Taxation and Information Reporting for Foreign Trusts

The U.S. taxation and information reporting imposed on foreign trusts can be quite complex.

A trust is the foreign trust if it is not the U.S. trust.  A trust is a U.S. trust if: a court within the U.S. is able to exercise primary supervision over the administration of the trust (court test), and one or more U.S. persons have the authority to control all substantial decisions of the trust (control test).

Foreign trusts are subject to many tax filing requirements, and failure to meet them can result in significant penalties. The income taxation of a foreign trust depends on whether the trust is a grantor or non-grantor trust. The compliance can apply to U.S. owners of foreign trusts, U.S. beneficiaries of a foreign trust, and to the foreign trust itself. Additional tax filing requirements can be triggered by: creating a foreign trust, transferring any money or property to a foreign trust, or receiving a distribution from a foreign trust.

In an effort to prevent the use of foreign trusts for tax avoidance, the IRS defines the term “the U.S. owner of a foreign trust” very broadly. The U.S. owner of a foreign trust is the true owner of an asset or transaction as opposed to any stated ownership provided in the documents. In general, income tax consequences apply to the U.S. owner of the foreign trust.

Reporting Transactions with Foreign Trusts

Foreign trusts reporting requirements relate to information returns and income tax consequences. Form 3520, Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts, and Instructions, is the main information return used for reporting transactions with foreign trusts. Generally, Form 3520 must be filed when a U.S. person: creates or transfers money or property to a foreign trust, receives any distributions from a foreign trust, and, receives certain gifts or bequests from foreign entities. Other possible reporting requirements include: 3520-A (Annual Information Return of Foreign Trust with a U.S. Owner), 1040 (Schedule B, Foreign Accounts and Trusts), FinCEN form 114, (Report of Foreign Bank and Financial Account), 1040NR (Nonresident Alien Income Tax Return) and Form 709 (U.S. Gift Tax Return).

The complexity that surrounds foreign trusts should be regularly reviewed by taxpayers in order to minimize tax implications. Please contact us with questions regarding foreign trusts and visit the Schneider Downs Estate Planning Services page to learn about services that we can offer.