In the overview of the series, we advised that in addition to filing income tax returns, U.S. citizens residing outside the U.S. are required to file various reports in respect of foreign holdings. Failure to file these reports can result in onerous penalties. In part V of the series, we will discuss the requirements to file the Form 3520: Interest in Foreign Trust.
V. Interest in Foreign Trust, Form 3520
The following is a brief overview of when a taxpayer needs to file Forms 3520 & 3520A, as well as reporting details.
Form 3520: Interest in Foreign Trust
Form 3520: Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts, and Form 3520-A: Annual Information Return of Foreign Trust With a U.S. Owner (Under Section 6048(b)) provide information about the foreign trust. This information is basically regarding its U.S. beneficiaries, and any U.S. person who is an owner of any portion of a foreign trust.
What is a ‘foreign trust’?
Firstly, as per the IRS, a domestic trust is a trust which has one or more U.S. persons having significant control and decision-making authoritative rights over the trust. Additionally, a US court can exercise primary supervision over its administration. A foreign trust is one on which any US court can exercise no rights.
To address this issue, for Form 3520 and 3520-A reporting purpose, a foreign trust is that trust which is created as per the laws of another country but has U.S. person(s) as owners and/or beneficiaries. Certain Canadian investment vehicles are considered foreign trusts and thereby subject to US tax reporting.
Usually, problems arise when an item is tax-deferred in one country while taxable in the other. For example, Canadian Registered Education Savings Plans (RESP) is a qualified tax-deferred savings plan in Canada. However, if this plan has a U.S. owner or when a U.S. beneficiary receives a distribution from the plan, it is subject to Form 3520 and/or Form 3520-A reporting. Likewise, for the Canadian Tax Free Savings Accounts (TFSA) that are held under an arrangement in trust with a trustee.
Canadian pension plans need to file Form 8833 electing deferral of tax.
Who must file Form 3520 & Form 3520-A?
In general, the reporting rules apply to a U.S. person who:
- Creates a foreign trust
- Transfers any money or property to a foreign trust
- Receives a distribution from a foreign trust
- Is treated as the U.S. owner of a foreign trust
When to file Form 3520 & Form 3520-A?
Form 3520-A is due one the 15th day of the 3rd month (typically March 15th) and can be separately extended to September 15th, while Form 3520 is due at the same time as the taxpayer’s federal tax return for the year (including extensions). This filing is separate, and not with the annual income tax return.
It is important to note that generally the TRUST files Form 3520-A. However, if the trust does not file the form, each U.S. person treated as an owner of any portion of a foreign trust is responsible for ensuring that the foreign trust files Form 3520-A and furnishes the required annual statements to its U.S. owners and U.S. beneficiaries.
What is reported on Form 3520 & Form 3520-A?
As mentioned above, the Trust files the annual information return Form 3520-A. Even if the foreign trust has at least one U.S. owner, it needs to file this form to provide the following information about the trust:
- U.S. beneficiaries, and
- U.S. person, who is treated as an owner of any portion of the foreign trust.
The form requires an income statement and balance sheet of the foreign trust. In addition, the trust also needs to complete a ‘Beneficiary Statement’ for each U.S. beneficiary providing information about the taxability of distributions received and foreign trust income they must report.
The U.S. owner or beneficiary of the trust files Form 3520, and should report any transactions made with the trust, and amounts of distributions and income reported on the income tax return.
Gifts from non-residents in excess of $100,000 are also reportable on Form 3520.
What are the penalties in case of non-compliance?
Penalties apply if the foreign trust fails to file a timely Form 3520-A, does not furnish the statements to the owners and beneficiaries, or the form includes incorrect information. The U.S. owner is subject to this initial penalty, which is equal to the greater of:
- $10,000; or
- 5% of the gross value of the U.S. person’s portion of the trust’s assets at the close of that tax year
In addition, penalties also apply for failure to file the Form 3520 which start at $10,000.
AG Tax LLP Can Help
If you have any tax-related queries, need assistance with tax planning or filing your tax returns please contact us. Our team comprises of highly experienced tax professionals with extensive knowledge of U.S. and Canadian tax laws as well as cross-border compliance.
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