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IRS Provides Relief to Certain Individuals with Foreign Trusts – What it May Mean for You

Table of Contents

    Revenue Procedure 2020-17 and Background

    On March 16, 2020, the Internal Revenue Service (IRS) published Revenue Procedure (Rev. Proc.) 2020-17 which grants certain eligible individuals exemption from information reporting requirements under Internal Revenue Code (IRC) section 6048 regarding transactions with, and ownership of, certain tax-favored foreign trusts.

    IRC section 6048 requires responsible parties to provide written notice of reportable events, such as the amount of money or property transferred to foreign trusts, as well as the identity of the trust and each trustee and beneficiary, on an annual basis. A reportable event includes the creation of any foreign trust, the transfer of money or property to a foreign trust, or the death of a U.S. citizen who was an owner of a foreign trust. A taxpayer may satisfy this requirement by filing Forms 3520 and/or 3520-A. IRC section 6677 imposes penalties for failure to comply with the section 6048 reporting requirements.

    Rev. Proc. 2020-17 provides relief from these reporting requirements for “eligible individuals” with respect to their ownership of and/or transactions with certain applicable tax-favored foreign trusts. Rev. Proc. 2020-17 is effective as of March 16, 2020, and it will generally apply to all prior open tax years.

    The Reporting Requirement Exemption

    Pursuant to Rev. Proc. 2020-17, the IRS indicated that an exemption from the reporting requirements under IRC section 6048 is appropriate since tax-favored foreign trusts are typically already subject to numerous limitations and reporting requirements imposed under the laws of the country in which the trust is established. Moreover, U.S. individuals with an interest in such trusts are also generally subject to restrictions such as contribution and withdrawal limitations, and annual information reporting requirements under IRC section 6038D regarding the value of assets held in such trusts. Notably, the requirements to file Form 8938 (Statement of Specified Foreign Financial Assets) and FinCEN Form 114 (Report of Foreign Bank and Financial Accounts) are not affected by Rev. Proc. 2020-17. In recognition, the IRS has determined it is appropriate to provide eligible individuals an exemption from providing additional information on Forms 3520 or 3520-A.

    Taxpayers who would otherwise be required to file Form 3520 (Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts) and/or Form 3520-A (Annual Information Return of Foreign Trust with a U.S. Owner) for the 2019 tax year will not now be required to file these forms if they qualify for the relief set forth in Rev. Proc. 2020-17.

    Qualification – Eligible Individuals and Tax Favored Foreign Trusts

    In order to take advantage of this relief, a taxpayer must be an “eligible individual” who, prior to issuance of Rev. Proc. 2020-17, is or was required to report a transaction with, or ownership of, an applicable tax-favored foreign trust pursuant to IRC section 6048.  An eligible individual is a U.S. citizen or resident within the meaning of IRC section 7701(a)(30)(A), who is presently tax-compliant with all income tax filing requirements for any period for which the assessment statute remains open under IRC section 6501, and who is current on their income reporting of any contributions, earnings, or distributions related to their ownership in an applicable tax-favored foreign trust, as required under U.S. tax law1.

    Rev. Proc. 2020-17 provides clarification as to what constitutes a tax-favored foreign trust by breaking out the requirements into two groups: (1) tax-favored foreign retirement trusts which include trusts created to provide income for retirement or incidental benefits2, and (2) tax-favored foreign non-retirement savings trusts created to provide income for medical, disability or educational benefits that meet specific requirements3.  As Rev. Proc. 2020-17 alludes to the laws of the trust’s foreign jurisdiction in determining the trust’s conformity with the definition of an applicable tax-favored foreign trust, a careful review of the foreign jurisdiction’s laws will likely be required in order to properly evaluate whether the foreign trust will meet the requirements contained in Rev. Proc. 2020-17.

    Additional Relief – Abatement or Refund of Assessed Penalties

    In addition to providing prospective annual reporting relief, taxpayers may request abatement of assessed penalties or file a claim for refund of paid penalties. IRC Section 6677 imposes a civil penalty of $10,000 or 35% (5% if failure is by U.S. owner of a foreign trust under IRC section 6048(b)), whichever is greater.

    Rev. Proc. 2020-17 outlines procedures for eligible individuals for filing Form 843 (Claim for Refund and Request for Abatement) to request abatement of penalties previously assessed under IRC section 6677 and/or a refund of penalties already paid, subject to certain statutory limitations. This could be very significant for taxpayers who have foreign pensions that are trusted for U.S. tax purposes.

    Next Steps – Evaluation by Qualified Tax Advisor

    The Treasury Department and IRS plan to issue proposed regulations that would modify the requirements under IRC section 6048, as outlined in Rev. Proc. 2020-17.

    Taxpayers who believe they may be eligible for relief under Rev. Proc. 2020-17 should consult with their tax advisors to assess whether their trust fits within the requirements of what constitutes an applicable tax-favored foreign trust. The IRS has not provided guidance on specific foreign trusts that will qualify for the reporting exemption. Therefore, taxpayers will need to engage qualified counsel to carefully review relevant accounts and plans to determine if the reporting exemption will apply. Taxpayers should also take steps to confirm that they are fully compliant with all U.S. income tax return filing and reporting requirements because compliance will ultimately determine eligibility for penalty relief.

    1 Details of applicable requirements are set forth in Rev. Proc. 2020-17, section 5.02.

    2 Details of applicable requirements are set forth in Rev. Proc. 2020-17, section 5.03.

    3 Details of applicable requirements are set forth in Rev. Proc. 2020-17, section 5.04.

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