Discussion with @IRSMedic and @Keith__REDMOND about defensible compliance: Foreign Trusts, Form #3520 + Form #3520A – To be a "Foreign Trust", it must be a "trust". When in doubt about whether it's a "trust", is it safer to file a 3520 or NOT file a 3520? https://t.co/LNV0ady090
— John Richardson – lawyer for "U.S. persons" abroad (@ExpatriationLaw) August 10, 2019
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!
The latest Form #3520A Fundraiser underscores how over compliance can create difficulties. Perhaps the goal should be "defensible compliance" which is a happy medium between too little and too much. https://t.co/roHqUL5KZw pic.twitter.com/6Dp4G9yWBL
— John Richardson – lawyer for "U.S. persons" abroad (@ExpatriationLaw) August 10, 2019
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:
In my experience, having submitted a number of 3520-A clearly headed "PROTECTIVE SUBMISSION ONLY–THIS IS NOT A FOREIGN TRUST", IRS Ogden refuses to address that point, threatening 35% or $10,000 penalties for "defective" submission if (hard-to-get) data aren't entered their way.
— Andrew Grossman (@andygr) August 9, 2019
(Cont'd) The latest case is NY testamentary trust where 1 of 2 trustees renounced. The Will terms deprive the trustees of any discretion, and investment decisions are assigned to a U.S. broker. IRS Ogden don't want to know. Only way to fight it is in Tax Court if penalty imposed.
— Andrew Grossman (@andygr) August 9, 2019
It's not a trust for IRS purposes if you have total control over investment & disposition & FFI is just an intermediary to make it conform to local pension etc. law. OTH IRS will not give an opinion and if you file 3520/3520-A it's a never-ending cycle ending w your renunciation
— Andrew Grossman (@andygr) August 29, 2019
To be FORMwarned is to be FORMArmed!
John Richardson – Follow me on Twitter @ExpatriationLaw
like the only way to hit San Fran Bay at 100mph, is to jump off the GG bridge