Forget about the semantics argument raised last month by the “expatriate” controversy, the IRS is apparently moving aggressively to get at the details behind the financial dealings of US citizen-taxpayers who either transfer money or property into a foreign trust or receive benefits from a foreign trust.

 

Let’s look at the easy one first. The use of the word expat to describe those citizens who live in a country other than where they were born is different than the verb “expatriate” which means to denounce and abandon citizenship.

 

Those who voluntarily give up their US citizenship are treated harshly by the IRS. It is a complex issue and we will address it more fully in a following article, but let me give you some basics. Among the many documents you have to submit is an IRS Information Return Form 8854 which you can download from the irs.gov site. The law applies to any US Citizen or long-time resident whose prior five years income tax liability averaged more than $124,000 and whose net worth exceeds $2 million on the date of relinquishing citizenship or residency.

 

IF you relinquish your USA citizenship for tax reasons, the recently passed HEART Act imposes a tax based on a gain that would have resulted at the market value of all your worldwide assets as of the day before you renounce. It is yet to be tested in tax court and is a controversial topic of much discussion among tax attorneys in the gift and estate field. A local US attorney with experience and knowledge in the area and I will provide some references and more details soon.

 

So what does the IRS consider a ‘foreign trust’? - Our analysis of the IRC indicates that the Panamanian Private Interest Foundation would likely be treated as a foreign trust. It is NOT a private foundation under the US code which is usually treated as philanthropic tax-exempt entity.

 

August 5th, the IRS released a fact sheet focusing on reporting requirements that carry significant penalties for failure to comply. These are not new rules, but indicate a new emphasis by the IRS and a warning. The report and related financial information is likely to increase the compliance costs to the owners of a foreign trust by $1,000 a year – the required Form 3520 is a complex 6 page information return that provides full disclosure of the owners, beneficiaries and financial transactions between US Citizen-taxpayers and the trust.   It is very similar in content to the 4 page Form 5471 Controlled Foreign Corporation information return. Both of these forms are labor intensive to prepare and therefore can be expensive.

 

The IRS is explicitly trying to get at the funds they consider to be offshore where taxes can either be avoided or deferred, and they seem determined to prevent US persons from using offshore financial arrangements to accomplish those goals. 

 

Failure to file can result in penalties of 35% of the value of the transfers to the trust, 35% of the gross value of the distributions received from the trust, and 5% a month up to 25% of the gifts for each month the failure to file continues. Plus 5% of the gross value of the trust assets treated as owned by a US person. No penalties will be imposed for reasonable cause.

 

Be aware too, that the IRS explicitly states that a foreign country’s financial non-disclosure laws or the reluctance of an offshore fiduciary to provide the information, or provisions in the trust instruments that prevent the disclosure are NOT reasonable cause.

 

If you are the founder of a Private Interest Foundation, speak with your offshore services provider to make sure that there are no unpleasant surprises in your future.

 

Tom is a semi-retired US CPA who lives in Panamá and helps expats with their taxes and businesses set up QuickBooks systems. He can be contacted at tom@panamaquickbooks.com