Double Whammy – US Owner and Beneficiary of Foreign Trust Held Liable for 2 Separate Penalties! Failure to Report as “Owner” and Failure to Report as “Beneficiary”

When a US person has any involvement in any way with a foreign trust, extreme care is required to make sure that all of the strict US tax filing responsibilities are met.  Surprisingly, for US tax purposes, a trust can be treated as “foreign” even if it is created in the US under US laws.  What makes a trust “foreign” is set out in my earlier post.

My series of blog posts about foreign trusts, the US tax issues associated with them include an analysis of the US tax filing and reporting requirements for each of the different players in the foreign trust scenario. See the following links for US tax filing requirements imposed on the creator or “grantor”/”settlor” of the trust, the trustee, and the US beneficiary.

Remember as well, a “foundation” can often be treated as a trust (alternatively, it is a treated as a “corporation”), so if a taxpayer is involved with a foreign “foundation”, care must be taken to make sure of the proper US tax classification and that required tax filings are undertaken.  Want to learn more about foreign “foundations”?  Check my blog posts here and here.

2d Circuit says: “No Mercy”

The case of Wilson v. United States, (2d Cir. 2021) decided just last month, illustrates how harsh the penalties can be for failing to make the proper foreign trust filings. In Wilson, the creator and beneficiary of a foreign trust who received a trust distribution was assessed 2 separate penalties for failing to meet the two separate reporting obligations imposed under the Internal Revenue Code (IRC). Here are the facts of the case and a succinct summary of the relevant IRC provisions as explained by the Wilson court:

Joseph Wilson was the sole owner and beneficiary of a foreign trust. IRC Section 6048(b) and (c), respectively, require US owners of a foreign trust to ensure that the trust itself files an annual return, and US beneficiaries of a foreign trust to file a return reporting the distributions they receive from the foreign trust.  IRC Section 6677 imposes different penalties for the late filing of the two types of returns: a 35% penalty for beneficiaries who fail to timely report their distributions, and a 5% penalty for owners who fail to ensure that their trust timely files an annual return. Mr. Wilson was late in filing both returns for tax year 2007.

The Internal Revenue Service (“IRS”) assessed a 35% penalty against Mr. Wilson for failing to timely disclose the distribution he received from his trust, which he paid. Following Wilson’s death, the estate executors sued for a refund, arguing the IRS should have imposed only a 5% penalty that applies to owners of foreign trusts. The district court granted partial summary judgment in favor of the executors, concluding that because Wilson was the owner of the trust, under the IRC the government could impose only a 5% owner’s penalty on Mr. Wilson. The 2d Circuit disagreed, holding that the 35% penalty applies including when the beneficiary is the owner of the trust.  The court’s holding makes total sense since the plain meaning of the IRC sections clearly impose two separate reporting obligations and separate penalties for each.

Need Help?

If you need assistance in creating a tax efficient structure using foreign trusts or other entities, make sure you understand the rules and that your structure is sound. I am here to help. I have an expertise in the US tax ramification and use of foreign entities when the structure in any way  involves US persons.

Posted August 19, 2021

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