Disclaimer: The following is for informational purposes only. It is not intended to constitute legal advice, or to recommend a course of action, and does not create an attorney-client relationship between the reader and Renuka Somers, or Somers Tax Law, PLLC.
On 7 May 2024, the U.S. Treasury Department issued REG–124850–08 which included proposed regulations providing guidance on:
- the information reporting of transactions with foreign trusts, and loans from, and the use of property of, foreign trusts, and
- the receipt by U.S. persons of large gifts or bequests from foreign persons.
Also included are amendments to regulations relating to foreign trusts with U.S. beneficiaries.
The regulations proposed incorporate prior IRS guidance (in Notice 97-34, Rev. Proc. 2014-55, and Rev. Proc. 2020-17), and include additional rules relevant to foreign trusts and gifts.
They attempt to address the uncertainty under the current law, relating to compliance requirements with respect to the foreign trust and gift provisions, and the tax consequences and potential penalties for failing to do so.
The regulations would apply in tax years beginning after the date on which the final regulations are published in the Federal Register.
The proposed regulations are applicable to U.S. citizens or residents who are grantors (owners) or beneficiaries of foreign trusts and estates (including Australian discretionary trusts), holders of accounts in certain tax-favored foreign retirement trusts[1], and U.S. citizens or residents who receive gifts and bequests from foreign persons.
Relevant Changes Proposed Include:
1. Reg. 1.643(i)-1 – Loans From, and the Uncompensated Use of Property of Foreign Trusts:
IRC section 643(i) treats loans of cash or marketable securities (other than “qualified obligations”), from foreign trust to any U.S. beneficiary, or related U.S. persons, as distribution from the foreign trust to such grantor or beneficiary. The uncompensated use of other trust property by any U.S. grantors, beneficiaries, or related U.S. persons, is also treated as a distribution at FMV.
[For U.S. Persons with Australian superannuation accounts: It is unclear whether a superannuation account would qualify as a “tax-favored foreign retirement trust” due to contributions limits].
Prop. Reg. 1.643(i)-1 provides guidance on determining when the distribution rules are triggered.
It also includes an anti-abuse rule for loans from foreign trusts to a grantor or beneficiary who becomes a U.S. resident or citizen within two years of receiving the loan, with the outstanding loan balance being treated as having been distributed when the individual becomes a U.S. resident or citizen: Prop. Reg.1.643(i)– 1(b)(3).
Exceptions to the deemed distribution rules include (Prop. Reg.1.643(i)–2(a)):
- “Qualified obligations”: written loans, not exceeding a 5-year term, with payments being made in U.S. dollars, which are issued at par with stated interest at a fixed rate/qualified floating rate and a yield to maturity of 100% – 135% of the applicable Federal rate,
- the de minimis use of trust property,
- fair market value (FMV) compensation for use of trust property, where payment is made within a reasonable period (60 days or less), and
- loans of cash from a foreign corporation to a U.S. beneficiary of a foreign nongrantor trust.
2. Proposed Amendments to the IRC Section 679 Regulations – Foreign Trusts Treated as Having a U.S. Beneficiary:
Under IRC section 679(a)(1), a U.S. person who directly/indirectly transfers property to a foreign trust is treated as the owner of the foreign trust to the extent of the transferred property if, the trust has a U.S. person as beneficiary. Exceptions to this rule include transfers by reasons of death, or at FMV: IRC section 679(a)(2).
Subject to certain exceptions, Prop. Reg. 1.679-2(a)(5) provides guidance on when a direct/indirect loan of cash/marketable securities from a foreign trust to a U.S. person or the use of any other foreign trust property by a U.S. person causes the foreign trust to be treated as having a U.S. beneficiary.
Additionally, Prop. Reg. 1.679-2(d) provides guidance on the IRC section 679(d) presumption of when a Foreign Trust has a U.S. Beneficiary: The IRS may treat a foreign trust as having a U.S. beneficiary, unless the U.S. person for the tax year in which the transfer is made, reports the transfer pursuant to Prop. Reg. 1.6048-2, and attaches an explanatory statement to their federal income tax return, demonstrating (to the satisfaction of the IRS) that, immediately after the transfer, the trust does not have a U.S. beneficiary (i.e. that, no part of the income or corpus of the foreign trust may be paid to or accumulated for the benefit of, directly or indirectly, a U.S. person, and if the foreign trust is terminated at any time during the taxable year, no part of the income or corpus of the trust could be paid to or for the benefit of, directly or indirectly, a U.S. person (Treas. Reg. 1.679-2(a)(1)).
The IRS may request additional information related to the foreign trust and its potential beneficiaries to determine whether the trust satisfied these requirements.
3. Section 6039F – Information-Reporting Rules for U.S. Recipients of Foreign Gifts:
The regulations proposed for IRC Section 6039F include information-reporting rules for U.S. recipients of foreign gifts, generally incorporating the guidance provided in IRS Notice 97-34. They also provide additional guidance and include anti-abuse rules.
A U.S. person who treats an amount received from a foreign person as a foreign gift during a taxable year must report that amount on Part IV of IRS Form 3520 by April 15th, unless an extension applies: Prop. Reg. 1.6039F–1(a)(1). The IRS can re-characterize an amount as a “foreign gift” where the recipient does not treat it as a gift or income (such as purported loan) if facts and circumstances indicate that the transfer is in substance a gift: Prop. Reg. 1.6039F-1(b)(2).
The aggregate amount of all gifts and bequests received by a U.S. person during the calendar year which exceed the annual exclusion amount ($18,000 for 2024), must be reported on Form 3520/Part IV, notwithstanding that the reporting threshold is otherwise $100,000: Pro. Reg. 1.6039F–1(c)(2)(ii), 1.6039F-1(g).
U.S. citizen/resident spouses are still required to report gifts/bequests from non-resident alien spouses if reporting thresholds are met.
4. Section 6048 – Information with Respect to Certain Foreign Trusts:
The regulations proposed for IRC section 6048 include information-reporting rules with respect to a U.S. person’s transfers to, creation of, ownership of, and receipt of distributions from foreign trusts, including requiring a responsible party (such as a grantor / transferor / executor) to provide notice of “reportable events” that occurred during the taxable year on Part I of Form 3520: Prop. Reg. 1.6048–2(a)(1).
Reportable events include (Prop. Reg. 1.6048-2(b)):
- The creation of a foreign trust by a U.S. person,
- Any direct, indirect, or constructive transfer of property (including cash) to a foreign trust by a U.S. person, including a transfer by reason of death,
- The death of a citizen or resident of the United States if the decedent was treated as the owner of any portion of a foreign trust under the grantor trust rules, or if any portion of a foreign trust was included in the gross estate of the decedent,
- A U.S. person’s transfer of property to a domestic trust that becomes a foreign trust (outbound migrations of domestic trusts), and
- A U.S. person’s transfer of property in exchange for any obligation of the foreign trust or of a related person, regardless of whether the obligation is a qualified obligation.
A reportable event does not include transfers to certain foreign charitable trusts, foreign compensatory trusts (such as IRC section 402(b) employee benefits trusts), and tax-favored foreign retirement trusts and tax-favored foreign non-retirement savings trusts: Pro. Reg. 1.6048–5(b).
Special rules apply in relation to dual resident aliens who are treated as NRAs under a tax treaty. For the purposes of the proposed regulations, a dual resident / dual status taxpayer is excluded from being a “United States person”[2]. Gifts by such persons are treated as having been made by a foreign person and are reportable, and they do not have to report transfers to foreign trusts: Prop. Regs. 1.6039F-1(f)(1)), 1.6048-3(e)(5).
5. Section 6677 – Civil Penalties for Failure to File Information with Respect to Certain Foreign Trusts:
Prop. Reg. 1.6677–1 relates to civil penalties that may be assessed if any notice or return required to be filed under the Prop. Regs. relating to IRC section 6048 is not timely filed or contains incomplete or incorrect information.
The failure to timely file a required notice or return, or to provide complete and correct information, carries a penalty equal to the greater of $10,000 USD or 35% of the applicable gross reportable amount (the gross value of property involved in the reportable event determined as of the date of the event in the case of a failure relating to report, or the gross value of the portion of the foreign trust’s assets treated as owned by the U.S. person, or the gross amount of the distribution/deemed distribution): Prop. Reg. 1.6677–1(a)(1).
If the failure to comply with the applicable reporting requirement continues for more than 90 days after the day on which the IRS mails notice of failure to the U.S. person required to pay the penalty, the person is required to pay an additional penalty of $10,000 USD for each 30-day period (or fraction thereof) during which the failure continues: Prop. Reg. 1.6677–1(a)(2).
The aggregate amount of the penalties imposed with respect to any single failure may not exceed the gross reportable amount with respect to that failure: Prop. Reg. 1.6677–1(a)(3)(i).
Endnotes:
[1] A foreign trust that is established under the laws of a foreign jurisdiction to operate exclusively/almost exclusively to provide, or to earn income for the provision of, pension or retirement benefits and ancillary or incidental benefits, and which meets certain additional requirements, such as contribution limitations or value thresholds, conditions for withdrawal, and information reporting (Rev. Proc. 2020-17).
[2] IRC section 7701(a)(30) defines a “United States person” as (A) a citizen or resident of the United States, (B) a domestic partnership, (C) a domestic corporation, (D) any estate (other than a foreign estate) and (E) any trust if— (i) a court within the United States is able to exercise primary supervision over the administration of the trust, and (ii) one or more United States persons have the authority to control all substantial decisions of the trust.
