How to Know When a Trust is Foreign (Definition & Examples)

Definition of Foreign Trust by U.S. Person, 26 CFR 1.643(d)

Definition of Foreign Trust Created by a U.S. Person

When it comes to international tax law and overseas asset reporting compliance, one of the most complicated aspects of disclosure involves Foreign Trusts. That is because a trust can be defined in many different ways and have many different meanings depending on which country the trust was created and the purpose of the trust. Likewise, while a foreign trust may not be designated as a trust in the country where it was created, for United States tax purposes the IRS may determine that the foreign entity is a trust. And, if the taxpayer did not properly file the necessary forms such as Form 3520 and 3520-A, it may result in significant fines and penalties as was the case in Fairbank. Let’s walk through the definition of foreign trust as provided in the regulations to get a general idea of what may be considered a foreign trust when created by a US person.

1.643(d)-1 Definition of Foreign Trust Created by a United States Person

1. 1. 1. In general.

         • For the purpose of part I, subchapter J, chapter 1 of the Internal Revenue Code, the term foreign trust created by a United States person means that portion of a foreign trust (as defined in section 7701(a)(31)) attributable to money or property (including all accumulated earnings, profits, or gains attributable to such money or property) of a U.S. person (as defined in section 7701(a)(30)) transferred directly or indirectly, or under the will of a decedent who at the date of his death was a U.S. citizen or resident, to the foreign trust.

         • A foreign trust created by a person who is not a U.S. person, to which a U.S. person transfers his money or property, is a foreign trust created by a U.S. person to the extent that the fair market value of the entire foreign trust is attributable to money or property of the U.S. person transferred to the foreign trust.

         • The transfer of money or property to the foreign trust may be made either directly or indirectly by a U.S. person. Transfers of money or property to a foreign trust do not include transfers of money or property pursuant to a sale or exchange which is made for a full and adequate consideration.

         • Transfers to which section 643(d) and this section apply are transfers of money or property which establish or increase the corpus of a foreign trust. The rules set forth in this section with respect to transfers by a U.S. person to a foreign trust also are applicable with respect to transfers under the will of a decedent who at the date of his death was a U.S. citizen or resident. For provisions relating to the information returns which are required to be filed with respect to the creation of or transfers to foreign trusts, see section 6048.

Summarizing the Foreign Trust Definition

One of the key complications with foreign trust reporting is that a foreign trust is basically a catch-all. Under 7701(a)(31), the definition of a foreign trust is essentially any trust that is not covered under 7701(a)(30(E).

7701(a)(30) United States person The term “United States person” means—

• • • (E)any trust if—

      • (i) a court within the United States is able to exercise primary supervision over the administration of the trust, and

        • (ii) one or more United States persons have the authority to control all substantial decisions of the trust.

Next, presuming that the trust is a foreign trust, it does not matter if the US person actually created the trust or simply transferred assets into the trust. If the US person created the foreign trust then the value of the trust would be attributed to the US person. Conversely, if it is a foreign trust that was created by a non-us person to which the US person transferred money or property, then there attributed the fair market value of the foreign trust relative to the amount of money or property they contributed. In addition, transfers do not have to be made directly by the US person but rather could be directly or indirectly made into the foreign trust. If a taxpayer does transfer money into a foreign trust — but it is done pursuant to a sale or exchange for full and adequate consideration — then this would not impute ownership to the US person who made the transfer. The regulation also refers specifically to Section 6048 which provides detailed information about reporting the necessary international information returns, such as form 3520 reflecting ownership or an interest in the foreign trust.

Foreign Trust Examples

The regulation also provides 2 examples to assist taxpayers with understanding how the foreign trust rules work.

• • • Example 1. On January 1, 1964, the date of the creation of a foreign trust, a U.S. person transfers to it stock of a U.S. corporation with a fair market value of $50,000. On the same day, a person other than a U.S. person transfers to the trust Country X bonds with a fair market value of $25,000. The governing instrument of the trust provides that the income from the stock of the U.S. corporation is to be accumulated until A, a U.S. beneficiary, reaches the age of 21 years, and upon his reaching that age, the stock and income accumulated thereon are to be distributed to him. The governing instrument of the trust further provides that the income from the Country X bonds is to be accumulated until B, a U.S. beneficiary, reaches the age of 21 years, and upon his reaching that age, the bonds and income accumulated thereon are to be distributed to him. To comply with the provisions of the governing instrument of the trust that the income from the stock of the U.S. corporation be accumulated and distributed to A and that the income from the Country X bonds be accumulated and distributed to B, it is necessary that the trustee treat the transfers as two separate funds. The fund consisting of the stock of the U.S. corporation is a foreign trust created by a U.S. person.

    • Example 2. On January 1, 1964, the date of the creation of a foreign trust, a U.S. person transfers to it property having a fair market value of $60,000 and a person other than a U.S. person transfers to it property having a fair market value of $40,000. Immediately after these transfers, the foreign trust created by a U.S. person is 60 percent of the entire foreign trust, determined as follows: $60,000 (Value of property transferred by U.S. person) / $100,000 (Value of entire property transferred to trust) = 60 percent The undistributed net income for the calendar years 1964 and 1965 is $20,000 which increases the value of the entire foreign trust to $120,000 ($100,000 plus $20,000). Accordingly, as of December 31, 1965, the portion of the foreign trust created by the U.S. person is $72,000 (60 percent of $120,000). On January 1, 1966, the U.S. person transfers property having a fair market value of $40,000 increasing the value of the entire foreign trust to $160,000 ($120,000 plus $40,000) and increasing the value of the portion of the foreign trust created by the U.S. person to $112,000 ($72,000 plus $40,000). Immediately, after this transfer, the foreign trust created by the U.S. person is 70 percent of the entire foreign trust, determined as follows: $112,000 (Value of property transferred by U.S. person) / $160,000 (Value of entire property transferred to the trust) = 70 percent.

Late Filing Penalties May be Reduced or Avoided

For Taxpayers who did not timely file their international information-related reporting forms, the IRS has developed many different offshore amnesty programs to assist taxpayers with safely getting into compliance. These programs may reduce or even eliminate international reporting penalties.

Current Year vs Prior Year Non-Compliance

Once a taxpayer missed the tax and reporting (such as Form 3520, FBAR, and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, taxpayers should consider speaking with a Board-Certified Tax Law Specialist that specializes exclusively in these types of offshore disclosure matters.

Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)

In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful Taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties. 

Need Help Finding an Experienced Offshore Tax Attorney?

When it comes to hiring an experienced international tax attorney to represent you for unreported foreign and offshore account reporting, it can become overwhelming for taxpayers trying to trek through all the false information and nonsense they will find in their online research. There are only a handful of attorneys worldwide who are Board-Certified Tax Specialists and who specialize exclusively in offshore disclosure and international tax amnesty reporting. 

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure. 

Contact our firm today for assistan