By Anthony Diosdi
The Internal Revenue Code provides that if any United States Person (i.e. U.S. citizen or U.S. resident) beneficiary receives (directly or indirectly) a distribution from a foreign trust during any taxable year, such person is required to make a return with respect to such a trust for such year using Internal Revenue Service (“IRS”) Form 3520, and show thereon the name of the trust, the amount of the aggregate distribution received, and any other data the IRS may require. The IRS may assess an annual penalty equal to 35 percent of the gross value of the trust. See IRC Section 6048(c).
The Internal Revenue Code also provides that each U.S. Person treated as an owner of any portion of a foreign trust under Internal Revenue Code Section 671 through Section 679 is responsible for ensuring that the foreign trust files IRS Form 3520-A and that the required annual statement is provided to its U.S. owners and U.S. beneficiaries. Form 3520-A is the annual information return of a foreign trust with at least one U.S. owner. The form provides information about the foreign trust, its beneficiaries, and any U.S. persons who are treated as an owner of any portion of the foreign trust. The IRS may assess an annual penalty of $10,000 or 5 percent of the gross reportable amount of the trust per year if the Form 3520-A is not timely filed. See IRC Section 6048(b).
Revenue Procedure 2020-17
The IRS recently promulgated Revenue Procedure 2020-17. This Revenue Procedure exempts U.S. Persons from having to disclose certain foreign trusts on Form 3520 and Form 3520-A. U.S. Persons must continue to disclose contributions and earnings from foreign trusts on their U.S. income tax returns. U.S. Persons must also continue to disclose foreign assets on IRS Form 8938 and applicable Reports of Foreign Financial Accounts (“FBAR”) information returns. Revenue Procedure 2020-17 applies to the reporting of certain tax-favored foreign retirement trusts and tax-favored foreign non-retirement savings trusts because the countries in which these trusts are established impose various restrictions on the trusts, and there may be duplicative reporting to the IRS when reporting requirements under other sections of the Internal Revenue Code apply to the trusts. The countries in which such foreign trusts are established generally impose written restrictions and requirements, as well as information reporting requirements, on the trusts. Additionally, US individuals with an interest in one of these trusts may be required under Internal Revenue Code Section 6038D to separately report information about their interests in accounts held by or through these trusts to the IRS on Form 8938. The IRS therefore, exempts these US individuals from the Form 3520 and Form 3520-A reporting requirements otherwise applicable to these foreign trusts.
In order to fall under the rules promulgated under Revenue Procedure 2020-17, an individual seeking relief from the Form 3520 and 3520-A filing requirements must be an “eligible individual” with a “tax-favored foreign retirement trust” or a “tax-favored foreign non-retirement savings trust.” A US Person is an “eligible individual” who qualifies for the reporting exemption for a tax-favored foreign retirement trust or tax-favored foreign non-retirement savings trust, if the individual is a U.S. Person who has both:
1. Filed US income tax returns for all years during which the individual was a US citizen or resident and for which the statute of limitations under Section 6501 (this typically the last three years) has expired.
2. Reported as income any contributions to, earnings of, or distributions from an applicable tax-favored foreign trust, as required under US tax law, on an applicable return.
A “tax-favored foreign retirement trust” is a foreign trust for purposes of the Internal Revenue Code that 1) is created, organized, or otherwise established under the laws of a foreign jurisdiction as a trust, plan, fund, scheme, or other arrangement to operate exclusively or almost exclusively to provide, or earn income to provide, pension or retirement benefits and ancillary or incidental benefits; and 2) meets the following requirements established by the laws of the trust’s foreign jurisdiction:
i. Is exempt from income tax or is otherwise tax-favored.
ii. Provides annual information reporting about the trust, its participants, or its beneficiaries, or this information is otherwise available, to the relevant tax authorities in the trust’s jurisdiction.
iii. Limits contributions made to the trust to income earned from the performance of personal services.
ix. Limits contributions to the trust to a percentage of the participant’s earned income, no more than $50,000 annually or no more than $1 million in a lifetime.
v. Allows withdrawals from the trust only when the beneficiary reaches a specified retirement age, is disabled, or dies.
vi. For employer-maintained trust, must be: i) be nondiscriminatory; ii) actually provide significant benefits for a substantial majority of eligible employees, and iii) provide benefits that are nondiscriminatory.
A “tax-favored foreign non-retirement savings trust” is a foreign trust for US tax purposes that 1) is created, organized, or otherwise established under the laws of a foreign jurisdiction as a trust, plan, fund, scheme, or other arrangement to operate exclusively or almost exclusively to provide medical, disability or educational benefits; and 2) meets the following requirements:
i. Is generally exempt from income tax or is otherwise tax-favored in the trust’s jurisdiction.
ii. Provides annual informational reporting about the trust, its participants, or its beneficiaries, or this information is otherwise available, to the relevant tax authorities in the trust’s jurisdiction.
iii. Limits contributions to $10,000 annually or $200,000 in a lifetime.
ix. Withdrawals from the trust are only permitted for the provision of medical, disability, or educational benefits.
Conclusion
Revenue Procedure 2020-17 provides welcome relief from foreign trust information reporting requirements. However, an analysis is required for each foreign trust to determine if it falls into one of the exceptions provided in the Revenue Procedure. In addition, although Revenue Procedure 2020-17 provides welcome relief from 3520 and Form 3520-A filing requirements, the Revenue Procedure does not eliminate the filing requirements of other informational returns and applicable income tax reporting requirements associated with these foreign assets. Finally, lately the IRS has been automatically assessing penalties against individuals that have failed to timely file Forms 3520 and Forms 3520-A. In certain cases, Revenue Procedure 2020-17 may provide relief from these penalties either in administrative appeal cases or in administrative claims for refund cases.
Anthony Diosdi is a partner and attorney at Diosdi Ching & Liu, LLP located in San Francisco, California. Diosdi Ching & Liu, LLP also has offices in Pleasanton, California and Fort Lauderdale, Florida. Anthony Diosdi advises clients in tax matters domestically and internationally throughout the United States, Asia, Europe, Australia, Canada, and South America. Anthony Diosdi may be reached at (415) 318-3990 or by email: adiosdi@sftaxcounsel.com.
This article is not legal or tax advice. If you are in need of legal or tax advice, you should immediately consult a licensed attorney.