Beneficiaries Must Disclose Foreign Trust Distributions
One of the most complicated aspects of international tax law involves the tax and reporting requirements of foreign trusts. While many foreign trusts may be considered tax-deferred or tax-exempt in the overseas country-of-source, that does not mean that the foreign trust enjoys the same tax status in the United States under the US Tax Code. As a beneficiary of a foreign trust, there are two (2) key components in order to remain in compliance with the US government. First, the beneficiary of a foreign trust must remain in tax compliance with the US tax filings, and second, the beneficiary has to properly report any distributions they receive from the foreign trust that may be considered an owner of. Here are some of the basics of being a US beneficiary of a foreign trust.
Foreign Grantor Trust (FGT)
With a foreign grantor trust, the owner/grantor is taxed on the trust income based on their ownership share. In other words, from a US tax perspective, the grantor is essentially taxed in proportion to their ownership in the foreign trust, even if distributions are not made. For beneficiaries of the trust, the distributions are typically considered non-taxable since they are not the owner of the trust.
Foreign Non-Grantor Trust (FNGT)
The non-grantor foreign trust rules differ from the grantor trust rules in that once a beneficiary receives a distribution from an FNGT, they are taxed on the distribution they received. In order to minimize the tax implications, the foreign non-grantor should issue the beneficiary a foreign non-grantor trust beneficiary statement (which is not yet a form per se). The statute identifies what should be included in the statement, such as what portion is DNI vs UNI.
*Issues such as the throwback tax rule can make distributions more complicated than they otherwise should be.
In general, the beneficiary of a foreign trust only files a Form 3520 in a year that they receive a trust distribution. One important fact to keep in mind is that unlike the distribution of gifts from a foreign person to a US Person (which has a threshold requirement before reporting is required), there is no threshold when it comes to foreign trust distributions so that any foreign trust distribution would require the US beneficiary to file an IRS Form 3520.
Form 3520-A is primarily reserved for Taxpayers who have ownership in a foreign trust. Unless the beneficiary has ownership in the foreign trust, merely being a beneficiary of the foreign trust would not usually require them to file a Form 3520-A.
Amnesty for Non-Compliance with Foreign Trust
When a US Person Foreign Trust Beneficiary has not filed the proper tax or reporting forms, they can get hit with significant fines and penalties. Most of the time, these penalties are assessable penalties that result from the non-compliance, and the beneficiary in the US does not have an opportunity to dispute the penalty before it is issued — because their first notice of the penalty is when they receive the CP-15 Notice. US taxpayers have an opportunity to avoid the penalty or minimize it to one of the offshore amnesty programs, as well as to remove or abate the penalty through reasonable cause, appeals, and litigation if necessary.