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Foreign Trust Challenges for U.S. Tax Professionals Navigating Tax Traps and Opportunities, Fiduciary Accounting Income, Form 3520 and FATCA Compliance

TUESDAY, JULY 30, 2013, 1:00-2:50 pm Eastern

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Foreign Trust Challenges for U.S. Tax Professionals Seminar

Lawrence M. Lipoff, Lipoff Global Advisors

[email protected]

July 30, 2013

Cynthia Brittain, Northern Trust

[email protected]

Edward Vergara, Withers Bergman

[email protected]

Today’s Program

Facets That Make An Entity A Trust

[Cynthia Brittain]

Features That Make A Trust A Foreign Trust

[Lawrence M. Lipoff]

Categories Of Foreign Trusts

[Cynthia Brittain]

Complexities Of Sect. 679 And Foreign Grantor Trusts

[Edward Vergara]

Defining And Managing Trust Income And Fiduciary Accounting

Income

[Cynthia Brittain]

Complexities With Foreign Non-Grantor Trusts

[Edward Vergara]

Issues With U.S. Tax Forms

[Lawrence M. Lipoff]

Slide 7 – Slide 15







Notice

ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY

THE SPEAKERS’ FIRMS TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY

OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT

MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR

RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.

You (and your employees, representatives, or agents) may disclose to any and all persons,

without limitation, the tax treatment or tax structure, or both, of any transaction

described in the associated materials we provide to you, including, but not limited to,

any tax opinions, memoranda, or other tax analyses contained in those materials.

The information contained herein is of a general nature and based on authorities that are

subject to change. Applicability of the information to specific situations should be

determined through consultation with your tax adviser.

FACETS THAT MAKE AN ENTITY A TRUST


8

Initial Classifications

What is a trust, for U.S. tax purposes?

Lichtenstein Foundation

Stiftung

Usufruct

Treuhand

Establishment

Investment trust Are these all

Business trust trusts?

9

Initial Classifications (Cont.)

Ordinary trusts: 301.7701-4(a)

In general, the term “trust” as used in the Internal Revenue Code refers to an

arrangement created either by a will or by an inter vivos declaration whereby

trustees take title to property for the purpose of protecting or conserving it for the

beneficiaries under the ordinary rules applied in chancery or probate courts.

Usually the beneficiaries of such a trust do no more than accept the benefits

thereof and are not the voluntary planners or creators of the trust arrangement.

However, the beneficiaries of such a trust may be the persons who create it and it

will be recognized as a trust under the Internal Revenue Code if it was created for

the purpose of protecting or conserving the trust property for beneficiaries who

stand in the same relation to the trust as they would if the trust had been created

by others for them. Generally speaking, an arrangement will be treated as a trust

under the Internal Revenue Code if it can be shown that the purpose of the

arrangement is to vest in trustees responsibility for the protection and

conservation of property for beneficiaries who cannot share in the discharge of

this responsibility and, therefore, are not associates in a joint enterprise for the

conduct of business for profit.

10


Business trusts: 301.7701-4(b)

There are other arrangements which are known as trusts because the legal title to

property is conveyed to trustees for the benefit of beneficiaries, but which are not

classified as trusts for purposes of the Internal Revenue Code because they are

not simply arrangements to protect or conserve the property for the beneficiaries.

These trusts, which are often known as business or commercial trusts, generally

are created by the beneficiaries simply as a device to carry on a profit-making

business which normally would have been carried on through business

organizations that are classified as corporations or partnerships under the Internal

Revenue Code. However, the fact that the corpus of the trust is not supplied by

the beneficiaries is not sufficient reason in itself for classifying the arrangement as

an ordinary trust rather than as an association or partnership. The fact that any

organization is technically cast in the trust form, by conveying title to property to

trustees for the benefit of persons designated as beneficiaries, will not change the

real character of the organization if the organization is more properly classified as

a business entity under Section 301.7701-2.

11


Investment trusts: 301.7701-4(c)(1)

An “investment” trust will not be classified as a trust if there is a power under the

trust agreement to vary the investment of the certificate holders. See

Commissioner v. North American Bond Trust, 122 F. 2d 545 (2d Cir. 1941), cert.

denied, 314 U.S. 701 (1942). An investment trust with a single class of ownership

interests, representing undivided beneficial interests in the assets of the trust, will

be classified as a trust if there is no power under the trust agreement to vary the

investment of the certificate holders. An investment trust with multiple classes of

ownership interests ordinarily will be classified as a business entity under Section

301.7701-2; however, an investment trust with multiple classes of ownership

interests, in which there is no power under the trust agreement to vary the

investment of the certificate holders, will be classified as a trust if the trust is

formed to facilitate direct investment in the assets of the trust and the existence of

multiple classes of ownership interests is incidental to that purpose.

12


301.7701-4(c)(2), Example 4: Business interest vs. trust classification:

Corporation N purchases a portfolio of bonds and transfers the bonds to a bank

under a trust agreement. At the same time, the trustee delivers to N certificates

evidencing interests in the bonds. These certificates are sold to public investors.

Each certificate represents the right to receive a particular payment with respect to

a specific bond. Under section 1286, stripped coupons and stripped bonds are

treated as separate bonds for federal income tax purposes. Although the interest

of each certificate holder is different from that of each other certificate holder, and

the trust thus has multiple classes of ownership, the multiple classes simply

provide each certificate holder with a direct interest in what is treated under

section 1286 as a separate bond. Given the similarity of the interests acquired by

the certificate holders to the interests that could be acquired by direct investment,

the multiple classes of trust interests merely facilitate direct investment in the

assets held by the trust. Accordingly, the trust is classified as a trust.

13

Can A Retirement Plan Be A Trust?

Canadian retirement plans - are they so different from

U.S. retirement plans?

See IRS Notice 2003-75

This notice sets out how these plans are to be

treated and certain procedures related to

informational return filings.

Forms 3520 and 3520-A used to be required.

Now, there is a new reporting regime for

Canadian RRSPs and RRIFs.

AICPA.ORG: IRS responds to AICPA concerns for filing Forms

3520 and 3520-As on Canadian retirement plans. Similar

issues apply for non-US retirement plans.

14

Can A Life Estate Be A Trust?

Usufruct: Are they so different from a U.S. life estate?

In Public Letter Ruling – 9121035 (91 TNT 116-

47 (February 25, 1991), the IRS characterized a usufruct

under German law (a Civil Law country) as a foreign non-

grantor trust.

In Estate of O.T. Swan, 24 T.C. 803 (1981, acq.

1981-2 C.B. 1., the Tax Court determined that stiftungs

should be treated as trusts, for U.S. tax purposes.

15

Disclosures

Not FDIC Insured | No Bank Guarantee | May Lose Value

LEGAL, INVESTMENT AND TAX NOTICE: This information is not intended to be and should not be treated as legal advice, investment advice or tax advice. Readers, including professionals, should under no circumstances rely upon this information as a substitute for their own research or for obtaining specific legal or tax advice from their own counsel. IRS CIRCULAR 230 NOTICE: To the extent that this communication or any attachment concerns tax matters, it is not intended to be used, and cannot be used by a taxpayer, for the purpose of avoiding any penalties that may be imposed by law. For more information about this notice, see http://www.northerntrust.com/circular230. This presentation is for your private information and is intended for one-on-one use with current or prospective clients of Northern Trust. The information does not constitute investment advice or a recommendation to buy or sell any security, may not be suitable for all investors and is subject to change without notice. Securities products and brokerage services are sold by registered representatives of Northern Trust Securities, Inc. (member NASD, SIPC), a registered investment adviser and wholly owned subsidiary of Northern Trust Corporation.

FEATURES THAT MAKE A TRUST A FOREIGN TRUST


Defining Foreign Trust

All trusts are deemed to be foreign unless both the “court test” and “control test” are met.

• Court test: Court in U.S. is able to exercise primary supervision over trust administration.

• Control test: One or more U.S. persons have authority to control all substantial decisions of the trust.

Accidental tripping of the control test rules to become a foreign trust does have 12-month opportunity to correct.

17

§684 Caution

Direct or deemed transfers by a U.S. person to a foreign trust are taxable

under §684 as a sale or exchange for the amount of the property’s fair market value.

Gains, but not losses, are recognized.

Death of grantor creates an exception.

18

Slide Intentionally Left Blank

CATEGORIES OF FOREIGN TRUSTS


21

Foreign Grantor Trust Rules: Specific To Non-U.S. Residents, Non-U.S. Citizens

When would I use a foreign grantor trust?

• Essential tool for non-U.S. residents, non-U.S. citizens who have children

moving to the U.S.

• Let’s look at the Internal Revenue Code for the requirements:

• If a trust is a grantor trust (within the meaning of IRC sections 673 through

679), its income and gains generally will be taxed to the grantor (IRC Sect.

671).

• If a trust is set up by a foreign person, then specific rules, introduced by

the 1996 Small Business Act, will apply to determine whether the trust is a

grantor or non-grantor trust.

• Trusts that were established on or before Sept. 19, 1995 that were grantor

trusts under the general rules of sections 676 or 677 are “grandfathered”

as grantor trusts, provided that if any amounts were transferred to such

trusts after this date, the portion of the trust attributable to such transfers

must separately accounted for (See Notice 97-34, 1997-1 C.B. 422).

22

Foreign Grantor Trust Rules: Specific to Non-U.S. Residents, Non-U.S. Citizens (Cont.)

1. Mom and Dad do not want U.S. estate tax on what they

give to child.

2. Mom and Dad do not want U.S. gift tax on what they

give to child.

3. Mom and Dad do not ever want to have U.S. estate tax.

4. Mom and Dad would like to minimize U.S. income tax.

So, Mom and Dad set up a foreign grantor trust. There are

a number of scenarios, but their child is usually named as one of

the beneficiaries along with the parents.

• Mom and Dad (In China)

Child in U.S.

23

Initial Classifications

• IRC 672(f): In general, the grantor trust rules under the code will not apply to

foreign trusts unless the requirements of Sect. 672(f)(2) are satisfied.

672(f)(1) – In general: Notwithstanding any other provision of this subpart,

this subpart shall apply only to the extent such application results in an amount (if

any) being currently taken into account (directly or through 1 or more entities) under

this chapter in computing the income of a citizen or resident of the United States or a

domestic corporation.

Exception to general rules

672(f)(2)(A) – foreign grantor trust status available if:

1. 672(f)(2)(A)(i) – The power to re-vest absolutely in the grantor title to the

trust property to which such portion is attributable is exercisable solely by the grantor

without the approval or consent of any other person or with the consent of a related

or subordinate party who is subservient to the grantor, ****or*****

2. 672(f)(2)(A)(ii) – The only amounts distributable from such portion

(whether income or corpus) during the lifetime of the grantor are amounts

distributable to the grantor or the spouse of the grantor.

24

Benefits To A Foreign Grantor Trust

Treatment of income in a foreign grantor trust:

NRA: Preferred income tax regime

NRA: U.S. estate tax planning

NRA: U.S. gift tax avoidance

25

Disclosures



COMPLEXITIES OF SECT. 679 AND FOREIGN GRANTOR TRUSTS


Foreign Grantor Trusts: Overview

• Inbound and outbound

― Foreign grantor trusts under Sect. 679

― U.S. transferor treated as grantor of foreign trust

― Foreign grantor trusts under Sect. 672(f)

― Foreign person treated as grantor of foreign trust

27

Foreign Grantor Trusts: Sect. 679

• Policy to eliminate deferral opportunities for U.S. grantors

• Sect. 679 treats the U.S. transferor of assets to a foreign trust

with U.S. beneficiaries as the owner of the trust assets.

• Four requirements:

― Trust must be a foreign trust.

― Transferor must be a U.S. person.

― Trust must have one or more U.S. beneficiaries.

― Transferor must make a direct or indirect transfer of

assets to the trust (also satisfied by trust migration).

28

Sect. 679: Transferor Must Be U.S. Person

• “U.S. person” as defined in Sect. 7701(a)(30):

― U.S. citizens

― U.S. residents

― Domestic partnerships or corporations

― Certain estates

― Trusts meeting the control and administration tests

― Non-resident aliens making a Sect. 6013(g) election to file

jointly

• U.S. person includes NRAs who become U.S. residents within

five years of transfer to foreign trust.

― Complicates the ability to create an income tax “drop-off”

trust

29

Sect. 679: One Or More U.S. Beneficiaries

• Sect. 679(c)(1) creates a presumption that every foreign trust has a

U.S. beneficiary.

• Transferor bears the burden of rebutting the presumption by showing

that:

― Under the terms of the trust, no income or principal may be paid

or accumulated during the taxable year for the benefit of a U.S.

person.

― Termination of the trust during the taxable year would not result

in a distribution to a U.S. person.

• Important considerations:

― Local law of the trust may create contingent interest in persons

not specifically referenced in the trust.

― Trusts or entities with U.S. person

partners/beneficiaries/members may trigger inclusion.

30

Sect. 679: Transfers: Casting A Wide Net

• Sect. 679(a) includes both direct and indirect transfers to foreign

trusts.

― Direct transfers: Any transfer, for less than fair market value,

from the U.S. person to the foreign trust

― Indirect and constructive transfers

― Some examples of indirect transfers within the scope of

679(a):

― Transfer through a foreign person or entity serving as a

conduit

― Transfer from a U.S. or foreign grantor trust

― Constructive transfer via the assumption or satisfaction

of trust debt

― Transfer of assets to entities owned by a foreign trust

31

Sect. 679: Transfers: Exceptions

• Testamentary transfers

― Any transfers made to a foreign trust under a U.S. or foreign

will, including testamentary trusts

• Transfers for fair market value

― Any sale or exchange for fair market value

― Caution: Promissory notes only fall within the fair market value

exception if:

― Transferor and trust are not related persons under Treas.

Reg. 1.679-1(c)(5).

― Transferor and trust are related persons, but the note is a

“qualified obligation” within the meaning of Treas. Reg.

1.679-4(d)(1).

• Transfers to charitable or employee trusts

32


Sect. 672(f): Foreign Grantor Ownership Rule

• General rule: The grantor trust rules do not apply to any

portion of a trust that is treated as owned by a person other

than a U.S. citizen, resident or domestic corporation.

• Exceptions:

― Revocable trusts

― Trusts that may only distribute during grantor’s life to the

grantor or grantor’s spouse

• Special rules

― Certain foreign corporations treated as domestic

corporations

― Compensatory trusts

34

Sect. 672(f): Foreign Grantor Ownership Rule (Cont.)

• Revocable trusts

― No denial of grantor trust status where foreign person has power

to re-vest title in himself without consent or only with consent

of related or subordinate parties under Sect. 672(c)

― Presumption of subservient status

― Power to re-vest title must be exercisable for 183 days during

the tax year.

• Trusts distributable only to grantor and grantor’s spouse

― No denial of grantor trust status when, during the grantor’s life,

distributions may only go to grantor or grantor’s spouse

― Amounts distributable for the support of dependents qualify for

the exception.

35

Sect. 672(f): Treatment Of Foreign Entities

• For the purposes of 672(f), the following are treated as domestic

corporations:

― Controlled foreign corporations (CFCs)

― Passive foreign investment companies (PFICs)

― Foreign personal holding companies (FPHCs)

― Anti-abuse rule

• Recharacterization of gifts under Sect. 672(f)(4)

― A “purported gift” by a foreign partnership or corporation may, at the

IRS’ discretion, be recharacterized and taxed to the beneficiary.

― Gifts from foreign partnerships are recharacterized as ordinary

income.

― Gifts from foreign corporations are recharacterized as distributions

and are subject to CFC and PFIC rules.

― Beware Treas. Reg. Sect. 1.674(f)-4(a)(2)

36

Sect. 672(f)(5) Anti-Conduit Rule: Attribution To U.S. Beneficiary

• Prior to Sect. 672(f)(5), U.S. persons might transfer assets to a

foreign intermediary, who would contribute them to a grantor

trust for the benefit of the U.S. person or his affiliates,

thereby avoiding U.S. income tax.

• Sect. 672(f)(5) shuts the door on this type of planning by

denying grantor trust status when the grantor is a foreign

person, and a U.S. person beneficiary of trust has previously

transferred money to the grantor.

― Exception for annual exclusion gifts

37

DEFINING AND MANAGING TRUST INCOME AND FIDUCIARY ACCOUNTING INCOME


39

Foreign Non-Grantor Tax Rules: Harsh Results for U.S. Beneficiaries

When would these harsh rules apply?

Foreign non-grantor trusts are generally taxed in the same

manner as individuals, with certain modifications (Sect. 641(b)).

Let’s compare with a domestic trust …

40

Foreign Non-Grantor Trust Rules

Domestic trust: Will pay U.S. tax on its worldwide income and

capital gains. Items of ordinary income are generally taxed at

graduated rates, now up to 39.6%, after allowance of certain

deductions and credits.

Similarly to the tax rates for individuals, long-term capital gains

are taxed in the trust at 15% (unless a high income earner under

the American Taxpayer Relief Act of 2012).

In calculating taxable income, a trust will receive a deduction for

any distributions to its beneficiaries, to the extent that these

distributions carry out the trust’s “distributable net income (“DNI”)

for the year ((Section 661(a)). The DNI distributed will retain its

character as income or capital gains in the hands of the recipient

beneficiary and will be taxed to them (Section 662(b)). Capital

gain is usually tax in the trust.

41

Foreign Non-Grantor Trust Rules: DNI

Domestic trusts:

DNI consists of the trust’s fiduciary accounting income, with

modifications (Sect. 643(a)).

Standards rates apply, and income and capital gains retain

their character (Sect. 662(b)).

Foreign trusts:

As long as there is a current-year distribution of a trust’s

income and gains to a recipient, the tax due should not differ

significantly (except for the allowance of deductions and

credits) between a foreign grantor trust and a domestic grantor

trust.

42

Throwback Rules

The throwback rules essentially attempt to treat the beneficiary as having

received the income and gains when they were earned.

There is a “penalty” for failure to distribute and pay tax when due.

So, any distributions in later years in excess of DNI (under the first-in,

first-out basis) will be taxed at the recipient’s highest marginal income tax

rate for the year in which the income or gain was earned by the trust.

Capital gains lose their status effectively as LTCGs, and such are taxed

as ordinary income.

The throwback rules add an interest charge to the taxes in order to offset

the benefits of the tax deferral (Sect. 668).

This interest charge accrues from the year in which the income or gain is

recognized and ends with the year that the UNI amount is distributed, and

is assessed at the rate applicable to underpayment of tax, as adjusted,

compounded daily.

In many instances, the throwback rules can wipe out any economic benefit

from the deferral and can actually deplete all the trust assets.

Domesticating the foreign trust will not solve the issue. UNI remains in the

U.S. domestic trust, and the throwback rules apply as the UNI is

distributed.

43

Default Method Of Taxation To Mitigate UNI

The default rule is used to assist a taxpayer who did not

receive any supporting accounting to complete the foreign

non-grantor trust beneficiary statement. The taxpayer uses

this statement to ascertain UNI vs. DNI.

The default rule is wholly an administrative creation and

has no statutory underpinning, other than the usual grant of

authority to Treasury and the Service to issue regulations

and rules that are necessary to carry out congressional

intent. The method is described in the instructions to Form

3520.

There may be certain investment strategies that can assist

to bail out the trust’s UNI.

Consider modeling the default rules and potential payout

strategies

44

Disclosures




COMPLEXITIES WITH FOREIGN NON-GRANTOR TRUSTS


Sect. 667: The “Throwback Rule”

• Prior to the “throwback tax,” foreign non-grantor trusts

generally were not subject to U.S income tax on undistributed

foreign source income, which created an opportunity for

deferral or elimination of U.S. income taxes on income and

gains ultimately benefitting a U.S. taxpayer.

• Applies to any distribution from a foreign non-grantor trust to

a U.S. beneficiary in excess of current year DNI.

• Such distributions are deemed “accumulation distributions”

and are taxable to the U.S. beneficiary under Sect. 667.

• Practical effect is taxation of all accumulated income at

ordinary income rates, plus penalty interest charge. Effective

rate of taxation can reach 100%.

47

Planning Distributions To Avoid Throwback • Use “default method”

― Interest charge only applies to amounts in excess of 125% of average distributions

received during the three prior years.

― All distributions, whether income or principal, will be taxable.

• Avoid accumulations

― Payment of yearly DNI to U.S. “mirror trust”

• Throwback rule exceptions

― Include specific bequests – exempt under Sect. 663(a)(1)

― Bequests for specific sums are payable in not more than three installments.

― Specific bequests do not carry DNI to beneficiary under TR 1.663(a)-1.

• FAI exception

• Distribution of appreciated assets

― Distributions of property other than cash are valued at the lesser of the trust’s basis

in the property and the fair market value, reducing distribution value.

• Insurance solutions

48

CFC And PFIC Attribution: Foreign Trusts

• CFC overview and attribution rules

• PFIC overview and attribution rules

• The authority of proposed regulations

• Potential solutions

As with the throwback rule, the CFC and PFIC attribution rules are aimed at

taxpayers who use foreign entities to defer U.S. income taxation.

49

CFC Attribution: CFC Basics

• A foreign corporation is classified as a CFC if:

― More than 50% of either (i) the total combined voting power of

all classes of stock or (ii) the total value of the corporation’s

stock …

― … Is owned directly, indirectly or constructively by U.S.

shareholders each owning 10% or more of the total combined

voting power of all classes of stock on any day during the taxable

year.

• U.S. shareholders of a CFC must include in gross income their pro

rata share of the CFC’s Subpart F income.

― Subpart F generally includes most passive investment income and

income from certain transactions with related parties.

50

CFC Attribution To Foreign Trust Beneficiaries

• In determining whether a U.S. taxpayer is a 10% shareholder in

a corporation, the IRS considers shares owned directly,

indirectly and constructively.

• Under Sect. 958(a)(2), stock owned by or for a foreign

corporation, partnership, trust or estate is considered as being

owned proportionately by such entity’s shareholders, partners

or beneficiaries.

• The regulations note that the determination of a beneficiary’s

proportionate interest is a facts-and-circumstances analysis.

• FSA 199952014 and TR 1.958-1(d) ex. 3 suggest that the facts-

and-circumstances test will attribute CFC ownership to trust

beneficiaries without regard to the beneficiary’s actual ability

to vote the shares.

51

PFIC Attribution: PFIC Basics • Unlike the CFC rules, the PFIC rules do not take control into account.

• A PFIC is a foreign corporation that meets either test of Sect. 1297(a):

― 75% or more of the corporation’s gross income is “passive” income.

― Average of assets held by the corporation during the taxable year that produce (or are

held for the production of) passive income is 50%.

• Two punitive taxes for U.S. PFIC shareholders:

― Tax on distributions:

― Excess distributions: Distribution that exceeds 125% of average distribution in

three preceding years; subject to Sect. 1291 “deferred tax” regime + interest

― Non-excess distributions: Distributions that are not excess distributions are taxed

as ordinary dividends, but no QDI treatment is available.

― Tax on gain recognized on disposition:

― All gain recognized on disposition is treated like an excess distribution.

• Elections to avoid punitive taxes:

― QEF election: Shareholder pays pro rata share of PFIC ordinary income each year.

― Mark-to-market: Shareholder of marketable PFIC shares includes FMV of shares in

excess of basis as ordinary income each year.

52

PFIC Attribution To Foreign Trust Beneficiaries

• As with the CFC attribution rules, Sect. 1298(a)(3) provides for

attribution of ownership of PFIC shares by U.S. beneficiaries of foreign

trusts.

― The proposed regulations indicate that attribution of PFIC shares

through indirect ownership is a facts-and-circumstances analysis.

• Lingering uncertainty regarding effect of proposed regulations

• TAM 200733024

― Foreign non-grantor trust liquidated PFIC positions and distributed

half of its assets to U.S. beneficiaries.

― IRS relied on 1298(b)(5), without reliance on the proposed

regulations, and applied the PFIC disposition rules to the liquidation

and distribution.

― However, neither Sect. 1298 nor Sect. 1291 refer to “indirect” PFIC

shareholders. Only the proposed regulations make this connection.

53


Possible Planning Solutions

• Be aware of the U.S. tax characterization of foreign entities at

the time of formation

― Elective entity regime allows some flexibility.

― Caution: Reclassification of existing entities is treated as a

liquidation for U.S. tax purposes, and may trigger CFC and

PFIC attribution rules.

― Caution: Tax effects of pass-through treatment should be

carefully considered.

• Consider using grantor trusts to hold CFC and PFIC assets

― Beneficiaries of a grantor trust are not subject to the CFC

and PFIC attribution rules

55

ISSUES WITH U.S. TAX FORMS


Most Relevant IRS Forms

• Form 1040NR

• Form 1041

• Form 3520

• Form 3520-A

• Form 4970 (non-grantor trust)

• Form 8832 (check the box)

• Form 8938

• Form TD F 90-22.1 - FBAR

57

Form 1040NR

• Title: “U.S. Nonresident Alien Income Tax Return”

• Difficulty: The form reads for an individual but is required for non-resident aliens, for income tax purposes, and for estates and trusts.

• Schedule NEC (tax on income not effectively connected with a U.S. trade or business): Requires time to understand and become experienced; plus, often making an effectively connected election

• Focus on Schedule OI (other information), Item J

58

Form 3520

• Title: Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts

• Note: “Qualified obligations” are not deemed distributions.

Reporting generally includes:

• U.S. transfers directly or indirectly to foreign trust, or receives a distribution or loan from a foreign trust

• Simply being the U.S. grantor (i.e., income tax owner of foreign trust income, deductions and credits) any time during year

• Default (Schedule A) or actual (Schedule B) trust distribution regimes – generally one or other

• Distribution regimes both lead to Form 4970.

• Penalties include the greater of $ 10,000 or 35% of the amount transferred to/distributed from or 5% gross value.

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Form 3520-A

• Title: Annual Information Return of Foreign Trust With a U.S. Owner

• Cannot stress enough that form is due by the 15th day of third month after end of the trust’s tax year – think March (not April) 15th

• Late-filing penalty is the greater of $ 10,000 or 5% of gross value of assets “owned” by the grantor.

• Foreign country confidentiality rules are not reasonable cause.

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Forms 3520 And 3520-A

These returns require considerable documentation, time and thought.

Do not try to do these returns at the last minute.

Generally, the entire professional team touching on required information should review.

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Form 4970

Title: Tax on Accumulation Distribution of Trusts

For foreign trusts, this form is not filed but when required, it is attached as a worksheet to Form 3520.

Leaving aside definitions of UNI vs. DNI throwback years, this is basically an anti-deferral regime.

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Form 8832

• Title: Entity Classification Election

• Known as “check the box election”

• For foreign trusts, this is crucial since often underneath the foreign trust and above investments, there is a foreign entity that generally taxed as a corporation for U.S. tax purposes.

• At some point, controlled foreign corporation (CFC) and passive foreign investment company (PFIC) rules might arise, with untold complications.

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Form 8938

• Title: Statement of Specified Foreign Financial Assets

• This form is for domestic entities.

• However, an interest in a foreign trust (or estate) held for investment and not held in a financial account is a “specified foreign financial asset.”

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Form TD F 90-22.1

• Title: Report of Foreign Bank and Financial Accounts

• §679 is included with §§ 671 – 678, in terms of grantor trust to require a U.S. person to file.

• If a trust, including a foreign trust, has a greater-than-50% beneficial interest in assets or income, requires a U.S. person to file

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Documents

Foreign Trust Challenges for U.S. Tax Professionalsmedia.straffordpub.com/products/foreign-trust-challenges-for-u-s... · Foreign Trust Challenges for U.S. Tax Professionals ... and