In the first part of the general overview of Form 3520, we mentioned several important key words as well as details that need additional explanation in order to gain a better understanding of the form. We are going to further clarify these items and have broken the post out into several areas accordingly:
First, in order to avoid unnecessary filing along with lost time and money, it is important to know when you do NOT have to file Form 3520. The following section will describe the exceptions to filing.
As we noted in the last post, there are certain transactions that do not require Form 3520 to be filed. These exceptions include:
(i) Transfers to foreign trusts as defined in Sections 402(b), 404(a)(4), and 404A.
(ii) Most FMV transfers by a U.S. person to a foreign trust are also excluded. However, it is important to recognize that certain transfers are required to be reported. More detail is provided in Section III 97-34, 1997-25 I.R.B. 22, but here are a few examples:
-transfers in exchange for obligations that are treated as qualified obligations
-transfers of appreciated property to a foreign trust for which the U.S. transferor does not immediately recognize all of the gain on the property transferred.
-transfers involving a U.S. transferor that is related to the foreign trust
(iii) Ownership of, transfers to, and distributions from a Canadian registered retirement savings plan (RRSP) or a Canadian registered retirement income fund (RRIF) where with respect to the RRSP or RRIF, the U.S. citizen or resident alien that holds an interest in the RRSP or RRIF is eligible to file Form 8891 (U.S. Information Return for Beneficiaries of Certain Canadian Registered Retirement Plans)
(iv) Distributions from foreign trusts are taxable as compensation for services rendered so long as the recipient reports such distributions as compensation income on its applicable federal income tax return (see section 672(f)(2)(B) for further definitions and related regulation)
(v) Distributions from foreign trusts to domestic trusts that have a current determination letter from the IRS recognizing their status as exempt from income taxation under section 501(c)(3)
(vi) After application of 672(f), a domestic trust that becomes a foreign trust to the extent the trust is treated as owned by a foreign person.
For purposes of the above and our previous discussion of distributions in the context of Form 3520, a distribution is considered to be any gratuitous transfer (defined below) of money or other property from a trust. It does not matter whether or not the trust is treated as owned by another person under the rules of Section 671 through 679 or whether the recipient is designated as the beneficiary by the terms of the trust. The receipt of trust corpus and the receipt of a gift/bequest are also considered to be distributions. It also includes constructive transfers from a trust. For example, if you write checks on the bank account of a foreign trust, the amount will be treated as a distribution. Likewise, if a foreign trust pays or guarantees or secures the charges you make on a credit card, the amount charged will be treated as a distribution to you by the foreign trust. Additionally, if you receive a payment from a foreign trust in exchange for property transferred to the trust or services rendered to the trust and the FMV of the payment received exceeds the FMV of the property transferred or services rendered, the excess will then be treated as a distribution from the trust to you. For example, if you sell stock with a FMV of $200 to a foreign trust and receive $225 in exchange, you have received a distribution of $25. Similarly, if you received $500 from a trust for services you performed for the trust that had a FMV of $400, you have received a distribution of $100.
A gratuitous transfer to a foreign trust includes any transfer to the trust other than the following:
(i) A transfer for FMV
(ii) A distribution to the trust with respect to an interest held by the trust in an entity other than the trust (such as an LLC or partnership)
(iii) A distribution to the trust with respect to an interest held by the trust in an investment trust under Regulations section 301.7701-4
(iv) A liquidating trust (as described in Regulations section 301.7701-4)
(v) An environmental remediation trust (as described in Regulations section 301.7701-4)
Additionally, a transfer of property to a trust may also be considered a gratuitous transfer whether or not the transfer is considered a gift for gift tax purposes. Furthermore, if a U.S. person, in exchange for any type of interest in the trust, contributes property to the trust, the interest will not be considered in the determination of whether FMV has been received. However, if you transfer property to a foreign trust in exchange for an obligation of the trust (or an obligation of a person related to a trust), it will be a gratuitous transfer unless the obligation is a qualified obligation. See previous post for the definition and requirements of a qualified obligation.
In addition, it is important to note that just because a transferor is deemed to recognize gain on the transaction does not mean that the U.S. person will be treated as making a transfer for FMV.
Grantor and Grantor Trusts
To help us better explain the rules and regulations of Sections 671 – 679, we should clarify what is meant by the term grantor. According to the IRS, a grantor includes any person who creates a trust or directly or indirectly makes a gratuitous transfer of cash or other property to a trust. It includes any person treated as the owner of any part of a foreign trust’s assets under Sections 671 – 679 (excluding section 678). Unless a partnership or corporation makes a transfer for a specific business purpose of the partnership or corporation, the partners or shareholders are treated as grantors of the trust if the partnership or corporation makes a gratuitous transfer to the trust.
Furthermore, if one trust makes a gratuitous transfer to another trust, the grantor of the trust making the transfer is also treated as the grantor of the trust receiving the transfer. There is an exception if a person with a general power of appointment over the trust making the transfer exercises that power in favor of another trust. In that situation, the person is treated as the grantor of the trust receiving the transfer even if the grantor of the trust making the transfer is treated as the owner of the trust making the transfer.
A grantor trust is a trust whose assets are treated as owned by a person other than the trust. Various rules relating to grantor trusts are included in Sections 671 – 679. Note that a portion of a trust may be treated as the grantor trust to the extent that only a portion of the trust assets are owned by a person other than the trust.
A nongrantor trust is a trust whose assets are not treated as owned by a person other than the trust. As such, a nongrantor trust is treated as a taxable entity. A trust may be treated as a nongrantor trust with respect to only a portion of the trust assets.
Hopefully after reading this post you now have a better understanding of when it is necessary to file Form 3520, distributions, and grantors. They are important terms and issues to be aware of when completing the form.
Preparing form 3520 is not a task to be taken lightly. You should consider hiring professional help. At TaxPlannerCPA.com we focus exclusively on the tax issues of Americans living abroad, and we can certainly help you with this form. Contact us for a no charge initial consultation.
Tax Planner CPA is a team of Certified Public Accountants and Enrolled Agents with over 25 years of experience focusing exclusively on the taxation of US taxpayers living abroad. Our services include preparing form 3520. We maintain this knowledgebase where all articles are written by CPA’s, Enrolled Agents, or attorneys (Except for those on Expat Life – which have proven to be a popular read with fun facts on different cities!). Our main objective is to educate Americans abroad on their tax responsibilities, so that they can look for planning alternatives on time. They are also designed to help taxpayers looking to self prepare, providing specific tips and pitfalls to avoid. If you found this article helpful, you’ll likely benefit from our future ones as well – so we encourage you to avoid pitfalls and join our mailing list:
You can also request a no charge consultation by requesting a quote for our services here:
Or Speak to us live through the chat button on the bottom of your screen or by calling us at 1-855-TAX-2555.