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U.S. Tax Form 3520-A Annual Return of Foreign Trust with U.S. Beneficiaries

Who Must Use This Form?

The trustee of a foreign grantor trust with a U.S. grantor must complete an annual Form 3520-A, which is substantially like the income tax return of a U.S. trust. If the foreign trustee will not complete the return, it is the duty of the U.S. grantor to prepare and file the return.

If the foreign trust has a U. S. beneficiary during the settlor's lifetime or within one year after settlor's and settlor's spouse's deaths, a 3520-A is required to be filed as an annual report in order to provide (i) a full and complete accounting of all the trust activities and operations for the tax year; (ii) the name of the U. S. agent for the trust; and (iii) other information as prescribed by the Internal Revenue Service.

A complete Form 3520-A is to be filed with the Internal Revenue Service Center, Philadelphia, PA 19255, and is due on the 15th day of the third month after the end of the trust's tax year or by March 15 for a trust with a calendar year.

If the foreign trustee refuses or fails to file the form, the duty falls on any U.S. person who is a grantor of the trust to ensure that the report is filed. A failure or inability to file the return will subject the owner of the trust assets (the grantor) to a penalty of 5% of the value of the trust assets owned by the trust. The penalty can be waived for "reasonable cause" but the law explicitly states that criminal or civil penalties on the foreign trustee is not a "reasonable cause" for failing to file the required information.

Form 3520-A is not required for a foreign trust that is an employee benefit plan under tax code sections 402(b), 404(a)(4) or 404A. Nor is it required for a Canadian Registered Retirement Savings Plan or a Canadian Registered Retirement Income Fund. However, the form is required for a Canadian Registered Education Savings Plan, for a Mexican fideicomiso (trust) and any kind of purpose trust. A foreign foundation that functions like a trust will most likely be treated as a foreign trust by the IRS and this form should be filed for any such foundation by those who wish to avoid potentially punitive penalties.

What Information Is Required?

If the foreign trust has a U. S. beneficiary during the settlor's (insured's) lifetime or within one year before the settlor's and settlor's spouse's deaths, a 3520-A is required to be filed as an annual report in order to provide (i) a full and complete accounting of all the trust activities and operations for the tax year; (ii) the name of the U. S. agent for the trust; and (iii) other information as prescribed by the Internal Revenue Service.

Form 3520-A is a four-page form that requires the disclosure of the income and expenses of the trust and a balance sheet as of the beginning and end of the tax year. The form also includes a "Foreign Grantor Trust Owner Statement" and a "Foreign Grantor Trust Beneficiary Statement" which provides the information that must be submitted by the trust grantor and any U.S. trust beneficiary.

Note that the income statement and balance sheet are required to be based on "fair values" rather than on generally accepted accounting principles (U.S. GAAP). Reasonable estimates may be made for assets that are not listed on an auction market.

When Is It Due?

Form 3520-A is due the 15th day of the third month after the end of the trust's tax year. For a trust with a calendar year, the due date is March 15th. However, the trust can request an extension by submitting Form 7004 by the due date. For a calendar year trust, this means that the six month extension is up by September 15th rather than October 15th when the Form 1040 extension expxires.

Copies of the "Foreign Grantor Trust Owner Statement" and any "Foreign Grantor Trust Beneficiary Statements" are to be provided to the trust grantor(s) and trust beneficiaries by March 15th or the 15th of the third month after the end of the trust's tax year or by the extended due date for the Form 3520-A.

Basically, Form 3520-A is an annual report that requires financial information about the trust, even if there are no transactions with any U.S. persons.

Where Should It Be Filed?

The Form 3520-A is to be filed with the Internal Revenue Service Center, Philadelphia, PA 19255.

How Long Does It Take To Prepare?

The preparation time depends mainly on the extent and complexity of the financial activity of the trust and the variety of trust grantor relationships and trust beneficiary relationships. According to the IRS instructions, the average time required to prepare the form is about 3.5 hours. We believe this would be accurate only for a foreign trust with a fairly small number of investments that were not actively traded. This also does not include any time required to prepare a Form 5471 for a controlled foreign corporation in which the trust is a shareholder, a Form 8865 for a controlled foreign partnership in which the trust is a partner or a Form 8621 for each passive foreign investment company (mutual fund or pooled income fund) in which the trust was a shareholder.

Any privately held entities in which the foreign trust has invested that are based on accounting principles that differ from U.S. "Generally Accepted Accounting Principles" (GAAP) will have to be restated to conform to U.S. GAAP standards.

If the trust has an extensive and active investment portfolio, it is likely to take much longer than 3.5 hours to complete this form. Foreign investment managers and banks (which function like a brokerage firm in the U.S.) rarely provide information detailed enough to prepare the form 3520-A.In many cases, the tax accountant has to track down the cost basis to an earlier year when the investment was acquired.

Dividend income needs to be analyzed to segregate dividends that qualify for the 15% (or lower) rate on qualified dividends and capital gains need to be analyzed to determine if they qualify for the 15% (or lower) rate. Option transactions and short sales need to be analyzed to determine if they must be treated as tax straddles or even as notational principal contracts.

Debt obligations with deferred interest need to be adjusted to comply with the rles for original issue discount. Fixed term and fixed return foreign annuities are subject to tax based on the increase in cash value each year.

When investments are made in foreign currencies, the purchase transactions and the sales stransactions need to be converted to U.S. dollars at the time of the respective transaction. Many foreign investment managers or banks compute gains and losses in the respective foreign currency and then convert the net gain or net loss to U.S. dollars as of the end of the year. When foreign money managers invest in foreign mutual funds that are held for more than a year, the fund gains or income may be subject to some very time consuming throwback calculations of accumulated income.

Compared to the time that may be required for these tax accounting issues, the actual time required to prepare the Form 3520-A may be minimal.

Why Comply ? (Penalties)

The U.S. owner (grantor) of any trust assets is subject to a penalty of 5% of the gross value of the portion of the trust assets that are treated as owned by the U.S. grantor if the foreign trust fails to file a timely Form 3520-A or does not provide the information required. A waiver of penalties can be made by the IRS upon a showing of a reasonable cause for a failure to file this form, but, according to the IRS, "The fact that a foreign country would impose penalties for disclosing the required information is not reasonable cause."

Comments

Because a foreign trust is a grantor trust, some practitioners believe it is necessary to file a Form 1041 to disclose that the applicable information is being reported on the tax return of the trust grantor. The current form 1041 specifically states that it should be filed in the case of a grantor trust under code sections 671 through 678. No mention is made of section 679. However, the amount of time required to file the front page of Form 1041 is minimal and filing it might help to avoid future problems with the IRS.

The U.S. grantor of the foreign trust will be required to respond "Yes" to the questions on Form 1040, Schedule B, Part III regarding foreign financial accounts and foreign trusts. The grantor will also be required (in most cases) to file a Treasury Dept. Form TD F 90-22.1 by June 30th of each year.

Copies of IRS Tax Forms and Instructions are available from their web site at
http://www.irs.gov/app/picklist/list/formsInstructions.html

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