Proposed Regulations on Foreign Trusts and Foreign Gifts
IRS Form 3520-A Annual Return of Information Return of Foreign Trust with A U.S. Owner
The U.S. Treasury and IRS released proposed regulations in May this year, which would apply to transactions with foreign trusts and the receipt of foreign gifts. Some major changes are A. adoption and expansion of “qualified obligation” requirements throughout foreign trust statutes previously outlined in Notice 97-34 and previously only in Sec. 679 regulations, B. clarifying “dual resident/status taxpayer” not treated as a U.S. person regarding the portion of taxable year treated as NRA, C. enhancing the foreign gifts and foreign trust reporting requirements, such as name and address of foreign donor or foreign estate, D. starting annual inflation adjustment on the current $100,000 reporting threshold for large foreign gifts, and E. moving Form 3520 filing deadline to the 15th day of the 6th month for U.S. citizens and residents living abroad. A taxpayer may rely on these proposed regulations for any taxable year ending after May 8, 2024, and beginning on or before the date that final regulations are published, provided that the taxpayer applies the proposed regulations in its entirety and in a consistent manner for the tax years from the first year of reliance until the applicability date of final regulations.
While most part of the proposed regulations impose stricter rules and expanded reporting requirements on foreign gifts and foreign trusts, qualified obligation has long been a concept in foreign trust statutes, specifically in Treasury Regulations 1.679-4. However, it is less known before the proposed regulations. Therefore, rather than imposing restrictions, the proposed regulations on qualified obligations provide greater clarity on the requirements that would allow loans from foreign trusts to be treated as legitimate loans rather than taxable distributions.
The proposed regulations aim to enhance the IRS’ ability to enforce tax compliance by curbing taxpayer attempts to use foreign trusts and foreign gifts for tax avoidance. The expansion of data collection through increased reporting requirements would substantially increase the visibility of any foreign trust involving a U.S. person and any loan or income misclassified as a foreign gift.
Given the frequent errors we as tax practitioners have encountered in the IRS’ penalty assessments on Form 3520, Form 3520-A, as well as FATCA and FBAR reporting, we are pleased to see that the IRS has begun reviewing these Form 3520 and Form 3520-A penalties with the goal of improving enforcement accuracy, reducing the compliance burden and encouraging voluntary compliance. However, the proposed regulations will most likely increase the compliance burden on taxpayers. Further, while the goal is to encourage voluntary compliance, the proposed regulations did not provide for first-time abatement relief. Reasonable cause defense remains the only relief for a taxpayer who fails to report a foreign gift or certain transaction with a foreign trust. More instructions and guidelines should be in place, such as in the regulations and the IRM, to help agents make accurate initial assessments on Form 3520 and Form-A filings and promptly determine abatements.
