How to Report your Offshore Trust Structure

Do you hold assets through an offshore trust? You’ve just warmed the cockles of the IRS’s paperwork-loving heart. This article discusses everything you’ll need to file and what to do if you’ve missed a filing deadline or two.

Written by Stewart Patton

The IRS loves paperwork. If you choose to hold some of your assets through an offshore trust structure, then you’ll need to file several forms to report your structure each and every year.

Preliminary Paperwork

Before you can do the actual paperwork for your offshore trust, you need to set things up properly from the beginning with some preliminary paperwork.

First, the US tax administration of your offshore trust is made easier if the trust appoints a “US agent”—this is basically a US person who the IRS can ask for more information about the trust. The US agent can be the US settlor/grantor of the trust. If your trust does not appoint a US agent, then the trust must send even more paperwork to the IRS—there’s really no reason not to appoint a US agent.

So, the first piece of paperwork is an agreement whereby you and the trustee agree that you will act as the trust’s US agent. As discussed further below, one of the trust forms must be signed by the trustee every year, and it is easier to administer the trust if you have the power to sign this form. This detail can be taken care of in this same agreement.

Second, your trust is required to obtain a US tax identification number. Obtaining this number doesn’t make your trust subject to US tax or otherwise change the tax aspects of the structure, it just provides a way for the IRS to track the trust through all the various filings. The paperwork involved here is IRS Form SS-4, which simply provides basic information about the trust and its US owner.

Finally, the creation of the trust may be treated as a gift for US gift tax purposes depending on your specific facts. For example, where a father creates an irrevocable trust naming himself and his son as equal beneficiaries, the father has made a gift to his son of half of the amount contributed to the trust. In these cases, the donor would need to file a gift tax return on IRS Form 709. There is generally no tax to pay with this return, and there also will be no tax payable at any other time as long as the donor’s lifetime gifts and estate at death together are less than the applicable exclusion amount (which is currently over $5 million).

Actual Trust Paperwork

OK, now we can get into the actual paperwork for your offshore trust structure.

The trust itself must file an IRS Form 3520-A each year to provide information about the trust, its investment structure (including underlying entities), its assets, and the results of the trust’s investments. For this reason, preparing the IRS Form 3520-A can be rather time-consuming in the first year—it requires a thorough review of all applicable legal documents and an understanding of the overall investment structure.

Next, each settlor/grantor and each beneficiary who receives a distribution will need to file IRS Form 3520. Part of the IRS Form 3520-A is a statement provided to each settlor/grantor (reporting the income earned by the trust each year) and to each beneficiary who received a distribution (reporting the amount and other facts about such distribution). The filers of IRS Form 3520 must attach this portion of the IRS Form 3520-A to their IRS Form 3520 each year, and the failure to do so causes issues. This is why it is best for you to obtain the right to sign the IRS Form 3520-A—this helps insure that the form gets completed on time.

The IRS Form 3520 is due on the same date as your US federal income tax return (including extensions), but it is filed separately on paper—it is not a part of your tax return. The IRS can impose a penalty for failing to timely file the IRS Form 3520 equal to the greater of $10,000 or 35% of the amount transferred to the trust.

Additional Paperwork in your Tax Return

The forms discussed above are all filed separately from your tax return. However, your offshore trust structure will also impact your US federal income tax return itself. (This is actually a hidden danger of offshore trust structures—your tax return preparer may have no reason to ask whether you formed an offshore trust or experience in preparing the proper forms.)

First, if your offshore trust structure includes a foreign financial account (i.e., a bank or brokerage account with a non-US financial institution), then you’ll need to pay attention to the questions at the end of Schedule B (the schedule used to report interest and dividends you receive). You’ll want to make sure those questions are answered correctly to report your interest in such account and the country in which it is maintained.

Second, if your offshore trust structure includes a non-US entity below the trust, then you’ll have additional forms to file for this entity depending on the US tax treatment of the entity (i.e., as either a disregarded entity, a partnership, or a corporation). Non-US entities below offshore trusts are commonly classified as corporations for US federal income tax purposes, which would require you to file IRS Form 5471.

Third, if the trust’s assets are worth at least $50,000, and the trust owns a non-US entity or a foreign financial account, you may need to file IRS Form 8938. This form is relatively new (it was first required in 2011), and it essentially serves as a “cover letter” alerting the IRS that you own substantial offshore assets (because most of the information is reported on other forms anyway).

Finally, there are potential penalties for failing to file these forms, starting at $10,000 per failure, and criminal penalties can be imposed as well in the proper circumstances.

FinCEN Form 114

Think you’ve filed enough paperwork? Not quite yet—there may be just a little more. If your trust structure includes a foreign financial account, you’ll likely be required to file FinCEN Form 114 (which is commonly called the Foreign Bank Account Report or FBAR). This form is filed separately from your tax return using a separate Treasury Department e-filing system.

The penalty for failing to timely file the FBAR starts at $10,000 and can be as high as 50% of the account balance if the IRS determines that the failure to file was “willful.”

Help! I’m Behind on my Paperwork!

Don’t worry—you can get caught up using one of the IRS’s amnesty programs.

Get in touch so we can talk about your specific facts to determine which amnesty program would work best for you.

Want to know more? The Tax-Savvy Expat courses teach you everything you need to know about expat tax.