The UNI vs DNI Issue with Foreign Non-Grantor Trusts 

The UNI vs DNI Issue with Foreign Non-Grantor Trusts

The UNI vs DNI Issue with Foreign Non-Grantor Trusts 

When it comes to foreign trusts and the Internal Revenue Service – and especially foreign non-grantor trusts – one of the biggest headaches involves the distribution of foreign trust income to US beneficiaries. With a non-grantor foreign trust, the US beneficiary is not the owner of the trust, and the trust is considered foreign – so there are generally no US tax implications for the foreign trust itself unless there are certain investments in US income generating assets. One of the more complicated aspects of foreign non-grantor trust distributions to US beneficiaries is the concept of the Distributable Net Income (DNI) and Undistributed Net Incomes (UNI). So what happens when there is previous year DNI that was not distributed and no-65 day election was made? Let’s go through five (5) basic facts that all US beneficiaries who receive distributions from foreign non-grantor trusts should be aware:

UNI and 65-Day Election

First, if the Foreign Non-Grantor Trust has DNI that it is not going to distribute (or a portion of the DNI) and rather retain the income for distribution in a subsequent year, the trust should consider making a 65-day election to minimize any tax implication and additional interest for distributing the DNI income in the year it was earned.

Foreign Non-Grantor Trust Beneficiary Statement

The Foreign Non-Grantor Trust should be sure to issue a Foreign Non-Grantor Trust Beneficiary Statement (FNGTBS) to the US beneficiary – which can provide the US beneficiary with additional options when completing Form 3520 (Default Method vs Actual Method) – while there is not a specific form that is used, the IRS does lay out what is required to be in the statement — and what type of notice should be provided.

Choosing the Default vs Actual Method & UNI

Once a person chooses the default method (which depending on the history of the trust may be tax beneficial), then generally they have to move forward using that same method and cannot change it down the line.

Forms 3520/3520-A is More than UNI & DNI

Out of all the international information reporting penalties, for some unknown reason, the Internal Revenue Service has honed in on Forms 3520 and 3520-A.  If the US Person is a beneficiary of a foreign trust and has no ownership interest in that trust, then generally they only file a Form 3520 to report the distribution they received from the foreign trust distribution. If on the other hand, the taxpayer is the owner of a foreign trust then they normally have to file both forms — and there are different due dates for each form.

Late Filing Foreign Trust Penalties

If a person files late Form 3520 and Form 3520-A there is the potential for significant fines and penalties. Penalties can reach upwards of 25% value of a gift and 35% relating to the trust. In the recent case of US V Wilson, the Second Circuit Court of Appeals also confirmed that a taxpayer is not limited to a 5% penalty they are both the owner and beneficiary of the foreign trust. A taxpayer may be able to limit, avoid or abate foreign trust penalties through one of the offshore disclosure programs or by successfully convincing the Internal Revenue Service that any non-compliance was due to reasonable cause and not willful neglect.

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