US Taxes and Offshore Trusts: Understanding Form 3520

Because most offshore trusts are tax-neutral, many US citizens are not properly prepared for the IRS’ reporting requirements. Most notably, the US requires you to report your worldwide income on your US taxes, no matter where you earned it – meaning offshore trusts must be reported. Failure to handle these trusts in the proper way can lead to large penalties, so it’s important to understand the implications. Read on to learn more!

Know the Differences

Knowing what is different between a US trust and a foreign trust are key, because the reporting requirements are different for both. But, first, it’s important to know that the IRS doesn’t use the term “offshore trust” to differentiate the two, because technically “offshore” could be either a US or a foreign trust. The biggest differentiator between the two types is how you file them.

US Trust

  • You will use Form 1041, with the “grantor trust” box in the upper left corner checked

Foreign Trust

  • You will use Form 1040NR with the “estate or trust” box in the upper right corner checked
  • Additionally, if the grantor is an individual, he or she will have to check the box on Schedule B, Part III, line 8 of Form 1040 annually to report the foreign trust

While the settlor is living, the typical asset protection trust will be classified as “grantor trust” which means the grantor will report and pay all US taxes reported by the trust. This includes interest, dividends and capital gains.

What To Know About Foreign Trusts

On the bottom of the Schedule B (Schedule of Interest and Ordinary Dividends) you must file, there is a box where you must check “Yes” or “No” to show whether you have any transactions with a foreign trust. You will also be required to fill out Form 3520-A/3520 due to foreign tax compliance requirements. You should expect that if your Schedule B response is “Yes”, it will be crosschecked with the required Form 3520, so make sure these are filed properly.

Trustees will file Form 3520-A with the information the grantor needs to complete his Form 3520. For most trusts, the deadline to file Form 3520-A is March 15th (with the possibility of a six-month extension), and the deadline for Form 3520 is the due date of the filer’s tax return. There are potential penalties of $10,000 or more that can be enforced by the IRS for failing to file these forms – but can be lessened if you can show reasonable cause.

Who Else Needs To File Form 3520

In addition to a US owner of a foreign trust, you must also file Form 3520 if you are a US citizen or resident alien and one of the following situations applies to you:

  • You have certain transactions with foreign trusts
  • You receive a large gift or bequest from certain foreign persons

If you meet any requirement for more than one foreign trust, you will have to file Form 3520 with your US taxes for each trust.

There are three types of transactions that will require you to file Form 3520 in the year the transactions occur:

  • Transfer of money or any 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 and that you treat as a qualified obligation – or if you hold a qualified obligation owed to you by a related foreign trust

Also, you must file Form 3520 if you received a gift 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

Determining whether or not you must file Form 3520 may be complicated, as you can see. Avoiding costly mistakes is important when it comes to your taxes, so it’s always a good idea to consult a tax professional if you have any questions about the process of reporting your foreign trust information.

Have More Questions About Taxes Related to Foreign Trusts?

Greenback is happy to help. Our team of dedicated CPAs and IRS Enrolled Agents can provide you with the information you need to navigate the complex world of US taxes – contact us today!

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