also referred to as Form TD F 90-22.1.
Form 3520 is designed to capture information about a single trust. As such, you must file a separate Form 3520 for each foreign trust account.
Penalties Associated with Foreign Trust Filing Requirements
If you fail to report Form 3520, you will be subject to as high of a fine as $10K fine for each foreign trust account you failed to report. In addition, each one of your foreign trusts may also be assessed with an equally punitive fee. If you have a justifiable reason for not having filed Form 3520, it is up to the discretion of the IRS representative reviewing your file to reduce or completely reverse assessed penalties. If you had interest accumulation on your foreign trust account tax liability you will most likely be required to pay, as interest is a non-discretionary assessment applied to your IRS tax debt automatically.
Failure to meet FBAR filing requirements will also result in excessive penalties. Not only are you subject to a fine of up to $10K per foreign account you failed to report, you also may be fined as much as 50% of the aggregate total of your foreign assets.
Do You Have Questions that Need Answered?
Do you have questions about foreign trusts, Form 3520, or any other situations or forms mentioned in this article? If you need clarification on your rights and responsibilities as a US Citizen or Green Card Holder with tax issues regarding foreign assets, get expert advice from the international tax professionals at Taxes for Expats.