Certain U.S. Individuals Exempted From Tax-Favored Foreign Trust Information Reporting

Eli S. Noff, Esq., Partner

Mary Lundstedt, Esq., Associate

By now, most Americans with assets abroad understand that the Internal Revenue Service (IRS) expects them to disclose these assets-or risk subjecting themselves to serious penalties for failure to comply. Recently, the IRS has provided significant and welcome relief from reporting requirements for a particular category of assets that were notoriously messy-often resulting in duplicate reporting.

On March 2, 2020, the IRS released Rev. Proc. 2020-17, which provides certain U.S. individuals and residents (U.S. individuals) an exemption from Internal Revenue Code (IRC) §6048 information reporting requirements pertaining to their ownership of, and transactions with, certain tax-favored foreign trusts.[1] Additionally, subject to some restrictions discussed below, Rev. Proc. 2020-17 establishes procedures for U.S. individuals to recoup IRS penalties which they paid in the past for their failure to comply with the information reporting requirements. Similarly, U.S. individuals may also request abatement of penalties assessed but not paid yet. Rev. Proc. 2020-17 will be effective once it is published in the Internal Revenue Bulletin and is generally applicable to all open tax years.[2]

U.S. individuals who have previously reported tax-favored foreign trust interests-particularly those who have been assessed, or who have already paid, penalties for late filings-are urged to consult a tax professional who may help them achieve abatement or refund of those penalties.

Applicable Law and Rev. Proc. 2020-17 Definitions

1. Applicable Law

Generally, under IRC §6048, a U.S. individual's transfer(s) "of money or other property to, ownership of, and distributions from, foreign trusts" are subject to annual information reporting (See IRS Forms 3520 and 3520-A).[3] Failure to comply with IRC §6048's requirements may implicate penalties under IRC §6677. A notable reporting exception is provided in IRC §6048(a)(3)(B)(ii) for transfers to those foreign compensatory trusts described in IRC §§402(b), 404(a)(4), or 404A.

Importantly, the IRS is authorized under IRC §6048(d)(4) to suspend or modify any IRC §6048 requirement if the US lacks any significant tax interest in gathering the required annual information. Previously, the IRS issued guidance clarifying that reporting is not required for distributions from certain foreign compensatory trusts, so long as: (1) the distribution recipient reports the distribution as compensation income on the correct income tax return, and (2) that IRC §6048(a) through (c) information reporting is not required for certain Canadian retirement plans.[4]

Per IRC §6038D (IRS Form 8938) and corresponding regulations, a U.S. individual is required "to report any interest in a specified foreign financial asset provided that the aggregate value of all such assets exceeds certain thresholds."[5] Non-compliance may result in a penalty under IRC §6038D(d). "Specified foreign financial asset" specifically includes "interests in certain foreign retirement, pension, and non-retirement savings funds or accounts."[6] A U.S. individual subject to the IRC §6038D reporting requirement may also be required to report (on a separate form) similar information under IRC §6048.

In the context of revenue tax[E1] , IRC §6402(a) authorizes the IRS to credit an overpayment against any liability and refund the balance of such, so long as it is within the applicable period of limitations. However, IRC §6511 is clear that "no credit or refund shall be allowed or made after the expiration of the period of limitation prescribed in section 6511(a), unless the taxpayer filed a claim for credit or refund within that period."[7]

2. Important Rev. Proc. 2020-17 Definitions

Section 5.04 of Rev. Proc. 2020-17 defines an "eligible individual" as:

an individual who is, or at any time was, a U.S. citizen or resident (within the meaning of section 7701(a)(30)(A)) and who, for any period during which an amount of tax may be assessed under section 6501 (without regard to section 6501(c)(8)), 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).

According to sections 5.03 and 5.04 of Rev. Proc. 2020-17, a tax-favored foreign trust means a trust created under a foreign jurisdiction's laws which is operated exclusively (or almost exclusively) to provide pension or retirement benefits (retirement trust) or to provide medical, disability, or educational benefits (non-retirement trust).

Rev. Proc. 2020-17: Relief and Procedures

Significantly, in Rev. Proc. 2020-17, the IRS acknowledges that applicable tax-favored foreign trusts are already generally subject to written restrictions imposed by the foreign jurisdiction (i.e., contribution limitations, withdrawal conditions, and information reporting), and U.S. individuals with interests in such trusts may also be required to separately report information about their interests per IRC §6048. As such, the IRS, using its authority under IRC §6048(d)(4), has exempted "from section 6048 information reporting an eligible individual's transactions with, or ownership of, an applicable tax-favored foreign trust."[8]

In other words, U.S. individuals no longer face the IRC §6048 information reporting requirements regarding their tax-favored foreign trusts. As a result, none of the IRC §6677 penalties apply to U.S. individuals now exempt from that reporting requirement. In fact, the IRS explains that U.S. individuals who are now exempt from the IRC §6048 information reporting requirements may now request abatement of previously assessed, or refund of previously paid, IRC §6677 penalties (albeit, subject to the limitations in IRC §§6402 and 6511).

Rev. Proc. 2020-17 outlines the procedures for requesting abatement or refund of IRC §6677 penalties. Again, subject to limitations in IRC §§6402 and 6511, U.S. individuals may make their request by filing Form 843, Claim for Refund and Request for Abatement. This form should be mailed to Internal Revenue Service, Ogden, UT 84201-0027. Additionally, U.S. individuals should write "Relief pursuant to Revenue Procedure 2020-17" on Line 7 of Form 843. That same line should include an explanation of how the U.S. individual meets the requirements under Rev. Proc. 2020-17, §5.02 and how the foreign trust satisfies the requirements under Rev. Proc. 2020-17, §5.03 or §5.04. The IRS notes that U.S. individuals are not precluded from using any other applicable relief provisions.

Conclusion

Rev. Proc. 2020-17 offers U.S. individuals a welcome exemption the IRC §6048 information reporting requirements pertaining to their tax-favored foreign trusts. Additionally, Rev. Proc. 2020-17 provides instructions for U.S. individuals to request abatement or refund of IRC §6677 penalties.

However, U.S. individuals must remember that, although they are exempted from the IRC §6048 information reporting requirements, Rev. Proc. 2020-17 does not exempt the from any reporting requirements under IRC §6038D (Form 8938), including the filing requirement for Form 114, Report of Foreign Bank and Financial Accounts (commonly referred to as FBAR). Furthermore, Rev. Proc. 2020-17 does not affect earlier guidance providing an exception from IRC §6048 information reporting pertaining to: (1) certain foreign compensatory trust distributions,[9] and (2) certain Canadian retirement plans.[10]

Again, taxpayers are strongly encouraged to consult a tax professional who can help them determine: (1) if their account(s) qualifies as a tax-favored foreign trust, and (2) if they should request abatement or refund of any IRC §6677 penalties.

If you have questions or concerns about informational reporting requirements for your foreign trusts, retirement and non-retirement, call Eli Noff of Frost & Associates, LLC today at 410-497-5947.


[1] 2020-12 I.R.B. __ (Mar. 16, 2020).

[2] Applicability is subject to the IRC §6511 limitations, discussed herein.

[3] Rev. Proc. 2020-17 at 2.

[4] Id. at 2-3, citing Section V of Notice 97-34, 1997-1 C.B. 422; Rev. Proc. 2014-55, 2014 I.R.B. 753.

[5] [1]Id. at 3, citing Reg. §1.6038D-2(a).

[6] Id. at 3, citing Reg. §1.6038D-3.

[7] Id. at 9.

[8] Id. at 4.

[9] Section V of Notice 97-34, 1997-1 C.B. 422

[10] Rev. Proc. 2014-55, 2014 I.R.B. 753.

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