Content Provided by Damian Stanislaw Ponicki, Senior International Tax Associate
The globalized nature of modern finance has led to the U.S. government’s increased push for transparency and oversight when it comes to foreign financial interests held by U.S. taxpayers.
To ensure compliance with U.S. tax regulations and reporting requirements with respect to foreign trusts, the Internal Revenue Service (IRS) mandates the submission of specified tax disclosures: Forms 3520 and 3520-A. These forms serve as an essential IRS tool for tracking and obtaining information regarding foreign financial interests held by U.S. taxpayers, thereby supporting the IRS objective to promote transparency and prevent tax evasion.
What is a U.S. foreign-owned trust?
A U.S. foreign-owned trust, often referred to as a foreign grantor trust, is a type of trust established in the United States but owned by a non-U.S. individual, corporation, or entity. These trusts are typically used for various financial and estate planning purposes, including asset protection, estate tax reduction, and confidentiality.
Key characteristics of a U.S. foreign-owned trust include:
Establishment in the U.S.: The trust is created under the laws of the United States and is subject to U.S. jurisdiction.
Non-U.S. Owner: The owner, also known as the grantor or settlor, is a non-U.S. person or entity. This means that the person or organization establishing the trust is not a U.S. citizen or resident.
Tax Considerations: The trust may have certain tax implications, especially for the non-U.S. owner. Income generated by the trust may be subject to U.S. taxation, and there are specific tax rules that apply to foreign-owned trusts.
Asset Protection: Some foreign-owned trusts are established to protect assets from potential creditors, legal disputes, or other financial risks.
Estate Planning: Foreign-owned trusts can be used to pass on assets to beneficiaries while potentially reducing or avoiding U.S. estate taxes, depending on the specific circumstances and structure of the trust.
Confidentiality: These trusts can provide a degree of privacy and confidentiality, as they may not be subject to the same reporting and disclosure requirements as trusts with U.S. owners.
How do you report foreign financial interests?
Form 3520: Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts
Form 3520 is an IRS informational return that U.S. taxpayers must file to report various transactions with foreign trusts. It is also used to report the receipt of significant foreign gifts or inheritances. The following are key considerations related to Form 3520:
Foreign Trust Transactions: Foreign trusts can include foreign pension plans, foreign inheritances, or trusts established for educational or charitable purposes outside the United States. Form 3520 is used by U.S. taxpayers to report any transactions, contributions, or distributions involving foreign trusts.
Penalties for Non-Compliance: Failure to file Form 3520 or filing an incomplete or inaccurate form can result in severe penalties, including fines that can be as high as 35% of the gross reportable amount.
Reporting Deadlines: Form 3520 is typically due by April 15th following the tax year in which the transaction occurred, but extensions are available.
Responsibility: While the primary responsibility for filing Form 3520 typically falls on the deemed U.S. owner, there are circumstances were the trustee and beneficiary may be required to ensure that the form is filed accurately and on time. Please consult tax professionals to learn more about your possible filing responsibilities.
Form 3520-A: Annual Information Return of Foreign Trust with a U.S. Owner
Form 3520-A is an annual information return filed by foreign trusts that have a U.S. owner. It provides the IRS with important details about the foreign trust's financial activities, investments, and beneficiaries. The following is what you need to know about Form 3520-A:
U.S. Owner: A foreign trust with a U.S. owner is one where a U.S. person has an ownership interest, including the power to control certain trust decisions or receive trust income or distributions.
Reporting Requirements: The foreign trust must report its income, assets, distributions, and beneficiaries, as well as any changes in its structure, to the IRS through Form 3520-A.
Penalties for Non-Compliance: Failure to file Form 3520-A or filing an incomplete or inaccurate form can result in significant penalties, which can increase over time.
Responsibility: While the primary responsibility for filing Form 3520-A typically falls on the foreign trust, the U.S. owner may be required to ensure that the form is filed accurately and on time.
When Does a Foreign Trust Require a Form 1041 Filing?
Form 1041 is the U.S. Income Tax Return for Estates and Trusts. It is typically used for U.S. trusts. A foreign trust may be classified as a U.S. trust and require a Form 1041 filing under certain circumstances:
- If the foreign trust has a U.S. beneficiary who receives income or distributions from the trust, it may be considered a U.S. trust for tax purposes.
- The trust income attributable to U.S. beneficiaries may be subject to U.S. income tax, and a Form 1041 may be required to report and pay this tax.
We’re here to help
Forms 3520 and 3520-A play a crucial role in the IRS's efforts to track and regulate foreign financial interests held by U.S. taxpayers. Proper compliance with these reporting requirements is essential to prevent tax evasion, ensure transparency, and avoid costly penalties.
Taxpayers with foreign financial interests should be aware of their obligations to file these forms. At Mowery & Schoenfeld, we specialize in international taxation and can help you navigate the complexities of these reporting requirements and maintain compliance with the law.