Foreign Grantor Trust Taxation & the IRS
Foreign Grantor Trust Taxation & the IRS: A foreign grantor trust is a common type of trust. Essentially, it is just a grantor trust that fails the IRS court and control tests. In other words, it is a trust that simply does not qualify as a U.S. based grantor trust. Thereby, by default is a foreign grantor trust. When it comes to a grantor trust, there are two main types of trusts:
- Revocable Trust; and
- Irrevocable Trust
What distinguishes a grantor trust from a non-grantor trust is the U.S. tax rules.
Namely, with a grantor trust, the grantor or settler still essentially controls the trust.
While technically, the trustee is responsible for administering the trust, the grantor still has power over the asset and the operation of the trust.
Within a non-grantor trust, the settler or grantor has relinquished ownership of the assets. From a U.S. tax perspective, there is a major difference in tax liability for U.S. beneficiaries for a grantor trust vs. a non-grantor trust.
We will summarize Foreign Grantor Trust Taxation.
How is a a Foreign Grantor Trust Taxed?
With a grantor trust, the Settlor or the person who created the trust still has ownership/control over the assets, and is taxed accordingly.
For example, if a person has a home in Spain and puts that home into a trust that qualifies as a foreign grantor trust, then the grantor is the owner of the trust — and has the power to revoke or cancel the trust.
As a result, the Grantor is the person(s) who is taxes on the income.
Therefore, if for example there were rental properties in the trust that generated income, and the income is distributed to the beneficiaries, it is the grantor, and not the beneficiaries who are taxed on the income.
The beneficiaries may have a reporting requirement – since the money is considered a gift — but the beneficiaries are not taxed.
Form 1041 Foreign Grantor Trust Tax Return
Unlike irrevocable trusts, most revocable trusts do not file a Form 1041.
That is because the settlor/grantor of the revocable trust is treated as the owner of the trust. Therefore, a trust identifier number is not required and the grantor reports the income on form 1040.
Tax Rate Revocable Trusts
The Grantor is generally taxed on the trust income at the same tax rate of their other general income.
In other words, if the taxpayer has a net-effective tax rate of 35%, then the additional income is reported and aggregated to the other income, and taxed accordingly.
Character of Revocable Trust income
With revocable trust income, it retains the character of the income as it was earned.
Therefore, capital gains is taxed as capital gain, and dividend is taxed as dividend, etc.
3520 Form Reporting of Foreign Trust
The reporting of foreign trusts can be complicated. The two main forms for reporting foreign trusts are the Form 3520 and 3520-A.
Form 3520 & Foreign Grantor Trust Taxation
The Form 3520 is filed for trust purposes, when the filer:
- Transferred Property to a Foreign Trust
- Was the Owner of any part of the Assets of a Foreign Trust
- Received a Foreign Trust Distribution
- Received certain loans
- Uncompensated use of foreign property
Form 3520-A & Foreign Grantor Trust Taxation
The Form 3520-A is also filed for trust purposes, when the filer:
- A foreign trust with a U.S. owner must file Form 3520-A in order for the U.S. owner to satisfy its annual information reporting requirements under section 6048(b).
- Each U.S. person treated as an owner of any portion of a foreign trust under the grantor trust rules (sections 671 through 679) is responsible for ensuring that the foreign trust files Form 3520-A
- 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 for the foreign trust to the U.S. owner’s Form 3520, Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts, by the due date of the U.S. owner’s Form 3520 (and not the due date for the Form 3520-A.
Foreign Gift, Trust, and Inheritance Tax Specialist Team
Our firm specializes exclusively in international tax, and specifically IRS offshore disclosure, including help clients with late reporting of Forms 3520 and 3520-A.
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