IRS Tax Form 3520 U.S. Information Return with Respect to the Creation of or Transfers to a Foreign Trust
Who Must Use This Form?
The grantor or beneficiary of a foreign trust is required to file this form each time there is a "reportable event". Reportable events include .....
- The formation of a foreign trust
- The transfer of cash or other assets by the settlor/grantor to a foreign trust
- The receipt of any distributions by U.S. beneficiaries from the foreign trust
- The receipt by any U.S. person of a bequest from a foreign person in excess of $100,000
- The receipt by any U.S. person of a gift from a foreign partnership or corporation in excess of $13,000 (for 2009)
- Loan transactions between the trust and any beneficiary
- In addition, the U.S. grantor of a foreign trust must file this form each year.
What Information Is Required?
The Form 3520 is a six-page form with twelve pages of instructions. However, the information that must be provided depends on the kind of transfers made to the trust by the trust grantor or the kind of transfers made from the trust to the trust beneficiaries. For transfers to a foreign trust by the trust settlor/grantor, a description of the property and the amount of any unrealized gain on the property must be disclosed. For loans to a foreign trust, details are required to establish that the loan terms are comparable to an arms-length loan. Distributions from a foreign trust to a U.S. beneficiary require information to establish the tax treatment of the distributed amounts. This form is also used to compute the tax on excess accumulation distributions from a foreign trust.
When Is It Due?
According to the instructions to Form 3520, it is due on the date of the filing of the taxpayer's (grantor's) income tax return -- including any extensions of time to file.
However, Internal Revenue Code Section 6048(a)(1) states that "On or before the 90th day -- or such later day as the Secretary may prescribe -- after any reportable event, the responsible party shall provide written notice of such event to the Secretary in accordance with paragraph 2." Paragraph 2 basically descrbies the contents of the notice. The related IRS Regulations 1.63-1 affirm the 90 day filing requirement and specificlly refer to form 3520 and the required method of communication. (See the comments below for possible ways to deal with this contradiction.)
The form is required each year by the U.S. grantor of a foreign trust and by anyone who has made a loan to a foreign trust.
In addition, Form 3520 is only filed by a beneficiary when there are certain transactions with the foreign trust such as loans or distributions from the trust.
Where Should It Be Filed?
The instructions to the form state that this return is to be filed with the federal income tax return with a copy sent to the Philadelphia Service Center, Philadelphia, PA 19255. However, IRS Regulation 1.63-1(e)(2) states that "Returns required by section 6048 and this section shall be filed with the Director of Operations, Internal Revenue Service, Washington 25, DC." We could not find any indication that a copy of the Form 3520 was required to be attached to the income tax return of the taxpayer. (See comment below for possible ways to deal with this contradiction.)
How Long Does It Take To Prepare?
The time required to prepare the form varies greatly depending on the types of transactions that are to be reported. The IRS estimates that the average time required to prepare the form is about 6.5 hours, not including the time required to keep the related records and to study the applicable law and instructions for filing the form. However, if there are accumulation distributions or loan transactions, it is likely to take mch longer but if there are no accumulation distributions or loan transactions, it might take less than an hour to complete the form.
Why Comply ? (Penalties)
The penalties for a failure to file this form on time include (1) 35% of the gross value of the distributions received from a foreign trust or transferred to a foreign trust, and (2) 5% per month for the amount of certain foreign gifts -- to a maximum of 25%. Penalties may be waived by the IRS on a showing of reasonable cause for a failure to file. The U.S. does not consider that a reasonable cause includes the fact that the disclosure of this information might be a crime in another country. Howeever, penalties can be waived by the IRS upon a showing of reasonable cause for not filing the report on time.
Most U.S. tax preparers are not likely to be familiar with this form and very few of the professional tax preparation software programs used by U.S. tax preparers include this form. Thus, the tax preparer must carefully study the complex instructions and then complete the form by hand or by using the online fill-in-the-blanks pages on the IRS web site. (The fill-in-the-blank pages may require the use of the Adobe Acrobat program.)
A gift tax return is also required ( Form 709 ) for any irrevocable transfers to a foreign trust with U.S. beneficiaries other than the grantor or the spouse of the grantor.
Some Tips About the U. S. Foreign Trust Tax Forms
Form 3520 must be filed when there is a "reportable event" such as
- the creation/formation of a foreign trust
- the transfer of any money or property to a foreign trust
- the death of a U.S. grantor of a foreign trust
- the conversion of a domestic trust to a foreign trust
- sales to a foreign trust that are not "arms-length" transactions
Reg. Section 16.3-1(c) stipulates that the Form 3520 should be filed within 90 days of forming or funding a foreign trust. Although this is in contradiction to the instructions to the Form 3520, there are significant penalties for a failure to comply with the regulations and the instructions to the tax forms do not supercede the Regulations. However, for those who may have failed to comply with this requirement because of reliance on the instructions to the form 3520, such reliance should constitute reasonable grounds for a waiver of the penalty.
In addition, Form 3520 is required to be filed by any U.S. person who is "...treated as the owner of any part of the assets of a foreign trust under the grantor trust rules." Thus, a grantor of a foreign trust must file this form every year in addition to Form 3520-A .
The instructions for this form are not the clearest of the normally obscure instructions written by the IRS. It's virtually impossible to study the instructions without constant reference to the Internal Revenue Code and/or to various IRS regultions and information publications that are cross referenced in the instructions.
Tax Requirement of U.S. Beneficiaries of a Foreign Trust
One of the often overlooked details about foreign trusts is the tax reporting requirements of a U.S. beneficiary of a non-grantor foreign trust created by a non U.S. person or after the death of the U.S. grantor of a foreign grantor (asset protection) trust. It's not unusual for the beneficiary to have little or no knowledge of the details of the trust. Even so, the U.S. tax law imposes some significant reporting duties on the U.S. beneficiary of a foreign trust.
The specific provisions of the foreign trust may give the beneficiary sufficient powers as to make the beneficiary an owner of any part (or all) of the assets of the trust under the grantor trust rules in code sections 671-678. While IRC section 679 makes any foreign trust with (1) a U.S. grantor and (2) any U.S. beneficiary, a grantor trust -- regardless of the terms of the trust or the powers granted to the beneficiaries, IRC Sections 671 through 678 may also cause the beneficiary to be deemed to be an owner of some portion of the assets of the trust.
When that happens, the beneficiary becomes a trust grantor, with respect to that portion of the trust and is a "responsible party" for reporting a "reportable event" in connection with the trust. Therefore, a U.S. beneficiary of a foreign trust must determine if he or she has any rights or powers other than to receive distributions at the discretion of the trustee(s). If any such rights are available, the U.S. beneficiary should consult with a qualified foreign estate tax specialist who can determine if those rights or powers are sufficient to make the beneficiary a trust grantor.
The foreign trust reporting rules enacted by the 1996 and 1997 U.S. tax laws basically require the U.S. beneficiary of a foreign trust to report any distributions received from the trust whether or not the distribution is taxable. A U. S. beneficiary who receives a distribution from a foreign non-grantor trust is required to complete Form 3520, Part III.
In addition, a "Foreign Non-grantor Trust Beneficiary Statement" (see Form 3520-A) must include:
- the first and last day of the taxable year of the offshore trust to which the statement applies;
- an explanation of the appropriate U. S. tax treatment of any distribution or deemed distribution for U. S. tax purposes, or sufficient information to enable the U. S. beneficiary to establish the appropriate treatment of any distribution or deemed distribution for U. S. tax purposes;
- a statement identifying whether the owner of the trust is an individual, a partnership or a foreign corporation;
- a statement that the trust will permit either the Internal Revenue Service or the U. S. beneficiary to inspect and copy its permanent books of account, records, and such other documents that are necessary to establish that for U. S. tax purposes the trust should be treated as owned by another person. The statement is not necessary if the trust has appointed a U. S. agent; and;
- a description of property (including cash) distributed or deemed distributed to the U. S. person during the taxable year, and the fair market value of the property distributed; and
- a statement of whether the foreign trust has appointed a U. S. agent and, if so, the name, address, and taxpayer identification number of the agent must be included.
However, if the funds received from a foreign trust are compensation for services and have been reported as such on the beneficiary's tax return, then it does not need to be reported again on form 3520.
If there is no U.S. grantor of a foreign trust, then the U.S. beneficiary may need to be the "U.S. Agent" for the purpose of receiving any requests for information about the trust from the IRS. This includes any request by the IRS to examine any records of the foreign trust or to request any testimony regarding those records. The U.S. agent is also the party to whom the IRS delivers any summons for records or testimony.
In some cases, the U.S. beneficiary of a foreign trust that has invested in the stock of a foreign corporation (or IBC) may also be required to file form 5471 as an indirect shareholder of the foreign corporation. This will occur when the foreign trust and any other related parties to the beneficiary own 10% or more of the stock of the foreign corporation. If the foreign corporation has some "sub-part F" income, the U.S. beneficiaries will be obligated to pay income taxes on their share of that income. (Sub-part F income includes most forms of investment income and some specific types of business income.) Nominee and bearer share ownership does not change this rule. The Regulations look for "real" control in determining ownership.
Where the foreign trust is a partner in a foreign partnership (or LLC taxed as a partnership) and has a 10% or greater interest in the partnership, then the U.S. beneficiary may be required to file Form 8865 .
If the foreign trust has invested in any foreign investment companies, mutual funds or unit investment trusts, it's very likely that the beneficiary will be required to file Form 8621 to report income from a passive foreign investment company.
And if the foreign trust has a foreign bank or securities account or similar account, the U.S. beneficiaries will most likely be required to file Form TD F 90-22.1 even if the beneficiary has no personal signature authority over the account. This form is required if the beneficiary has a "... present beneficial interest in more than 50 percent of the assets or from which such person receives more than 50 percent of the current income." And, again, nominee and bearer share ownership does not avoid "real" control.
Treatment of Contradictory Instructions
A number of experienced practitioners have indicated that the 90 day filing rule is a vestige of the outdated code sections 1491 excise tax on certain transfers to a foreign trust, which have been repealed. Because excise taxes had to be paid on a quarterly basis, it made sense to require a filing of the form within 90 days. It appears that the tax writing committee and the IRS have simply overlooked the inconsistency of the 90 day filing rule and the repeal of the previous excise tax on transfers to foreign trusts. It also appears that this is the reason for the requirement to send a copy of the form to the "Director of Operations, Internal Revenue Service, Washington 25, DC."
Nonetheless, the clear language of the code and the regulations require that this form be filed within 90 days of each reportable event and that a copy be sent to the Director of Operations. While it would seem to be extremely unlikely that the IRS would impose penalties for not complying with the Code and Regulations, it appears that they could if they chose to do so. While the courts would most likely side with the taxpayer in the event of any significant penalties, each practitioner and taxpayer will have to decide whether to comply with all of the inconsistent instructions or whether to attempt make a decision as to which instructions should be followed.
Until the IRS issues regulations which affirm the instructions for Form 3520, we believe the most conservative course of action would be to file the form within 90 days of each and every reportable event throughout the tax year, with a cover letter explaining the contradiction between the instructions in the form and instructions in the Code and Regulations. In addition, although the requirment to file a copy with the "Director of Operations, Internal Revenue Service, Washington 25, DC." it seems the conservative approach would be to send a copy to that address, to the Service Center in Philadelphia and to also attach a copy to the taxpayer's Form 1040.
For a copy of the form and instructions, see http://www.irs.gov/app/picklist/list/formsInstructions.html
For background information on Form 3520, see Foreign Trust Reporting
For closely related information see Form 3520-ADownload PDF