The Internal Revenue Code (IRC) requires taxpayers to provide information to the IRS about a wide variety of foreign transactions. This includes the creation of a trust in a foreign country or the transfer of money to that trust. In early March 2020, the IRS issued Rev. Proc. 2020-17, which exempts certain foreign trusts from the usual reporting requirements. It also allows taxpayers who are covered by the exemption to request abatements or refunds of penalties for failure to file the required reports.
Foreign Trusts Defined
A trust, according to the IRS, is an entity formed under state law that “holds title to property, subject to an obligation to keep or use the property for the benefit of another.” Under the IRC, any trust that is within the jurisdiction of a U.S. court, or which is primarily controlled by a U.S. citizen or resident, is considered to be a “U.S. person.” A “foreign trust” is any trust that does not meet either of those criteria, meaning trusts organized in other countries, subject to those countries’ laws, and which are controlled by non-U.S. citizens or residents.
Section 6048 of the IRC requires taxpayers to make a report to the IRS within ninety days of a “reportable event” involving a foreign trust. Reportable events include:
– The creation of a foreign trust by a U.S. person, which could include individuals as well as business entities and organizations;
– Transfer of property, including money, to a foreign trust by a U.S. person; and
– The death of an individual U.S. person who owned a foreign trust, or whose estate included all or part of a foreign trust.
This requirement does not apply to transfers made for at least fair market value. Certain types of employee trusts, deferred compensation plans, and annuity plans are not subject to the reporting requirement. Failure to make a required report, or filing an incomplete report, can result in civil penalties of $10,000 or thirty-five percent of the “gross reportable amount,” whichever is greater, as well as criminal penalties.
In order to be eligible for the exemption provided by Rev. Proc. 2020-17, a taxpayer must be a U.S. citizen or resident. They must generally be in compliance with all tax-filing requirements, and they must have made all required reports on foreign trusts prior to the issuance of Rev. Proc. 2020-17.
Foreign Trusts Covered by the Exemption
Rev. Proc. 2020-17 identifies two categories of foreign trusts covered by the exemption, which it describes as “applicable tax-favored foreign trusts”:
1. A “Tax-Favored Foreign Retirement Trust” is created in a foreign country for the purpose of “provid[ing], or to earn income for the provision of, pension or retirement benefits and ancillary or incidental benefits.” To be eligible for the exemption, it must be tax-exempt under the laws of the country where it is located, it must be in compliance with that country’s reporting requirements, and it must limit contributions to earned income from employees. Other criteria also apply.
2. A “Tax-Favored Foreign Non-Retirement Savings Trust” is created “to provide, or to earn income for the provision of, medical, disability, or educational benefits.” It must meet the same requirements regarding tax-exempt status and national tax reporting compliance.
If you have questions about a tax-related issue, please contact the tax advisors at the Enterprise Consultants Group online or at (800) 575-9284 today to see how we can help you.