All U.S. taxpayers who have an interest in, or signatory or other authority over foreign trust accounts must file FinCEN Form 114, Report of Foreign Bank and Financial Accounts (FBAR), if the aggregate value of the foreign trust accounts exceeds $10,000 at any time during the calendar year. As of October 1, 2013 the FBAR form must be filed through the Financial Crimes Enforcement Network’s (FinCEN’s) Bank Secrecy Act E-Filing System on or before June 30th of the year following the calendar year being reported. For example, to report foreign accounts held open in 2013, the taxpayer must file the FBAR by June 30, 2014.
A U.S. taxpayer is deemed to have a foreign interest in a foreign trust account in two situations. First, the owner of record or holder of legal title is a trust of which the U.S. taxpayer is the trust grantor and has an ownership interest in the trust for U.S. federal tax purposes. Second, the owner of record or holder of legal title is a trust in which the U.S. taxpayer has a greater than 50 percent present beneficiary interest in the trust’s assetsor in the trust’s current income for the calendar year. The U.S. person who is a trust beneficiary may be exempted from filing an FBAR, however, if the trust, trustee, or agent of the trust is a U.S. person and files an FBAR disclosing the trust’s foreign financial accounts. A U.S. person who is only a reminder beneficiary or is the beneficiary of a discretionary trust is not required to file an FBAR for the trust as these interests are not “present” beneficiary interests.
In addition to filing an FBAR form, the U.S. taxpayer with an interest in a foreign trust account must follow certain reporting requirements on his or her annual tax return. First, the U.S. taxpayer must include a completed Schedule B, Interest and Ordinary Dividends, with his or her annual tax return. On Schedule B, the taxpayer will complete Part III, Foreign Accounts and Trusts. Questions 7a asks whether, at any time in the year, the taxpayer had a financial interest in or signatory authority over a foreign financial account. Question 7b also asks whether the taxpayer is required to file an FBAR, and if so, in which foreign country the financial account was located. Finally, Question 8 asks whether the U.S. taxpayerreceived a distribution from, or was the grantor of, or transferor to, a foreign trust.
If the U.S. taxpayer answered yes to Question 8 on Schedule B, he or she may be required to file Form 3520, Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts. Form 3520 applies to several types of U.S. taxpayers, including those who received a distribution from a foreign trust and those who created or transferred money or property to a foreign trust.
The U.S. taxpayer may also be required to file Form 8938, Statement of Specific Foreign Financial Assets with his or her annual tax return. Whether a taxpayer is required to file this form depends on where the taxpayer lives, the taxpayer’s filing status, and the value in the accounts. For example, unmarried taxpayers living in the United States must file Form 8938 if the total value of your interest in the foreign trust is more than $50,000 on the last day of the tax year or more than $75,000 at any time during the tax year. The value of the interest in the foreign trust equals the value of all cash or other property distributed during the tax year to you as beneficiary plus a value indicated on the valuation tables under section 7520.
A U.S. taxpayer who transfers money or property to a foreign trust may also be required to file a Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return. Generally, a U.S. taxpayer who transfers money or property totaling more than $14,000 for the year must file a Form 709. Form 709 is a separate tax return, which is not submitted with the taxpayer’s annual tax return.
Failure to comply with the above reporting requirements can result in steep penalties to the unwitting taxpayer. Failure to file an FBAR may result in civil penalties for negligence, pattern of negligence, non-willful, and willful violations. These penalties range from a high penalty for willful violations, equal to the greater of $100,000 or 50% of the balance in the account at the time of violation, to a low penalty of $500 for negligent violations. For failing to file a correct Schedule B or Form 8938, the taxpayer could face a failure-to-file penalty of $10,000, criminal penalties, and if the failure to file results in underpayment of tax, an accuracy-related penalty equal to 40% of the underpayment of tax and a fraud penalty equal to 75% of the underpayment of tax.
Failure to file a correct and complete Form 3520results in an initial penalty of the greater of $10,000, 35% of the gross value of any property transferred to or distribution from a foreign trust, or 5% of the gross value of the portion of the trust’s assets treated as owned by the U.S. taxpayer. An additional 5% penalty of any unreported foreign gifts may also apply for each month for which the failure to report continues.
Finally, failure to file a Form 709 may come with penalties for willful failure to file a return on time, willful attempt to evade or defeat payment of tax, and valuation understatements that cause an underpayment of the tax. A 20% penalty of the tax underpayment may be imposed on both a substantial valuation understatement (the reported value of property listed on Form 709 is 65% or less of the actual value of the property) and a gross valuation understatement (the reported value listed on the Form 709 is 40% or less of the actual value of the property).
U.S. taxpayers who have an interest in a foreign trust would benefit from the experienced tax attorneys of the Law Office Of Jeffrey B. Kahn, P.C. representing you to avoid the pitfalls associated with failure to comply with the reporting requirements associated with having an interest in a foreign trust.
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