The IRS has clearly identified legitimate reasons why "U.S. Persons" would establish or maintain ownership in a foreign trust. However, a foreign trust creates complex IRS reporting requirements for US taxpayers who own a foreign trust under the grantor trust rules, or are beneficiaries with an investment in a foreign trust.
For example, there are specific triggers and reporting requirements for those who conduct transactions with a foreign trust, including:
- creating or transferring funds or property
- loaning money to or receiving a loan from a foreign trust
- moving assets
- transfer real property ownership
- receiving a beneficial distribution or the use of property without appropriate compensation
There are separate reporting requirements for US taxpayers who are beneficiaries or maintain ownership in a foreign trust and separate reporting requirements for the foreign entity or trust itself. These include but are not limited to the IRS Form 3520 - Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts, as well as the Form 3520-A - Annual Information Return of Foreign Trust With a US Owner.
Investment in a foreign trust creates complex IRS reporting requirements and FinCEN FBAR reporting obligations as well. Any United States person/taxpayer with a financial interest in or signatory authority over foreign financial investments or accounts must file an FBAR each year with the IRS if the value of the foreign trust exceeds $10,000 at any time (even for one hour) during each calendar year.
The failure to disclose your investment in a foreign trust to FinCEN (through FBAR reporting) or the IRS itself exposes you to substantial taxation, financial penalties, interest, and an increased likelihood of an IRS audit.
Recent international business and tax developments driven by FATCA enhanced IRS focus and resources within the agency itself have eliminated many tax strategies for shielding offshore income and assets. However, the IRS recently warned of a "specialized industry" of promoters and schemes specifically developed to facilitate US income tax avoidance through the use of foreign trusts and other offshore entity schemes.
The IRS warns that these providers often use faulty arguments based on complex tax and technical themes to convince the US taxpayer their schemes are "legal or compliant with the Internal Revenue Code." These arrangements often convince US taxpayers to enter into strategies designed to shield actual ownership and individual interests in these schemes while hiding the ownership, control, and activities of specific assets and associated income.
Over the past decade, the IRS has developed sophisticated direct reporting and data-sharing relationships with thousands of offshore banks, investment houses, and sovereign tax agencies. Therefore, the actions you take offshore and the transactions a foreign trust conducts are most often transparent to the IRS. Artificial intelligence has become the agency's go-to tool for combing through huge data streams from these agencies and other Foreign Financial Institutions (FFIs). These programs focus on foreign trusts, unreported income, and the associated unpaid taxes, penalties, and interest.
