US income tax and reporting requirements for foreign trusts and their US beneficiaries can vary depending on the types of assets that are owned by the foreign trust.
Most foreign trusts with US beneficiaries should expect that the US beneficiary or the foreign trust will be required to file Form 3520 and Form 3520-A. The specific reporting requirements will vary depending on the specifics of the foreign trust and whether the foreign trust is controlled by US persons.
In addition to Forms 3520 and 3520-A, US beneficiaries may be required to report the assets held within the foreign trust in the following international information returns.
Reporting Additional International Information
Foreign Financial Asset Reporting
US beneficiaries may be required to include the assets of the foreign trust in their US FBAR (FinCEN Form 114) or Form 8938 – Statement of Specified Foreign Financial Assets.
Passive Foreign Investment Companies
US beneficiaries often find that investments of the foreign trust, especially mutual fund investments, are subject to the Passive Foreign Investment Company (PFIC) regime.
The US beneficiary may be required to file Form 8621 – Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund with their income tax return and additional income taxation rules may apply.
If the foreign trust has invested in a foreign partnership, the US beneficiary may be required to file Form 8865 – Return of US Persons with Respect to Certain Foreign Partnerships.
If the foreign trust has invested in a foreign corporation, they may also be required to file Form 5471 – Information Return of US Persons with Respect to Certain Foreign Corporations or Form 926 – Return by a US Transferor of Property to a Foreign Corporation.
Importance of Tax Analysis
Understanding how a type of entity is classified under US tax principles—such as, a foreign corporation or foreign partnership—is important. Similar to above where a legal arrangement is found to be either a US trust or a foreign trust, the type of entity must be determined under US tax law Any local country tax characterization will usually be irrelevant to making this determination.
Completing the required US tax analysis of the trust and its investments can be time consuming and the consequence of errors could be high. Many of the informational forms noted above have $10,000 plus per year penalties for a missed or improper filing. The filings may be required for a US beneficiary who has never received a distribution from the foreign trust.