Foreign Trust Reporting: Substance Over Forms? I Think Not

By:
Alicea Castellanos, CPA, TEP, NP and Jack R. Brister, TEP
Published Date:
Jun 1, 2016

In a world dominated by data, the IRS’s role in data collection continues to expand. No longer is the agency’s sole focus domestic income tax reporting, collection, and enforcement; rather, today’s IRS is responsible for activity that occurs beyond U.S. borders and disseminating an array of information. The IRS is increasingly focusing its efforts on foreign financial assets and cross-border activities, and the result has been a growing number of forms and reporting requirements for foreign wealth structures and foreign-based entities with U.S. connections.

Failure to meet these reporting requirements can trigger significant penalties - both financial and criminal - regardless of income or loss. Staying informed and compliant is a must, especially for those involved with foreign trusts, civil law foundations, or similar offshore wealth structures. As a result of the attributions rules related to certain foreign entities, U.S. individuals with connections to foreign trusts or similar wealth transfer structures that utilize underlying entities to hold trust assets may have additional disclosure and filing requirements with respect to those underlying entities. Consequently, an already complex situation becomes even more complex and frustrating. 

A few important U.S. tax forms, along with the consequences for failing to submit them in a timely manner, are listed below. In 2014, only an estimated 10% of U.S. taxpayers were in compliance with the following reporting requirements.

Foreign Financial Asset Reporting

Form 114 and Form 8938 both relate to the disclosure of foreign financial assets.

Form 114, Report of Foreign Bank and Financial Accounts (FBAR), is designed to capture information relating to individuals who have financial interest or authority over foreign financial accounts that in aggregate exceed $10,000 on any given day during a tax year. A non-willful failure to complete and submit the form could result in a penalty of $10,000, while the penalty for willful failure to comply can be the greater of $100,000 or 50% of the account balance, as well as criminal penalties.

Form 8938, Statement of Specified Foreign Financial Assets, captures foreign financial assets that exceed certain thresholds beginning with a total value that exceeds $50,000 on the last day of the tax year or $75,000 at any time during the tax year. These thresholds vary depending on the U.S. person’s filing status and where the person resides. Failure to comply can result in a $10,000 penalty, which increases by $10,000 for each 30 days of non-filing up to a maximum penalty of $60,000.

Foreign Entity Reporting

U.S. persons with a direct or indirect interest in certain foreign corporations, foreign partnerships, or foreign disregarded entities are required to file Forms 5471, 8865, and 8858, respectively. Each form, regardless of income or loss, carries a significant penalty for failure to file or file timely, resulting in penalties ranging from $10,000 to $50,000 (per form, per year). Cases where the transfer of property is involved can result in an additional penalty of 10% of the property’s value, up to a maximum of $100,000. 

An indirect interest can result through certain attribution rules, which deem that a U.S. person has an interest in a foreign entity even though the interest may be owned by a trust in which the U.S. person is a beneficiary or settlor, another entity, or even a family member.

Other International Reporting

If a foreign trust or similar wealth transfer structure (civil law structures) are invested in foreign mutual funds or private equity funds, a U.S. person having a beneficial interest or having settled such structure may also be required to file Form 8621 to disclose an indirect interest in the trust’s investments. 

Pre-Immigration to the United States

Wealthy foreigners considering immigrating to the United States should take note of these rules because they will likely apply to them. It would be wise to have a discussion of these matters with your tax counsel before coming to the United States and becoming a U.S. tax resident.

Voluntary Disclosure

Regardless of whether you reside in the United States, if you are already a U.S. tax resident (U.S. citizen, permanent resident (green card holder), or meet certain U.S. presence test rules) and you have a direct ownership interest or indirect interest in any foreign structures that have not been reported on your U.S. income tax returns, you should seek U.S. tax counsel regarding the IRS’s various voluntary disclosure procedures to see how best to come into compliance. 

Expatriation

Those considering giving up their U.S. citizenship or permanent resident status also need to ensure they have been filing all the appropriate international information tax forms for the five years prior to expatriating. If not, they cannot sign the Form 8854 stating they have met their U.S. tax filing obligations for the five years prior to expatriating without committing perjury and suffering substantial penalties for doing so.

Therefore, if a U.S. taxpayer, regardless of the jurisdiction of their residence, has a direct or indirect interest in any foreign economic activities in recent years, it warrants a discussion with appropriate U.S. tax counsel and the taxpayer’s wealth advisor. Seeking advice to ensure compliance can preserve capital and help avoid what could be a substantial loss of wealth.

This article originally appeared in the March 2016 issue of The International Wealth Tax Advisor. Copyright, International Wealth Tax Advisors LLC, 2016. Reprinted with permission.


Alicea Castellanos, CPA, TEP, NP, has more than 15 years of experience. She specializes in U.S. tax planning and compliance for non-U.S. families with international wealth and asset protection structures, which include non-U.S. trusts, estates, and foundations that have a U.S. connection and executives living and working abroad. Alicea also specializes in non-U.S. persons investing in U.S. real property and other U.S. assets, pre-immigration planning, U.S. expatriation matters, U.S. persons in receipt of gifts and inheritances from non-U.S. persons, non-U.S. account and asset reporting, offshore voluntary disclosures, FATCA registration, and non-U.S. companies seeking to do business in the United States. Alicea has been published and has spoken at numerous events on U.S. cross border tax matters. She can be reached at acastellanos@iwtas.com.

Jack R. Brister, TEP, has more than 25 years of experience. He specializes in U.S. tax planning and compliance for non-U.S. families with international wealth and asset protection structures, which include non-U.S. trusts, estates and civil law foundations that have a U.S. connection, and non-U.S. companies seeking to do business in the United States. Jack also specializes in non-U.S. persons investing in U.S. real property and other U.S. assets, pre-immigration planning, U.S. expatriation matters, U.S. persons in receipt of gifts and inheritances from non-U.S. persons, non-U.S. account and asset reporting, offshore voluntary disclosures, FATCA registration and compliance (W-8BEN-E and Form 8966) and executives working and living abroad. He can be reached at jbrister@iwtas.com.

 
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