Who is a Foreign Trust Owner for Form 3520 (Part II) Purposes

Who is a Foreign Trust Owner for Form 3520 (Part II) Purposes

Who is a Foreign Trust Owner for Form 3520

Who is Owner a Foreign Trust for Form 3520 (Part II) Purposes: There are various different categories of US Taxpayers who may have a form 3520 filing requirement. one of the most common categories of individuals is a US owner of all or any portion of a foreign trust. It is important to note, that a Taxpayer does not have to actually receive any distributions from the trust — or be the only owner of the trust — to have a filing requirement. In fact, a US owner of a foreign trust who only has a partial interest in the foreign trust and did not receive any distributions may still have an IRS Form 3520 filing requirement. Let’s go through the basics of who is considered the owner of a foreign trust for form 3520 Part II purposes.

Form 3520 Definition of Owner of Foreign Trust

The instructions perform 3520 provide that the definition of the owner of a foreign trust is as follows:

      • “An owner of a foreign trust is the person that is treated as owning any of the assets of a foreign trust under the rules of sections 671 through 679”

26 USC 671-679

Internal Revenue Code section 671 through 679 helps identify certain trust rules that Taxpayers should know when they are trying to determine whether or not they have a reporting requirement:

      • IRC 671: Trust Income, Deductions and Credits

      • IRC 672: Definitions and Rules

      • IRC 673: Reversionary Interests

      • IRC 674: Power to Control Beneficial Enjoyment

      • IRC 675: Administrative Powers

      • IRC 676: Powers to Revoke

      • IRC 676: Income for Benefit of Grantor

      • IRC 678: Person Other than Grantor as Substantial Owner

      • IRC 679: Foreign Trusts with one or More US Beneficiaries

Part II for US Owner of a Foreign Trust

The IRS Form 3520, Part II is relatively brief — and requires the following:

      • Name of Foreign Trust Owner

      • Address

      • Country of Residence

      • TIN

      • Relevant Code Section

      • Country Code of country where Foreign Trust was Created

      • Country Code of country whose laws govern the trust

      • Date Trust was created

      • Did the Foreign Trust File a Form 3520-A in the current year.

Owner of Foreign Trust Requirements

The IRS provides the following Instructions for completing Part II of the Form:

      • Complete Part II if you are considered the owner of any assets of a foreign trust under the rules of sections 671 through 679 during the tax year.

      • You are required to enter an EIN for such foreign trust on line 2b on page 1 of the form.

      • Note. You are required to complete Part II even if there have been no transactions involving the trust during the tax year. You may also need to complete Part III if you receive a distribution from the foreign trust. See the instructions for Part III. Line 20.

      • Enter information regarding any person, including yourself, who is considered the owner of any portion of the trust under the rules of sections 671 through 679. Also, enter in column (e) the specific Code section that causes you and any other person (as applicable) to be considered an owner for U.S. income tax purposes.

      • See the grantor trust rules under sections 671 through 679. Lines 21a and 21b. Enter the applicable two-letter code from the list at IRS.gov/CountryCodes. Line 22. If “Yes,” the copy of the Foreign Grantor Trust Owner Statement (pages 3 and 4 of Form 3520-A) should show the amount of the foreign trust’s income that is attributable to you for U.S. income tax purposes. See section IV of Notice 97-34.

      • If “No,” to the best of your ability, complete and attach a substitute Form 3520-A for the foreign trust to your Form 3520 by the due date of your Form 3520 (and not the due date for the Form 3520-A).  Otherwise, you may be liable for a penalty equal to the greater of $10,000 or 5% of the gross value of the portion of trust assets that you are treated as owning. There are additional penalties for continuing failure to file after notice by the IRS. See section 6677(a) through (c). Also see Penalties, earlier. Line 23. Enter the FMV of the trust assets that you are treated as owning.

      • Include all assets at FMV as of the end of the tax year. For this purpose, disregard all liabilities. The trust should send you this information in connection with its Form 3520-A. If you did not receive such information (line 9 of the Foreign Grantor Trust Owner Statement) from the trust, complete line 23 to the best of your ability.

      • At a minimum, include the value of all assets that you have transferred to the trust. Also, use Form 8082 to notify the IRS that you did not receive a Foreign Grantor Trust Owner Statement. However, filing Form 8082 does not relieve you of any penalties that may be imposed under section 6677.

Form 3520 Penalties for Foreign Trusts

Just as foreign trust reporting is complicated, so is the IRS penalty scheme associated with it. The applicable code section is Internal Revenue Code section 6677, as follows:

      • A penalty applies if Form 3520 is not timely filed or if the information is incomplete or incorrect (see below for an exception if there is reasonable cause). Generally, the initial penalty is equal to the greater of $10,000 or the following (as applicable).

      • 35% of the gross value of any property transferred to a foreign trust for failure by a U.S. transferor to report the creation of or transfer to a foreign trust in Part I.

      • 35% of the gross value of the distributions received from a foreign trust for failure by a U.S. person to report receipt of the distribution in Part III.

      • 5% of the gross value of the portion of the foreign trust’s assets treated as owned by a U.S. person under the grantor trust rules (sections 671 through 679), if the foreign trust

      • (a) fails to file a timely Form 3520-A and furnish the required annual statements to its U.S. owners and U.S. beneficiaries, or

      • (b) does not furnish all of the information required by section 6048(b) or includes incorrect information.

      • If a foreign trust fails to file Form 3520-A, the U.S. owner must complete and attach a substitute Form 3520-A to the U.S. owner’s Form 3520 by the due date of the U.S. owner’s Form 3520 (and not the due date for the Form 3520-A, which is otherwise due by the 15th day of the 3rd month after the end of the trust’s tax year) in order to avoid being subject to the penalty for the foreign trust’s failure to timely file Form 3520-A.

      • For example, a substitute Form 3520-A that, to the best of the U.S. owner’s ability, is completed and attached to the U.S. owner’s Form 3520 by the due date for the Form 3520 (such as April 15 for U.S. owners who are individuals), is considered to be timely filed.

      • See section 6677(a) through (c) and the instructions for Part II of this form and Form 3520-A. Additional penalties will be imposed if the noncompliance continues for more than 90 days after the IRS mails a notice of failure to comply with the required reporting.

      • If the IRS can determine the gross reportable amount (defined later), then the penalties will be reduced as necessary to assure that the aggregate amount of such penalties does not exceed the gross reportable amount. For more information, see section 6677.

      • Reasonable cause. No penalties will be imposed if the taxpayer can demonstrate that the failure to comply was due to reasonable cause and not willful neglect.

      • Note. The fact that a foreign country would impose penalties for disclosing the required information is not reasonable cause. Similarly, reluctance on the part of a foreign fiduciary or provisions in the trust instrument that prevent the disclosure of required information is not reasonable cause. See section 6677(d) for additional information.

      • What does this mean?

This is more complicated than the foreign gift penalty, so let’s break it down into parts:

$10,000 Penalty vs. Trust or Income Value

With foreign trust penalties, the starting penalty amount is $10,000. The $10,000 is in comparison to other trust transactions that may have occurred during the tax year. If these other transactions result in values that are higher than the $10,000, then the penalty is the greater of the values (unless and exception, exclusion, or limitations applies).

These other values may include:

      • 35% of the gross value of any property transferred to a foreign trust (Part I)

      • 35% of the gross value of the distributions received from a foreign trust (Part III)

      • 5% of the gross value of the portion of the foreign trust’s assets treated as owned by a U.S. person under the grantor trust rules (sections 671 through 679), if the foreign trust

        • (a) fails to file a timely Form 3520-A and furnish the required annual statements to its U.S. owners and U.S. beneficiaries, or
        • (b) does not furnish all of the information required by section 6048(b) or includes incorrect information.

Depending on the value of the trust, and/or contributions and distributions made to the trust — it may result in significant penalties exceeding $10,000.

What if Trust Does Not File Form 3520?

If the trust does not file the necessary forms, the U.S. owner must file or else they become subject to the penalty. The owner does not need to file it perfectly – just the best they can using due diligence.

Also, if there are distributions, it may impact the overall penalty.

IRC 6662

Internal Revenue Code section 6662 which deals with underreporting penalties has an additional section that refers specifically to foreign trust owners and how the penalty may be increased based on certain underpayments attributed to transactions that should have been included on form 3520-A.

As provided by the IRS:

    • “Section 6662(j). If a U.S. owner of a foreign trust is subject to a penalty imposed under section 6662 for an underpayment of tax required to be shown on a return, then such penalty may be increased under section 6662(j) for any portion of an underpayment which is attributable to any transaction involving any asset with respect to which information was required to be provided on Form 3520-A. For more information about undisclosed foreign financial asset understatements, see section 6662(j).

      No penalty will be imposed with respect to any portion of an underpayment if the taxpayer can demonstrate that the failure to comply was due to reasonable cause with respect to such portion of the underpayment and the taxpayer acted in good faith with respect to such portion of the underpayment. See section 6662 and section 6664(c) for additional information.”

Reasonable Cause & Form 3520 Penalty

If a taxpayer is going to be penalized but is able to show reasonable cause — and that the failure to file timely, properly, or accurately was not due to willful neglect, then they may be able to avoid the penalty. Reasonable cause is based on the totality of the circumstance and will vary from taxpayer to taxpayer.

International Tax Law Specialist Team: Golding & Golding

Our firm specializes exclusively in international tax, and specifically IRS offshore disclosure, including help clients with late reporting of Forms 3520 and 3520-A and Form 3520 Penalty & Relief Procedures.

Contact our firm today for assistance.

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