To be FORMWarned is to be FORMArmed! The easiest way to receive a Form 3520A penalty would be to file a Form 3520

There is evidence from both tax practitioners and from individuals that Americans abroad are suffering from a “Form 3520A” penalty epidemic. Some of the best discussion of both the scope and technicalities of this problem may be found at Tax Connections. See particularly the posts here, here and here. (Mr. Carter’s original post was also reproduced at American Expat Finance.) The posts have attracted commentary from a number of tax professionals. The IRS Taxpayer Advocate has been invited to intervene.

“Tax Compliant” Americans Abroad are just a penalty waiting to happen!

Americans abroad are potentially required a very large number of IRS forms.

My point is simple. It’s the “possible” requirement to file International Information Returns that makes Americans abroad so vulnerable to the IRS penalty regime. As I commented at Tax Connections:

The only reason that the Form 3520A penalty was imposed was because a Form 3520 was filed!

Therefore, it’s important that Form 3520 (or any other International Information Return) be filed ONLY when it is required to be filed. Form 3520 is a form that is used for various requirements. This post is focused ONLY on the possible requirement of a Form 3520 because of a Foreign Trust.

In order to be a “foreign trust”, it must be a “trust”. Hence, the starting point is:

What are the requirements for an arrangement to qualify as a “trust” under the Internal Revenue Code?

1. Definitions are found in Internal Revenue Code 7701.

2. Treasury Reg. 301.7701-4(a) defines a trust as for Internal Revenue Code purposes as:

“an arrangement created either by will or inter vivos declaration whereby trustees take title to property for the purpose of protecting and conserving it for the beneficiaries under the ordinary rules applied in chancery or probate courts . . . . Generally speaking, an arrangement will be treated as a trust under the Internal Revenue Code if it can be shown that the purpose of the arrangement is to vest in trustees responsibility for the protection and conservation of property for beneficiaries who cannot share in the discharge of this responsibility and, therefore, are not associates in a joint enterprise for the conduct of business for profit”

There are at least two key components to this test:

1. The trustees have a responsibility for the protection and conservation of the property; and

2. The beneficiaries cannot share in the discharge of that responsibility.

It appears, that this means that a number of tax advantaged savings plans would NOT meet the definition of a “trust”. The suggestion that most Canadian TFSAs are “trusts” is laughable. How could a self-managed retirement fund be a “trust” under this definition? (See this 2013 post from Phil Hodgen where he applies this definition in order to to consider whether a UK ISA qualifies as a trust.)

The fact that the arrangement is labelled a trust is NOT determinative

Notice also that the definition focuses on the characteristics of the arrangement and NOT on the title of the arrangement. The fact that a TFSA is referred to as a “Trust” under the Income Tax Act of Canada is irrelevant. For example, much to the relief of Americans abroad, the IRS has ruled that “Mexican Land Trusts” are NOT trusts withing the meaning of the Internal Revenue Code.

Possible conclusion …

The first step is to consider whether the arrangement is a trust at all. An arrangement should be treated as a trust only if has the characteristics that are required to make it a trust.

When in doubt, it may be better to NOT treat the arrangement as a trust (possibly necessitating a Form 3520 and Form 3520A).

Interesting thoughts from Andrew Grossman:

To be FORMwarned is to be FORMArmed!

John Richardson – Follow me on Twitter @ExpatriationLaw

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