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Can a Person Who Is Both Owner and Beneficiary of a Foreign Trust Be Liable for Separate Penalties for Failure to Report in Both Categories?

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    U.S. tax code imposes varying foreign information and income tax reporting requirements wherever foreign income generating assets may benefit U.S. taxpayers. These requirements differ depending on whether the U.S. taxpayer is an owner or beneficiary of these assets, such as with trusts. But what obligations do taxpayers have when they are both owner and beneficiary of a foreign trust? And what penalties do they face if they fail to meet these obligations?

    According to the Second Circuit in a recent decision, taxpayers still must shoulder their obligations as a beneficiary of a foreign trust, even if they are an owner, and vice versa. Failure to report as required will cause the taxpayer to incur penalties, and their positioning as an owner and beneficiary can double up their exposure to penalties.

    The only way to prevent these penalties is by meeting the cumbersome requirements imposed by the federal government. The best way to make sure that you are compliant is to work with the dual-licensed Tax Attorneys and CPAs at the Tax Law Offices of David W. Klasing. Call our offices today at (800) 681-1295 or schedule a reduced rate initial consultation online HERE.

    FBAR Obligations and Penalties for Failure to Report a Foreign Trust

    Under 26 U.S.C. § 6048(b)-(c), any U.S. citizen who is an owner or beneficiary of a foreign trust is required to file an annual return. Failure to file the specified return is a violation of the Internal Revenue Code (IRC) and subjects the delinquent party to substantial penalties. However, the reporting requirements and penalties for the failure to meet them differ depending on whether the delinquent party is an owner or a beneficiary of the trust.

    Obligations and Penalties for Trust Beneficiaries

    U.S. beneficiaries of foreign trusts must file Form 3520 for each year they receive a distribution from the foreign trust. If the beneficiary does not file a timely and correct return, the IRS imposes a penalty of up to 35% of the distribution. The deadline for filing Form 3520 as a beneficiary of a foreign trust is typically the same as the taxpayer’s regular filing deadline.

    Obligations and Penalties for Trust Owners

    U.S. owners of foreign trusts, even partial owners, must ensure that the trust files both Form 3520 and Form 3520-A each year. The trust’s annual filing must include accounting information for all trust activities and operations.

    U.S. owners can file a substitute Form 3520-A if the trust will not. To do this, the owner must complete Form 3520-A as best they can with the information that they have and attach it to their Form 3520 when they regularly file. If both the foreign trust and the U.S. owner fail to make the required disclosure, the penalty for the owner is 5% of the gross reportable amount.

    Second Circuit Holds Defendant Liable for FBAR Reporting Failure Penalties as Both Owner and Beneficiary

    In Wilson v. United States, Wilson was both the sole owner and beneficiary of a foreign trust. Wilson established the trust in 2003 to hold assets valuing roughly $9 million. In 2007, Wilson liquidated the trust and distributed the remaining assets, then valued at $9.2 million, to the sole beneficiary – himself.

    District Court Procedure

    Wilson failed to file Form 3520 in 2007 to declare his distribution from the foreign trust. As the sole owner, Wilson also failed to ensure that Form 3520-A was filed on behalf of the trust. The IRS assessed the 35% penalty on the distribution, which came out to a total of just over $3.2 million. Wilson paid the penalty, but within two months of paying, submitted a claim for a full refund. Wilson argued that, as an owner, the 5% penalty of § 6677(b) should have applied, as opposed to the 35% penalty.

    Wilson died while his case was pending, and his estate brought the case to court. The lower court granted the estate’s motion for summary judgement, stating that the IRS could only assess the 5% penalty under § 6677. Wilson’s estate also argued that the owner of a trust should only be required to file Form 3520 once, as an owner. The government appealed the decision, which is how the case reached the Second Circuit Court of Appeals.

    Second Circuit Appeal and Outcome

    On appeal, the Second Circuit vacated the district court’s decision. In the opinion, Judge Richard C. Wesley indicated that the district court’s reasoning was flawed for two reasons. First, even if the owner were only required to file one Form 3520, filing the form without including all the relevant information, such as distributions, is still a violation of the IRC. Second, a U.S. taxpayer who receives distributions from a foreign trust is required to disclose those distributions, even if they are an owner.

    In other words, the Second Circuit identified the two obligations as separate from one another, and therefore reasoned that the penalties should be separately enforced as well. Under this decision, ownership status in a trust will not allow FBAR violation targets to escape the hefty fines for failure to disclose.

    How to Avoid FBAR Penalties for Failure to Report

    Identifying whether you face reporting obligations for overseas assets such as trusts may be difficult without the help of seasoned eyes. The dual-licensed Tax Attorneys and CPAs at the Tax Law Offices of David W. Klasing can wield their experience and familiarity with FBAR reporting guidelines to your situation so that you can remain in compliance and avoid serious penalties.

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    Get the Facts About FBAR Penalties from the Tax Law Offices of David W. Klasing

    You are right to be concerned about how failure to meet complex FBAR reporting requirements may impact your financial situation. Schedule an appointment with one of the dual-certified tax attorneys and CPAs at the Tax Law Offices of David W. Klasing today by calling (800) 681-1295.

    See our 2011 OVDI Q and A Library

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