International Tax Gap Series
U.S. persons and their tax return preparers should be aware that 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.
Caution: A specialized industry of offshore scheme promoters has developed to assist U.S. taxpayers in circumventing the current payment of income tax through the use of foreign trusts and other offshore entities. The promoters of offshore schemes often advance technical arguments which purport to show that their scheme is legal or compliant with the Internal Revenue Code. These arguments are used to induce their clients to enter into an abusive scheme, which usually involves concealing the true ownership and control of assets and income.
To help prevent the use of foreign trusts and other offshore entities for tax avoidance or improper deferral of income, the Internal Revenue Code has provisions that address this abuse. Some of these provisions trigger immediate recognition of gains that would otherwise be deferred, while others require annual information reporting and impose significant penalties for failing to comply on a timely basis.
For more information about offshore tax schemes, refer to Abusive Foreign Trust Schemes.
Additional information about any of the foreign trust reporting requirements and related income tax consequences is available by clicking on the relevant links throughout the article.
A U.S. person includes a citizen of the United States, a domestic partnership, a domestic corporation, any estate other than a foreign estate, any trust if a U.S. person exercises primary supervision over the administration of the trust or if one or more U.S. persons have the authority to control all substantial decisions of the trust, and any person that is not a foreign person.
Tax consequences can apply to U.S. persons who are treated as owners of a foreign trust and U.S. persons treated as beneficiaries of a foreign trust, and to the foreign trust itself. There can be income tax as well as transfer tax consequences that should be considered.
In addition to tax consequences, there a number of information reporting rules that can apply to a U.S. person who enters into transactions with a foreign trust or is treated as an owner of a foreign trust under the grantor trust rules of Internal Revenue Code (IRC) sections 671-679, including information reporting on Forms 3520 and 3520-A; on Form 8938, Statement of Specified Foreign Financial Assets; and on FinCEN Form 114, Report of Foreign Bank and Financial Accounts (FBAR).
This page focuses on information reporting requirements on Forms 3520 and 3520-A (under IRC section 6048), as well basic income tax considerations.
Income Tax Consequences
- U.S. owner of a foreign trust - In general, a U.S. person who is treated as the owner of a foreign trust under the grantor trust rules (IRC sections 671-679) is taxed on the income of that trust. IRC section 679 applies specifically in the context of foreign trusts and will treat as an owner of a foreign trust a U.S. person who transfers assets to a foreign trust which has or is presumed to have a U.S. beneficiary. Each U.S. owner of a foreign trust should receive a Foreign Grantor Trust Owner Statement (Form 3520-A, page 3) from the foreign trust, which includes information about the foreign trust income they must report.
- U.S. beneficiary of a foreign trust – In general, a U.S. beneficiary of a foreign non grantor trust will report its share of foreign trust income. Depending on whether the U.S. beneficiary is a beneficiary of a grantor or non grantor trust, the beneficiary should receive a Foreign Grantor Trust Beneficiary Statement or a Foreign Non Grantor Trust Beneficiary Statement, which includes information about the taxability of distributions the beneficiary has received.
- U.S. transferor of assets to a foreign non grantor trust - IRC section 684 requires the recognition of gain on certain transfers of appreciated assets to a foreign trust by a U.S. person.
In general, a Form 3520, Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts is required to be filed when a U.S. person:
- creates or transfers money or property to a foreign trust or makes a loan to a foreign trust;
- receives distributions from a foreign trust, receives the uncompensated use of property of a foreign trust, or receives a loan from a foreign trust;
- is treated as the U.S. owner of a foreign trust under the grantor trust rules; and
- receives certain large gifts or bequests from foreign persons.
The instructions for Form 3520 include more information about:
- who must file a Form 3520;
- when and where the Form 3520 must be filed; and
- possible penalties for filing the Form 3520 late or filing incomplete or inaccurate information.
See Form 3520 filing tips below. See also Gifts from Foreign Persons for information about reporting receipts of certain large gifts or bequests from certain foreign persons.
In addition to Form 3520, U.S. persons who are treated as owners of a foreign trust under the grantor trust rules must ensure that the foreign trust timely files a complete and accurate Form 3520-A, Annual Information Return of Foreign Trust with a U.S. Owner , and furnishes the required annual statements to its U.S. owners and U.S. beneficiaries. If a foreign trust fails to file Form 3520-A, the U.S. owner must:
- complete and attach a substitute Form 3520-A to a timely filed Form 3520, and
- furnish the required annual statements in order for the U.S. owner to avoid penalties for the foreign trust’s failure to file a Form 3520-A.
The instructions for Form 3520-A include more information about:
- who must file a Form 3520-A or ensure that a Form 3520-A is filed;
- when and where the Form 3520-A must be filed; and
- possible penalties for filing Form 3520-A late or filing incomplete or inaccurate information. The instructions for Form 3520-A and Form 3520 also provide information about filing a substitute Form 3520-A.
Exceptions to filing Forms 3520 and 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). See Rev. Proc. 2014-55 . In addition, Forms 3520 and 3520-A are not required to be filed for certain tax-favored foreign retirement trusts or tax-favored foreign non-retirement savings trusts, provided that the U.S. owner is an “eligible individual” and the tax-favored foreign trust meets certain requirements. See Rev. Proc. 2020-17 . Caution: These exceptions do not affect any reporting obligations that a U.S. person may have to report specified foreign financial assets on Form 8938 or any other reporting requirement, including the requirement to file FinCEN Form 114, Report of Foreign Bank and Financial Accounts (FBAR).
Form 3520 and Form 3520-A filing tips to avoid penalties
- Form 3520
- File Form 3520 by the 15th day of the fourth month following the end of the U.S. person’s tax year, or April 15th for calendar year taxpayers, subject to any extension of time to file that may apply. If you are a U.S. citizen or resident who lives outside the Unites States and Puerto Rico or if you are in the military or naval service on duty outside the United States and Puerto Rico, then the due date to file a Form 3520 is the 15th day of the 6th month following the end of the U.S. person’s tax year.
- If an extension was filed with respect to your income tax return, be sure to check Form 3520, Box 1k, and enter the form number of the income tax return to avoid your Form 3520 being treated as filed late.
- Form 3520-A
- File Form 3520-A using an Employer Identification Number (EIN) for the foreign trust on Line 1b of the form rather than the U.S. owner’s SSN or ITIN. If the foreign trust does not have an EIN, refer to How to Apply for an EIN.
- File Form 3520-A by the 15th day of the 3rd month after the end of the trust’s tax year. An automatic 6-month extension may be granted by filing Form 7004, Application for Automatic Extension of Time to File Certain Business Income Tax, Information and Other Returns. Form 7004 must be filed under the foreign trust’s EIN.
- If the foreign trust will not file a Form 3520-A, the U.S. owner of the foreign trust must file a substitute Form 3520-A by completing a Form 3520-A to the best of their ability and attaching it to a timely filed Form 3520, including extensions (see Form 3520 and Form 3520-A instructions for more information on filing a substitute Form 3520-A). Do not separately file a duplicate Form 3520-A if you are filing a substitute 3520-A.
Other Possible Filing Requirements
Form 1040, Schedule B, Part III, Foreign Accounts and Trusts, must be completed if you receive a distribution from, or were grantor of, or a transferor to a foreign trust.
If you transfer money or property to a foreign trust, you may be required to file Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return.
A foreign trust, which is not taxed as a grantor trust, may be required to file a Form 1040-NR, U.S. Nonresident Alien Income Tax Return to pay U.S. tax on certain U.S. sourced income. See Publication 519, U.S. Tax Guide for Aliens and the instructions for Form 1040-NR for additional information.
You may be required to file Form 8938, Statement of Specified Foreign Financial Assets, to report your specified foreign financial assets if the total value of all the specified foreign financial assets in which you have an interest is more than certain reporting thresholds.
If you have a financial interest in or signature authority over a foreign financial account, including a bank account, brokerage account, mutual fund, trust, or other type of foreign financial account, the Bank Secrecy Act may require you to report the account each year to the Internal Revenue Service by filing FinCEN Form 114 (formerly TD F 90-22.1), Report of Foreign Bank and Financial Accounts (FBAR).
Return to: The International Tax Gap Series