Reporting Relief for Foreign Trusts - Forms 3520 & 3520A

On March 2, 2020 Internal Revenue Service issued Rev. Proc. 2020-17 which provides relief from reporting certain foreign trusts on forms 3520 and 3520A, and which provides for procedures to recover previously assessed penalties for failing to comply with Code Sec 6048.

This is very important news, since the compliance burden for reporting Canadian Registered Education Savings Plans (RESP's) and Canadian Tax Free Savings Accounts  (TFSA's) were quite onerous and penalties of $10,000 per occurrence were levied for late, not filed or incomplete returns.

Quoting from Rev. Proc. 2020-17 [with added comments]:

"The Treasury Department and the IRS have determined that, because applicable tax-favored foreign trusts generally are subject to written restrictions, such as contribution limitations, conditions for withdrawal, and information reporting, which are imposed under the laws of the country in which the trust is established, and because U.S. individuals with an interest in these trusts may be required under section 6038D [foreign bank account reporting] to separately report information about their interests in accounts held by, or through, these trusts, it would be appropriate to exempt U.S. individuals from the requirement to provide information about these trusts under section 6048. Accordingly, pursuant to the authority granted under section 6048(d)(4), the Treasury Department and the IRS are exempting from section 6048 information reporting an eligible individual's transactions with, or ownership of, an applicable tax-favored foreign trust. As a result, the penalties under section 6677 do not apply to eligible individuals who fail to report transactions with, or ownership of, these trusts under section 6048. In addition, eligible individuals who have been assessed penalties under section 6677 for failing to comply with section 6048 with respect to these trusts may, subject to the limitations of sections 6402 and 6511 [dealing with penalty abatement periods and methods], request abatement of penalties that have been assessed or refund of penalties that have been paid, by following the procedures described in section 6 of this revenue procedure."

Who is an Eligible Individual:

An "eligible individual" is a U.S. citizen or resident (including any person considered a U.S. resident by meeting the substantial presence test or green card test), who is compliant with (or comes into compliance with) all requirements for filing a U.S. federal income tax return for each relevant period.  The definition also requires that an "eligible individual" properly reports any income earned or distributions received from a tax favored foreign trust on each applicable return.

In order to be exempt from filing forms 3520 or 3520A for certain trusts, an individual must therefore be in full compliance with all other U.S. income tax reporting obligations for all relevant years.

Which Foreign Trusts are Affected by These Rules:

Rev. Proc 2020-17 refers to two types of foreign trusts, namely "Tax Favored Foreign Retirement Trusts" and "Tax Favored Foreign Non Retirement Savings Trusts".  

a) Tax Favored Foreign Retirement Trust

A Tax Favored Foreign Retirement Trust is one which is established primarily to provide income for pension or retirement benefits, and which meets the following requirements established in the laws of the trust's home country:

  • The trust is exempt from tax or is otherwise tax-favored in the home country.  This is established if it meets any one of the following conditions:
    • Contributions to the trust are deductible or excluded from income, taxed at a reduced rate, give rise to a tax credit, or give rise to a government subsidy or contribution;
    • Taxation of investment income earned within the trust is deferred until distribution, or is taxed at a reduced rate.
  • Annual information reporting regarding the trust's beneficiaries or participants is made to or available to tax authorities in the home country;
  • Only contributions related to income earned from the performance of personal services are permitted;
  • Contributions to the trust are limited to a percentage of earned income subject to an annual limit of $50,000 or less, or are subject to a lifetime limit of $1 million or less;
  • Withdrawals or distributions are conditioned upon reaching a specified age, disability or death, or penalties apply to withdrawals made if conditions are not met;
  • If the trust is an employer based trust, benefits must not discriminate between rank of employees and is available to a majority of employees.
  • Rollovers to or from the trust to or from another trust do not disqualify it.

The above definition appears to apply to Canadian Registered Pension Plan's and similar retirement trusts.

b) Tax Favored Foreign Non-Retirement Trust

A Tax Favored Foreign Non-Retirement Trust means a trust established exclusively to provide income for the funding of medical, disability or educational benefits, and meets the following conditions:

  • The trust is exempt from tax or is otherwise tax-favored in the home country.  This is established if it meets any one of the following conditions:
    • Contributions to the trust are deductible or excluded from income, taxed at a reduced rate, give rise to a tax credit, or give rise to a government subsidy or contribution;
    • Taxation of investment income earned within the trust is deferred until distribution, or is taxed at a reduced rate.
  • Annual information reporting regarding the trust's beneficiaries or participants is made to or available to tax authorities in the home country;
  • Contributions to the trust are limited to an annual limit of $10,000 or less, or are subject to a lifetime limit of $200,000 or less;
  • Withdrawals or distributions are conditioned upon the provision of medical, disability or educational benefits or penalties apply to withdrawals made if conditions are not met;
  • Rollovers to or from the trust to or from another trust do not disqualify it.

This definition appears to refer to Canadian Health Savings Accounts (HSA) or Registered Education Savings Plan (RESP) accounts.

Important note:  Canadian Tax Free Savings Accounts (TFSA) do not appear to meet the definitions above for either type of foreign trust and therefore holders of TFSA accounts should continue to report these plans on forms 3520 and 3520A.

Internal Revenue Service has indicated that it will issue further guidance which may further define eligible foreign trusts.

Effect on Foreign Bank Account Reporting:

This revenue procedure does not affect the requirement under section 6038D to report all accounts, including foreign trusts on the FinCEN Form 114 - Report of Foreign Bank and Financial Accounts (FBAR) or the related form 8938 - Statement of Specified Foreign Financial Assets as required.  Further, prior rules concerning reporting of Canadian Registered Retirement Savings Plans are not affected.

Abatement and Refund of Penalties:

Individuals who have been assessed penalties for late, missing or deficient forms 3520 or 3520A for relevant trusts may request an abatement of the penalty assessed or a refund of the penalty paid, under section 6677.  An abatement or refund claim may be made without the requirement to show reasonable cause for failure to comply with the former regulations.

To claim an abatement or refund form 843 - Claim for Refund and Request for Abatement should be filed indicating "Relief pursuant to Revenue Procedure 2020-17" on line 7 of the form.  Line 7 should also indicate how the individual meets the criteria for exemption under this Revenue Procedure.  Form 843 is filed with 

Internal Revenue Service

Ogden, UT 84201-0027

 

Effective Date:

The provisions contained in Revenue Procedure 2020-17 are effective on March 2, 2020 and apply to all future and open taxable years, subject to the provisions of section 6511 (which generally limits a refund or abatement to the last three years).

 

If you have paid or have been assessed a penalty for failure to comply with the filing of forms 3520 or 3520A for a relevant foreign trust, please contact us for an evaluation of your situation and the filing of an abatement request.