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What Is a Grantor Trust and How Is It Taxed and Reported in the US?

Arin V., EA , MBA
Arin is an Enrolled Agent (EA), authorized to represent taxpayers in front of the IRS, and holds a BA and MBA (Management) degree from California State University, Northridge.
Are you the owner of a trust in your home country, but are now living and working in the United States? If so, there are some tax implications that you should be aware of. While a trust is a common vehicle for protecting and managing assets, setting up a foreign trust outside the U.S. brings with it various challenges from a tax reporting and compliance perspective, especially if one is considered to be the grantor of the trust.

But what is a grantor trust, and what is a grantor? The Internal Revenue Code and U.S. Treasury regulations provide that a foreign trust can be classified as a grantor trust in circumstances in which the grantor or other owner retains the power to control or direct the trust’s income or assets. These laws are designed to prevent U.S. taxpayers from achieving tax-free deferral by transferring property to foreign trusts. Therefore, a grantor of a trust is the owner of the trust and has control over the trust and its assets.

If a trust is classified as a grantor trust, then, for U.S. income tax purposes, the grantor of the trust is treated as the owner of the assets, the trust is disregarded as a separate tax entity, and all income is taxed to the grantor. In allocating all income to the grantor, the grantor is also allocated any applicable credits or deductions. Therefore, if you are the grantor of a foreign trust and at the same time a U.S. resident for tax purposes, then all the income and expenses of the trust will also need to be reported on your personal tax return as if those items were received or paid directly by you, and in turn, you will be liable for paying any tax that is due in the U.S. on the income generated by the trust. This is, of course, quite a different treatment than a domestic trust in the U.S.

As a U.S. owner of a foreign grantor trust, you would be required to file Form 3520, Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts, annually, to report ownership of the trust.

The trust itself must also file a Form 3520-A, Annual Information Return of Foreign Trust with a U.S. Owner, with the IRS, on an annual basis. As a U.S. owner of the trust, the grantor is responsible for ensuring that the trustee of the trust files the Form 3520-A.

Please note that the due dates for Form 3520 and Form 3520-A differ. Specifically, the filing due date for Form 3520 is April 15, whereas for Form 3520-A, the due date is March 15. You may file an extension to grant you an additional six months to lodge the returns.

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And what are the penalties for not filing a timely or correct Form 3520? In general, the initial penalty is equal to the greater of $10,000 or the following:

  1. 35 percent of the gross value of any property transferred to the trust for failure to report the transfer to a foreign trust
  2. 35 percent of the gross value of the distributions received by a foreign trust for failure to report receipt of the distributions
  3. 5 percent of the gross value of the portion of the trust’s assets treated as owned by the U.S. taxpayer under the grantor trust rules for failure to report the U.S. owner information

Further, an additional separate 5 percent penalty (or $10,000 if greater) may be levied for failure to ensure that the trust files a timely Form 3520-A and furnishes the required annual statements to its U.S. owner and U.S. beneficiaries, or does not furnish all the information required by section 6048(b), or includes incorrect information.

The penalty for failure to file Form 3520-A is imposed on the U.S. owner of the trust and is 5 percent of the value of the trust assets treated as being owned by the U.S. taxpayer. The failure to timely file a complete and correct Form 3520 and 3520-A may result in an additional penalty of $10,000 per 30-day period for failing to comply (within 90 days of notification by the IRS that the information return has not been filed).

Therefore, given these rather substantial penalties for filing a late or incorrect Form 3520 or Form 3520-A, we recommend not going it alone, and instead engaging the services of a professional and competent firm with experience lodging these returns for U.S. taxpayers. If you are the grantor of a foreign trust, please get in touch with us today so that we can assist with the timely and correct filing of these forms.

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