The IRS generally requires U.S. taxpayers who own a foreign trust, or are involved in transactions with foreign trusts, to report this information to them each year as part of the tax return process. Specifically, any U.S. tax resident, defined as any U.S. green card holder, U.S. Citizen or individual that meets the substantial presence test, who creates a foreign trust, transfers any money or property to a foreign trust, receives a distribution from a foreign trust, or is treated as the U.S. owner of a foreign trust must file Form 3520, the “Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts.”
Failure to properly file this document can result in severe financial penalties. Recently, the IRS has issued new guidance about certain situations where a taxpayer is exempt from these reporting requirements. Below, our experienced tax attorneys guide you through the foreign trust information reporting requirements and the new exceptions created by this rule.
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Form 3520 must be filed not only if you are the owner of a foreign trust account, but also when you receive distributions from or transfers of money to a foreign trust. This information is necessary for the IRS to assess your taxes properly. For example, the U.S. owner of a foreign trust is generally taxed on the income of that trust. Other rules may apply for those receiving distributions or transferring money or property into a trust.
Some people are not required to file Form 3520 even if they have financial interactions with foreign trusts. Certain transfers made to foreign trusts that are predefined under sections of the code are exempt from the reporting requirement. For the most part, Fair Market Value transfers to a foreign trust by a U.S. person are not required to be reported on Form 3520. If you receive a distribution from a foreign trust to a domestic trust which is recognized by the IRS as being tax exempt, you are not required to file Form 3520.
Sometimes, you may not be required to disclose this information on other forms rather than on Form 3520. For example, transactions from a Canadian Foreign Retirement Plan are not required to be reported on Form 3520, but they are required to be reported on Form 8891. Similarly, if you receive a distribution from a foreign trust as compensation for services rendered, you do not need to report this distribution on Form 3520, but you are required to report this on Form 1040 with your U.S. expat tax return.
In early March, the IRS announced some new exemptions to the information-reporting requirement for certain tax-favored foreign trusts, particularly pension and retirement accounts. A “tax-favored” trust is defined as a foreign trust for U.S. tax purposes that is created, organized, or otherwise established under the laws of a foreign jurisdiction. Under these new guidelines, the reporting requirement is waived for taxpayers if such trusts are operated exclusively or almost exclusively to provide, or to earn income for the provision of, pension or retirement benefits, or medical, educational, or disability benefits. For these types of accounts and transactions, you do not need to file Form 3520 any longer. Be sure to consult with an experienced tax lawyer like those at the Tax Law Offices of David W. Klasing to be sure that you do in fact qualify before you choose not to file.
There is another aspect to the new guidelines regarding certain tax-favored foreign trusts that can be beneficial to taxpayers. In past years, fines and fees were assessed against those who failed to report the required trust information, even for retirement and educational trusts like the ones now exempt. As such, the IRS has issued a policy giving an abatement, or refund, to those who paid penalties under this now-changed rule in past years.
If you have been assessed past financial penalties for failure to report and believe you qualify for an abatement under this new rule, you should contact a skilled international tax attorney like those at the Tax Law Offices of David W. Klasing to guide you through the application process. The first step you will need to take to get an abatement is to file Form 843, the Claim for Refund and Request for Abatement. When you come to Line 7 of this form, you will need to write “Relief pursuant to Revenue Procedure 2020-7.” Then, you will use the rest of the space under Line 7 to explain how the accounts for which you were assessed penalties qualify as tax-favored, exempt accounts under the new procedures.
While most U.S. taxpayers with involvement in foreign trusts are required to report this information to the IRS each year, there are many exemptions, including a new one regarding tax-favored retirement and pension accounts. You should consult with an experienced tax law professional like the attorneys at The Tax Law Offices of David W. Klasing to figure out what you are and are not required to disclose. If you have been assessed past penalties for failure to report information regarding the now-exempt trusts, we can also work to get you an abatement. Call us today at 800-681-1295 to schedule a consultation.
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