What is a Foreign Unit Trust and How is it Taxed & Reported in the US?
In the world of global taxation, where there is much complexity in terms of legal structures, compliance requirements, and changing laws, many financial and tax terms are used interchangeably, especially by those who are not familiar with the terms. While it may not be an issue while sitting around the dinner table having an informal discussion with your spouse or friends, getting the reporting of certain investments wrong can often spell disaster, especially in the United States.
One such example is the foreign unit trust, which, at first glance, to those who are unfamiliar with such structures, appears to be no different than a trust. However, that is certainly not the case when it comes to U.S. taxation, and getting the reporting of such structures wrong from a compliance perspective can cause much stress and potentially financial hardship in the way of penalties.
But what is a unit trust? Is it an investment? Is it a trust? In its most basic form, a unit trust is similar to a mutual fund, but the profits flow through to the individual unit owners, as opposed to being reinvested back into the fund. Another key difference is that a unit trust is established under a trust deed and the investor of the unit trust is also the beneficiary of the unit trust.
Unit trusts are divided into units of investments, and the value of each asset in the unit trust is equal to the price per unit, minus operating expenses, and then this figure is multiplied by the total number of units. When you invest in a unit trust, you essentially buy units in the fund. A foreign unit trust, then, is a unit trust that is domiciled in a foreign country.
All of this is fine, but how are such investment vehicles taxed and reported in the U.S.? Simply put, a foreign unit trust is essentially treated as a foreign mutual fund in the United States. This means that for all intents and purposes, a foreign unit trust is treated as a passive foreign investment company, or PFIC (which we discussed in a previous article).
But what does this mean? It means that you will need to fill out Form 8621 to report not only the ownership in the foreign unit trust but also, to report the earnings and capital gains/losses of the foreign unit trust. This might not sound like a big deal until you realize that you will need to fill out a separate Form 8621 for each foreign unit trust you own.
Furthermore, and more importantly, electing the wrong treatment of the foreign unit trust on Form 8621 means that you may end up paying capital gains and ordinary income tax, even if no money was distributed to you by the foreign unit trust. Therefore, it becomes very important to select the correct treatment of these unit trusts on your U.S. tax return.
In addition to the reporting requirements on Form 8621, you may also have a Form FinCEN 114 (FBAR) and Form 8938 filing requirement for the foreign unit trust. Therefore, the reporting requirements around such structures are numerous, and the implications of getting it wrong, are huge. If you are the owner of a foreign unit trust or have a portfolio of foreign investments, please get in touch with us today to discuss your options, as not reporting the foreign unit trust in the U.S. or reporting it incorrectly can be devastating to your finances.