IRS Provides Filing Relief to Certain Foreign Trusts Providing Retirement, Medical, and Educational Benefits

March 11, 2020

By  Brent Lipschultz

The IRS has finally heard the prayers of many tax practitioners who represent clients that have been stung for their failure to report certain compensatory/retirement arrangements structured as foreign trusts. In Revenue Procedure 2020-17, the IRS has designed a procedure whereby certain U.S. persons having an interest in tax-favored foreign trusts established and operated exclusively or almost exclusively to provide pension or retirement, medical, disability, or educational benefits are exempt from the informational reporting of IRC Sec. 6048 (i.e., Forms 3520 and 3520-A). Though Treasury and the IRS have previously issued guidance that reporting is not required for certain Canadian Retirement Plans, this new guidance expands the category of foreign trusts which are exempt from the informational reporting.

However, U.S. persons must still file a Foreign Bank Account Report, the Form 8938, Statement of Specified Foreign Financial Assets, and report the income from these plans.

The procedure further provides a road map for those who have incurred penalties for failing to comply with their previous reporting, with which they can request abatement of penalties assessed or a refund in the event that the penalties have been paid.

No Informational Reporting for Applicable Tax-Favored Foreign Trusts

The IRS and Treasury recognize that, because applicable tax-favored foreign trusts are subject to written restrictions (e.g., contribution limits, withdrawal consideration, and informational reporting imposed under the laws of the country in which trust is established) and because U.S. individuals holding an interest may be required to separately report information under IRC Sec. 6038D (FATCA), it would be appropriate to exempt U.S. individuals from the requirement to provide information about these trusts under IRC Sec. 6048.

The reporting exemption has no impact on FBAR or any previous guidance issued with respect to distributions from certain compensatory trusts set forth in Notice 97-34, Section V, or reporting with respect to transfers to foreign compulsory trusts that are described in IRC Secs. 404(b), 404(a)(4) or 404(A).

Who is Eligible for the Relief

An “eligible individual” is defined for this purpose as an individual who is, or at any time was, a U.S. citizen or resident and who is compliant (or comes into compliance) with all requirements for filing a U.S. federal income tax return (or returns) covering the period such individual was a U.S. citizen or resident, and, to the extent required under U.S. tax law, has reported as income any contributions to, earnings of, or distributions from, an applicable tax-favored foreign trust on the applicable return (including on an amended return).

Tax-Favored Foreign Retirement Trusts and Foreign Non-Retirement Savings Vehicles Benefit

Tax-Favored Foreign Retirement Trust

This is a foreign trust that is created, organized, or established under the laws of a foreign jurisdiction as a trust, plan, fund, scheme or other arrangement to operate either exclusively or almost exclusively to provide or to earn income for provision of pension or retirement benefits with ancillary or incidental benefits that meets the following requirements established by the law of the trust’s jurisdiction.

  1. The trust is generally exempt from income tax or is tax-favored. A trust is tax-favored if it meets any of the following:
    1. Contributions to trust that would otherwise be subject to tax are deductible or excluded from income, taxed at a reduced rate, give rise to a credit, or otherwise eligible for a government subsidy, and taxation of investment income earned by the trust is deferred until distribution or taxed at a lower rate.
  2. Annual information reporting is provided or available to the relevant taxing authorities in the trust jurisdiction.
  3. Only contributions with respect to income earned from performance of personal services are permitted.
  4. Contributions to the trust are limited by a percentage of earned income of the participant, subject to annual limits of $50,000 or less, or subject to a lifetime limit of $1,000,000 or less.
  5. Withdrawals, distributions, or payments from the trust are conditioned upon reaching a specified retirement age, disability, or death; otherwise, penalties will apply. Withdrawals for hardship, educational purposes, or purchase of primary residence will be treated as meeting this section’s requirement.
  6. Employer-maintained trusts meet the requirement so long as the trust is non-discriminatory insofar as it covers a wide range of employees, provides significant benefits for a substantial majority of eligible employees and benefits are non-discriminatory.

Tax Favored Non-Retirement Savings Trust

The trust operates similarly as a Retirement Savings Trust, see items 1 and 2 above. Contributions to the trust are limited to $10,000 annually or $200,000 or less on a lifetime basis. Withdrawals, distributions, or payments from the trust are conditioned upon the trustee providing medical, disability, or educational benefits.

Procedures for Requesting Abatement or Refund of Penalties for Failure to Comply with Foreign Trust Reporting

Subject to the normal statute of limitation rules for collections, eligible individuals who have been assessed a penalty for failing to comply with the Foreign Trust Reporting Rules, without regard to whether the penalty had reasonable cause, can file Form 843, Claim for Refund and Request For Abatement, and write a statement “Relief Pursuant to Revenue Procedure 2020-17” on line 7 of the form.

Comments:

Many innocent taxpayers have been caught failing to file Forms 3520 and 3520A for certain retirement and employee benefit trusts. Taxpayers will have to review each account or arrangement to determine if a particular trust meets the requirements to be classified as a “tax-favored foreign trust.” This will require the assistance of a professional in the local jurisdiction to assess if all requirements are met. If the plan is qualified, taxpayers are relieved of their filing obligations beginning for tax years commencing in 2019.

Citations: Internal Revenue Code Sections 6048, 6677, 6038D, 7701(a)(30)(A); Section V of Notice 97-34, 1997-1 C.B. 422, Rev. Proc. 2014-55, 2014-44 I.R.B 753,

Reproduced Courtesy: Leimberg Information Services, Inc (LISI) at http://www.LeimbergServices.Com

About Brent Lipschultz

Brent Lipschultz is a Partner in the Personal Wealth Advisors Group with over 25 years of experience, and a leader in the International Wealth Planning team.