Over the past few decades, the IRS has made an effort to increase awareness of reporting regulations for foreign trusts. If you are a U.S. taxpayer with financial ties to a foreign country, you may have a foreign trust that requires U.S. tax reporting.
Here are answers to some common questions we receive regarding U.S. taxation and reporting requirements for foreign trusts:
What is a foreign trust?
Generally, a trust is a structure in which legal title to property is transferred from the owner ("grantor") to another party ("trustee"), who will then administer the property for the benefit of a third party ("beneficiary"). Under US law, a trust that was organized in a foreign country and subject to that country’s laws and courts is a foreign trust.
How is a foreign trust taxed by the US?
For U.S. tax purposes, trusts are taxed as grantor or non-grantor trusts. When the grantor retains an incidence of ownership over the assets transferred to a trust, it is treated as a grantor trust under IRC Sec. 671- 679, and its income and capital gains are taxed to the grantor as if the assets had never been transferred. When the grantor gives up all incidence of ownership over assets transferred to a trust, the trust is taxed as a non-grantor trust in a manner similar to individuals. A foreign trust may be taxed as a grantor or non-grantor trust.
Why would a U.S. person own or be a beneficiary or a foreign trust?
We live in an increasingly mobile global society, consequently, many U.S. taxpayers have moved to the U.S. from, or have family members, in foreign countries and own or are the beneficiaries of trusts created in other countries. Trusts arrangements are common worldwide because they offer benefits such as preservation of property for future generations, asset protection, or a vehicle to carry on scientific, philanthropic, religious, or humanitarian purposes.
What U.S. tax reporting is required for a foreign trust?
If a foreign trust has a U.S. owner or beneficiary, U.S. tax reporting will be required. Transfers to, distributions from and annual income and expenses of foreign trusts must be reported on Forms 3520 and 3520-A as appropriate. These are filed annually, and reporting is based on US accounting principles.
How do I know if I have a foreign trust to report on my taxes?
Sometimes it is obvious that an arrangement is a trust and should be reported as such. However, there are several types of foreign income tax deferred financial vehicles that may be considered trusts for US reporting. For example, tax deferred investment vehicles such as Canadian RESP’s and TFSA’s are often treated as trusts, although there is disagreement among practitioners as to whether these arrangements should be reported as trusts and no clear guidance from the IRS.
What do I do now?If you think you have a foreign trust tax reporting issue, we can assist you with reviewing the trust documents, assessing reporting compliance, and catching up on past-due reporting if needed. Contact us here or call one of our tax planning professionals at 716.847.2651, we’re happy to help. View full article
“In the Great White North, there’s 5 pin bowling, and in the U.S., there’s 10 pin…”
-Bob and Doug McKenzie
Funny, but that simple phrase sums up the differences between estate taxes in the U.S. and Canada. Like bowling, both countries have a tax that is due upon a taxpayer’s death, it’s the same thing, (a tax) but it’s different. The following is a brief comparison of the death tax systems in both countries.
Having Assets in Canada Versus Having Assets in the U.S.
While there is no estate or inheritance tax in Canada, upon a Canadian taxpayer’s death, they are deemed to have sold their qualifying assets. A final income tax is calculated on the deemed gain on disposition of qualifying assets. Citizenship is irrelevant for this tax, it is based on residency or the location of the assets. The tax is reported on the decedent’s final income tax return.
Upon a U.S. taxpayer’s death, all of their property is valued at its current fair market value, less any deductible expenses and liabilities, and is taxed at estate tax rates. The tax is reported on an estate tax return. Unlike Canada, for all U.S. taxes, including estate taxes, citizenship is everything. Even if a U.S. citizen doesn’t reside in the U.S., estate taxes are based their worldwide assets. The current U.S. tax code allows for an exemption equal to the tax on $5,490,000 of the net taxable estate.
What If I Have Assets in Both Canada and U.S.?
If a taxpayer has assets in both the U.S. and Canada, both country’s estate tax could come into play. However, there is treaty relief from double taxation. If a Canadian taxpayer is subject to U.S. estate tax, there are treaty exemptions that allow for partial application of the $5,490,000 exclusion based on U.S. assets as a percentage of total worldwide assets. For a U.S. taxpayer subject to Canadian final income tax, the tax paid to Canada is creditable against U.S. estate tax on those assets subject to Canadian tax.
In the Buffalo area, owning property on the beach in Canada has been occurring for generations. Conversely, many Canadians purchase vacation homes in the southern U.S. for winter getaways. In addition to the cross border ownership of real property, it has become increasingly common for taxpayers to own closely held businesses in the non-resident country. Because of the interplay between the two country’s “estate” tax laws, careful cross border planning is recommended when a taxpayer desires to own real estate or other property in the U.S. or Canada when they are a citizen or resident of one country but not the other. It is generally best to own foreign investments through an entity such as a trust, LLC, or corporation rather than directly. If property is currently owned directly, there are options that can remedy exposure to estate or final income tax respectively.
Getting the Right Cross Border Tax Planning Guidance
If you currently own or are considering investment in property in the U.S. or Canada and are not a current resident or citizen of the country where your investment property is located, we can assist you in U.S.-Canada cross border tax planning considerations that can help you bypass estate tax issues for the non-citizen/non-resident country, contact us here.View full article
The Impact of the Foreign Account Tax Compliance Act (FATCA) of 2010
Breathes there the man with soul so dead, who never to himself hath said, “This is my own, my native land.” - Edward Everett Hale, “The Man Without a Country”
Poetic and patriotic words, but the reality of today is that many U.S. citizens don’t feel this way about their native land. In 2015, 4,279 U.S. persons relinquished or renounced their U.S. citizenship, a record-breaking amount. Many analysts project that the total number of renunciations or relinquishments in 2016 will exceed the 2015 mark. To put these numbers in perspective, less than 300 people renounced their U.S. citizenship in 2006.
Looking at statistics like these, you may ask yourself: “Why are so many people giving up U.S. citizenship?” And possibly, “Is this something I should consider?”
The Foreign Account Tax Compliance Act (FATCA) of 2010 and other U.S. tax reporting regulations may have something to do with why this is happening.
A simplified explanation of the FATCA legislation is as follows:
- It is primarily aimed at preventing tax evasion by U.S. taxpayers through the use of non-U.S. financial institutions and offshore investments.
- Foreign financial institutions are required to identify accounts held by U.S. persons and report account information to the IRS. Absent this information, they are required to withhold U.S. tax on U.S. source income paid and may decline account opening or terminate services.
Furthermore, the U.S. tax system is based on citizenship. A U.S. citizen pays tax on their worldwide income no matter what country they live in.
Beyond the tax compliance burden, the financial institution impact of the FATCA legislation has significantly impacted U.S. citizens living abroad. Rather than attempt to comply with FATCA reporting requirements, many foreign financial institutions are simply refusing to open or hold accounts for U.S. persons.
To alleviate the financial hardship and tax compliance burden, many U.S. citizens living abroad have decided not to maintain their U.S. citizenship. U.S. citizenship can be terminated through renunciation. A formal renunciation of U.S. citizenship must be made in a foreign state, generally at a U.S. consulate, and there are several State Department forms to file along with a processing fee.
In addition to the paperwork and fees, the exit tax under Internal Revenue Code Sec. 877A may apply. Generally speaking, in order to avoid the exit tax you must:
- be current with U.S. tax filings for the past 5 years,
- have had annual U.S. tax liabilities below $160,000 for those 5 years, and
- a net worth of less than $2,000,000.
If you find yourself in the situation where you are considering renunciation of your U.S. citizenship, there are planning opportunities and compliance requirements that must be considered. Contact Freed Maxick's International Expatriate Tax Services professionals to discuss your specific situation, or call to speak with an individual directly at 716.847.2651.View full article
As you know, dividing assets in divorce can be complicated. But, typically, charitable remainder trusts (also known as CRTs) are divided 50-50 into two separate trusts, in accordance with IRS Revenue Ruling 2008-41. But tax issues can make these divisions trickier than they might first appear.
How do you Spell Relief from Excise Tax?
There are two types of CRTs: 1) charitable remainder annuity trusts (CRATs) and 2) charitable remainder unitrusts (CRUTs). They are considered “split-interest trusts,” which means they generally are subject to Internal Revenue Code (IRC) Section 507(a) just as if they were private foundations. The provision levies a termination or excise tax when a private foundation’s tax status is terminated. But the question remains: Does transferring assets from a private foundation (or CRT) to another private foundation (or CRT) — as when divorce assets are split — trigger that tax?
According to Revenue Ruling 2008-41, if a transfer is pursuant to an “adjustment, organization or reorganization” that includes a significant disposition of assets, the transferee foundation isn’t treated as a newly created organization. Thus, the excise tax doesn’t apply. Significant disposition of assets encompasses the transfer of a total of 25% or more of the fair market value (FMV) of the net assets of the original private foundation to one or more private foundations. In the above scenario, 100% of a CRT’s FMV would be transferred. Therefore, no excise tax applies.
Defining Disqualified Persons
CRATs and CRUTs also are subject to IRC Sec. 4941(a)(1). It imposes an excise tax on each act of self-dealing between a private foundation and a disqualified person. Self-dealing may include any direct or indirect transfer of the assets or income of a private foundation to a disqualified person. It also includes use of such assets or income by — or for the benefit of — a disqualified person. Disqualified persons encompass (among other substantial contributors to the foundation) foundation managers, and members of the family of a substantial contributor or foundation manager.
Revenue Ruling 2008-41 states that divorcing spouses can be disqualified persons with respect to their original trust, which creates the potential for self-dealing. But it also concluded that spouse recipients are protected from self-dealing with respect to their interests upon the trust’s division. Because distributions are made pro rata, neither spouse will receive any additional interest in the original trust’s assets, the original trust’s remainder interest is preserved for charitable interests and no self-dealing transaction occurs.
Typically, trusts which are properly divided during divorce will still qualify as CRTs — avoiding certain excise taxes. Make sure you and your clients work with experienced financial professionals when it’s time to handle these types of assets.