Foreign trusts, their US grantors or owners, and their beneficiaries may have additional foreign informational filing requirements and other deadlines beyond the usual year-end tax filings, and the filing deadlines may differ from, and in some cases be earlier than, the usual April 15 due date. Affected taxpayers include:

— US income tax residents who:

— Have created foreign trusts, either in the current year or in the past, even if the taxpayers were not US residents at the time they created the trusts
— Are beneficiaries of foreign trusts
— Are treated as owners of foreign trusts
— Receive gifts from foreign persons

— Trustees of foreign trusts that have US beneficiaries or US grantors

Below is a list of these additional requirements and their respective due dates for the 2017 tax year.

Form 3520-A — Due March 15

Form 3520-A, Annual Information Return of Foreign Trust With a U.S. Owner, must be filed or extended by March 15. The form may be extended for six months to September 17 by filing Form 7004, Application for Automatic Extension of Time To File Certain Business Income Tax, Information, and Other Returns. An extension cannot be made by simply extending the due date for Form 1040. The penalty for failure to timely file Form 3520-A is the greater of $10,000 or 5% of the value of the portion of the trust treated as owned by the US person.

Form 3520-A must be filed by a foreign grantor trust with a US owner, as determined under Sections 671 through 679. The return must be filed by the trustee of the foreign trust. It is ultimately the US owner's responsibility, however, to ensure that the foreign trust files Form 3520-A and furnishes the required annual statements to all US owners and US beneficiaries. Therefore, if the trustee of the foreign trust does not file Form 3520-A, the US owner must file the return.

Form 3520 — Due April 17

Form 3520, Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts, is an annual return that must be filed no later than April 17. This return can only be extended by extending a taxpayer's income tax return (Form 1040). Form 3520 cannot be extended independently of Form 1040 or Form 1041. Thus, if Form 3520 cannot be filed by April 17, the taxpayer must request an extension to file Form 1040 or Form 1041 to also extend the due date for filing Form 3520.

Although the Surface Transportation and Veterans Health Care Choice Improvement Act of 2015 directed the Secretary of the Treasury to modify regulations to enable Form 3520 to be extended separately from Form 1040, the Secretary has not yet done so and the IRS has not updated its forms to reflect a separate extension. As a result, the rule that Form 3520 can only be extended by extending the taxpayer's Form 1040 still applies. Generally, failure to timely file Form 3520 will result in a 35% penalty on the unreported amount (5% of the value of the portion of the trust treated as owned by the US person if filing solely to report ownership of a foreign grantor trust), with a minimum penalty of $10,000.

Form 3520 must be filed by US persons to report certain transactions with foreign trusts and the receipt of certain large gifts and bequests from foreign persons. The following persons must file Form 3520:

— A US person who (directly or indirectly) receives a distribution from a foreign trust, regardless of the amount of the distribution

— A US person who, during the current tax year, is treated as the owner (under Sections 671 through 679) of any part of the assets of a foreign trust

— A US person who (directly or indirectly) received gifts from a foreign person exceeding, in aggregate, $100,000 during the current tax year (this includes US trusts that (directly or indirectly) received gifts from foreign persons exceeding, in the aggregate, $100,000 during the current tax year)

— A US person who (directly or indirectly) received gifts from a foreign corporation or foreign partnership (including foreign persons related to these foreign corporations or foreign partnerships) exceeding $15,797 that the US person treated as gifts

— A US person who is the issuer of an obligation held by a foreign trust that the US person treats as a "qualified obligation"

The grantor, transferor or executor (the responsible party) must file Form 3520 to report a "reportable event." Reportable events generally include:

— The creation of a foreign trust by a US person

— The direct or indirect transfer of any money or property to a foreign trust by a US person (including a transfer by reason of death) (this includes an individual who directly or indirectly transferred property to a foreign trust as a nonresident alien who becomes a US income tax resident within five years after such transfer)

— A change in status from a domestic trust to a foreign trust

— The death of a US citizen or US resident if the decedent was treated as the owner of any portion of a foreign trust or any portion of a foreign trust is included in the gross estate of the decedent

Due date for foreign and domestic trusts making 65-day distributions

Under Section 663(b), trustees may elect to treat distributions made in the first 65 days of a tax year as having been made on December 31 of the preceding tax year. This allows a trustee who wants to distribute all of the trust's distributable net income (DNI) during the tax year time to calculate the DNI and make the distribution.

Trustees intending to elect under Section 663(b) to treat distributions as having been made on December 31, 2017, must distribute the funds by March 6, 2018.

Background

While both domestic and foreign trusts can make the 65-day election, many foreign trusts utilize 65-day elections to ensure that all of the trust's DNI is fully distributed each year. This election is especially useful for foreign trusts because DNI that is not distributed in the calendar year in which it is earned may be subject to a throwback tax and interest charge if distributed to US beneficiaries in future years.

Computation of a foreign trust's DNI can be very complex, as the items of income and deduction included in the DNI of a foreign trust differ from those applicable to domestic trusts, and foreign trusts often hold foreign assets that pose unique US income tax inclusion and reporting issues.

Implications

Foreign trusts intending to make 65-day distributions must actually distribute the funds by March 6, 2018. The election itself is made on the trust's Form 1040NR, U.S. Nonresident Alien Income Tax Return, or, if none is required, by mailing the election statement to the IRS service center where a Form 1040NR would be required to be filed by the Form 1040NR due date.

All foreign trusts making distributions to US beneficiaries, regardless of whether they utilize the 65-day election, should consider computing their DNI in order to issue beneficiary statements to the US beneficiaries. This will allow the US beneficiaries to take advantage of the capital gains and qualified dividends rates on any current year income distributed to the beneficiary that consists of those capital gains and qualified dividends. If the foreign trust does not issue a beneficiary statement, all of the income will be treated as ordinary income, and the US beneficiary will be required to use a three-year averaging formula to determine whether a portion of the distribution is subject to the throwback tax and interest charge, potentially subjecting principal distributions to US income tax.

A US beneficiary's receipt of a 65-day distribution, which often occurs after the due date for payment of the beneficiary's fourth quarter estimated taxes, may cause the beneficiary to be underpaid and subject to underpayment of estimated tax penalties. A trust may elect under Section 643(g) to have any part of its estimated tax payments (but not income tax withheld) treated as made by a beneficiary or beneficiaries.¹ The fiduciary files Form 1041-T, Allocation of Estimated Tax Payments to Beneficiaries, to make the election.² Once made, the election is irrevocable.

State rules regarding treatment of 65-day elections may differ from the federal rules, so it is important to analyze whether a 65-day election that is effective for federal tax purposes also applies for state tax purposes.

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ENDNOTES

¹ This amount is treated as if paid or credited to the beneficiaries on the last day of the tax year of the trust, and is in addition to any amount deemed distributed on the last day of the year by reason of the 65-day election under Section 663(d).

² For the election to be valid, a trust or decedent's estate must file Form 1041-T by the 65th day after the close of the tax year as shown at the top of the form. For a 2017 calendar year decedent's estate or trust, that date is March 6, 2018.