U.S. Taxation: Information Reporting – Foreign Trusts
by George Gonzalez
As a U.S. citizen you are subject to taxation of worldwide income regardless of where you live. Also, regardless of your country of residence, you are subject to information reporting rules that may require you to file reports on your foreign assets and foreign activities.
This article discusses information reporting requirements that relate to foreign trusts. In separate articles in these web pages I discuss information reporting requirements related to (a) foreign corporations and (b) bank accounts and other foreign financial accounts.
Information Reporting Premise
It is worth keeping in mind that virtually all of the various information reporting requirements have the same ultimate goal: ensuring that you include all your foreign source income in your income tax return. With many types of U.S. source income, the payor of the income reports to the IRS how much income they paid you. Examples of this are Form W-2 for employment compensation, 1099-INT for interest income, 199-DIV for dividend income, and 1099-R for pensions, annuities and other retirement benefits. With this information the IRS can compare what you report in your tax return to what should have been reported. If there is a difference, the IRS will contact you with questions or assess a tax amount different from the tax shown in your tax return.
In contrast, with foreign source income there is usually no payor that communicates to the IRS how much income they paid you. It thus becomes more difficult for the IRS to know whether you reported all your foreign source income as required by law. By requiring you to submit information reports on foreign assets and foreign activities, under the threat of potentially severe penalties for non-compliance, you are essentially obligated to fulfill a similar role to that of payors of U.S. source income. Foreign information reports submitted to the IRS alert them to watch for certain foreign source income when you file your tax return.
A Quick Definition
A foreign trust is defined in the negative as a trust that is not a U.S. trust. A U.S. trust is one for which:
- A court within the United States is able to exercise primary supervision over the administration of the trust, and
- One or more U.S. persons have the authority to control all substantial decisions of the trust.
Thus, if a trust is created under the laws of a foreign country or is created in the U.S. but no U.S. persons have the authority to control all substantial decisions of the trust, then it is a foreign trust.
U.S. trusts are required to file an annual income tax return with the IRS on Form 1041. As part of that filing Form 1041 includes a Schedule K-1, copies of which are issued to trust beneficiaries. The Schedule K-1 tells the beneficiary how much of the trust’s income they are to report in their income tax return. Through these procedures the IRS knows what portion of trust income beneficiaries are to report in their own tax returns.
Information Reporting by Foreign Trusts on Form 3520-A
Foreign trusts with U.S. beneficiaries have IRS filing requirements. Form 3520-A (Annual Information Return of Foreign Trust With a U.S. Owner) is used for this purpose. It is somewhat equivalent to Form 1041 for U.S. trusts. Information that Form 3520-A asks for are divided into these six sections:
- Information about the trust
- The trust’s income statement
- The trust’s balance sheet
- A foreign grantor trust owner statement
- A statement of foreign trust income attributable to U.S. owner
- A foreign grantor trust beneficiary statement
Depending on the type of trust, e.g., a grantor trust versus a non-grantor trust, all or only some of the above sections may have to be completed.
Information Reporting by Foreign Trust Beneficiaries and Gift Donees on Form 3520
A form related to Form 3520-A is Form 3520 (Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts). This form is filed by a U.S. beneficiary of a foreign trust who had one or more transactions during the year with the trust. Types of transactions in this regard include the receipt of distributions from the trust, the receipt of a loan from the trust, and transfers of cash or other property to the trust.
Form 3520 is also a required filing for U.S. individuals who receive large gifts or bequests (more than $100,000) from a foreign estate or certain foreign persons.
There are many variations on, and exceptions to, the above general reporting requirements depending on circumstances. The reporting and income tax ramifications related to foreign trusts are complex; it is an area of U.S. taxation for which you should seek professional advice.