Many US expats are not prepared for the IRS reporting requirements for offshore trusts, as most of these trusts are considered tax-neutral. However, because the US requires its citizens to report worldwide income regardless of where it is earned, any offshore trusts must be reported on your US expat tax return. Understanding your reporting requirements can be tricky, but here are the facts you should know and prepare for with proper expat tax planning in order to avoid large penalties!
US Trusts vs. Foreign Trusts
When it comes to reporting a trust on your US Tax Return, you must know the difference between a US trust and a foreign trust, as the reporting requirements differ for each. Expat tax planning tip: the IRS avoids using ‘offshore trust’ to differentiate these two, because ‘offshore’ could technically be a US or foreign trust – so the key difference between the two is in how you file them.
US Trust: You will use Form 1041 and will check the ‘grantor trust’ box in the upper left corner.
Foreign Trust: You will use Form 1040NR and will check the ‘estate or trust’ box in the upper right hand corner. If the grantor is an individual, he or she will need to check the box on Schedule B, Part III, line 8 of Form 1040 each year to report the foreign trust.
The typical asset protection trust will be classified as a ‘grantor trust’ while the settlor is living. This means the grantor will report and pay all US taxes reported by the trust, including interest, dividends and capital gains.
Foreign Trust Filing Facts for Expat Tax Planning
When filing your US expat taxes, you must file a Schedule B (Schedule of Interest and Ordinary Dividends) and check the box ‘Yes’ or ‘No’ to show whether you have transactions with a foreign trust. If you check ‘Yes’, you must fill out Form 3520-A/3520 to meet foreign tax compliance requirements.
A trustee will file Form 3520-A with the information the grantor needs to complete his or her Form 3520. For a majority of trusts, the filing deadline for Form 3520-A is March 15th (with the ability to request a six-month extension) and the deadline for Form 3520 is the same due date as of the filer’s tax return. Failing to file either of these forms if required can lead to large penalties of $10,000 or more, but can be lessened if you show reasonable cause. It’s also very important that you file these forms (and your expat tax return!) correctly, as they fall into the category of forms that increase your audit risk.
Other Reasons to File Form 3520
1. Filing Form 3520 is not limited to US owners of foreign trusts; you must also file this form if you’re a US citizen or resident alien with one of the following situations:
- You have certain transactions with a foreign trust
- You receive a large gift or bequest from certain foreign persons
Expat tax planning tip: If you meet any requirement for one or more foreign trusts, you must file Form 3520 along with your expatriate tax return.
2. There are also three different transactions that require you to file Form 3520 in the year the transactions occur:
- Transfer of money or other property (directly or indirectly) to a foreign trust
- Direct or indirect distributions you receive from a foreign trust
- Your related foreign trust held an outstanding obligation that you or a person related to you issued, that you treat as a qualified obligation (or if you hold a qualified obligation owed to you by a related foreign trust)
3. You must also file Form 3520 if you received a gift (learn more about gift taxes here) in the current year that fits one of the following:
- A gift or bequest of over $100,000 from a non-resident alien individual or foreign estate
- A gift of more than $15,601 (adjusted for inflation) from a foreign corporation or foreign partnership
When it comes to expat tax planning, understanding the ins and outs of filing Form 3520 can be quite complex, so it’s always recommended that you consult with a tax professional for expat tax advice when preparing to report a foreign trust. For more helpful US expat tax information, be sure to download a US expat tax guide.
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