My earlier post set out certain details about the responsibility for a trust to file the Report of Foreign Financial Accounts (Form 114), or FBAR, with respect to foreign accounts it owns or is deemed to own under the FBAR rules. Today’s discussion covers the situation when trustees, trust beneficiaries and grantors (i.e., the trust creator) who are connected to the trust may have to report the foreign accounts owned by the trust on their individual/personal FBARs. As you will see, FBAR matters require a very deep dive into the relevant statute and regulations. Sadly, it is too often the case that practitioners do not do the “deep dive” and taxpayers are assessed penalties for FBAR failures.
By way of brief background, FBAR issues are governed by the rules set out in Title 31 of the United States Code, commonly called the “Bank Secrecy Act” (BSA) and implementing regulations (Regulations) issued by the Financial Crimes Enforcement Network (FinCEN) of the US Treasury. FBAR is not governed by Title 26 which is the statutory compilation of the Internal Revenue Code (IRC). Severe penalties apply for non-filing and improper FBAR filings, with the aggressive positions being taken by the Internal Revenue Service (IRS) upheld by some courts.
Misunderstandings regarding FBAR filing duties abound because the rules are complicated and full of eye-openers. The surprises range from who must report accounts they do not own, to what may be treated as a “foreign financial account” for FBAR purposes (for example, foreign pensions, an online gambling account, or a foreign life insurance policy are possibly FBAR reportable).
A rude awakening often awaits US trustees, beneficiaries and grantors who learn about personal FBAR-filing duties with regard to the foreign accounts owned by the trust. Yes, Mr. FBAR is full of surprises! Today’s article will look at the FBAR rules as they relate to such personal FBAR duties for the trustee, grantor and beneficiaries.
The Players: Trustee, Beneficiaries & Trust Grantor
A US person with a “financial interest” in, or signature authority over, a foreign account must report that account on the FBAR (assuming an aggregate USD$10,000 threshold during the calendar year). For FBAR purposes, a US person can be treated as having a “financial interest” in an account owned by an entity with which the US person has some kind of relationship.
In the case of a US trustee, I cannot imagine a case when a US trustee escapes reporting a trust’s foreign accounts on the trustee’s personal FBAR. For example, a “United States person” will have a “financial interest” in a foreign account for which the person “is the owner of record or holder of legal title, regardless of whether the account is maintained for the benefit of the United States person or for the benefit of another person”; or when the owner of record or holder of legal title (the trustee) “is an agent, nominee, attorney, or a person acting in some other capacity on behalf of the United States person” with respect to the account. A trustee would probably also have signature authority over the accounts as “trustee”.
As for the other players, set out below are two specific rules that can cause trust grantors or beneficiaries to be deemed to have a “financial interest” in, and impose personal FBAR reporting obligations with regard to, foreign financial accounts owned by the trust. (Of course, if they had signature authority over these trust accounts that would raise a separate duty to report the account on FBAR):
A United States person has a “financial interest” in a foreign account for which the owner of record or holder of legal title is—
- a grantor trust of which the United States person is the grantor and has an ownership interest in the trust for United States Federal tax purposes. The Regulations refer specifically to IRC Sections 671–679 and relevant Treasury regulations;
- a trust in which the United States person has a greater than 50 percent present beneficial interest in the assets or income of the trust for the calendar year.
In a helpful reporting exception, a trust beneficiary (but not a grantor or trustee) need not report a foreign account owned by a trust if the trust or the trustee (or other agent of the trust) is a United States person and reports the account on an FBAR. See Section 1010.50 (g)(5) of the Regulations.
The best way to illustrate how these various rules work is by way of an example. The example also incorporates the FBAR reporting rules discussed in my earlier article.
Abdulla, a nonresident alien individual (NRA) is the grantor of a trust created under Wyoming law. The trust is fully revocable by Abdulla alone and as such, it is treated as a foreign grantor trust owned by Abdulla for US income tax purposes (the trust as an “entity” is disregarded). Joann, a US citizen, is the sole trustee. The trust has 2 US citizen beneficiaries who are Abdulla’s nephews, Hamad and Salem. The trustee has absolute discretion over the amounts of any distributions (whether of income or principal) to the US beneficiaries. Upon the death of the survivor of the two nephews, the trust remainder is held for their children, who are all US citizens. The trust owns a brokerage account in London. The trust also owns 100% of a BVI corporation of which Joann acts as sole director and officer. The BVI corporation has legal title to an account at UBS bank in Zurich, Switzerland. In the tax year at issue, Salem received 60% of the trust income and Hamad received the balance of 40%.
Who must report what on an FBAR?
By reference to my first article, the trust, created under Wyoming law, is a “US person” regardless of the fact it is a foreign grantor trust and disregarded for US tax purposes. The trust must report on FBAR the London-based brokerage account owned by the trust. It must also report the Swiss bank account owned by the BVI corporation. The trust, a “US person” for FBAR purposes, owns over 50% of the shares in the BVI company and therefore the trust has a “financial interest” in the Swiss account.
Joann, a US citizen, must report the trust’s London brokerage account on her individual FBAR since she may possibly be treated as having a “financial interest” in the account and would also have signature authority over the account as “trustee”. Furthermore, as sole director and officer of the BVI corporation Joann has signature authority over the Swiss account and must report it on her individual FBAR.
It must be remembered that the FBAR is an annual form. This becomes especially important when US beneficiaries receive trust distributions. In the example, Salem received 60% of the trust income in the year in question. Absent an exception, Salem would have to report the trust’s London brokerage account on his individual FBAR. This is because a US person is deemed to have a financial interest in a foreign account for which “the owner of record or holder of legal title” is a trust from which the US person has a greater than 50 percent present beneficial interest in the assets or income of the trust for the calendar year. However, the exception to reporting can apply here. That is, a trust beneficiary need not report a foreign account owned by a trust if, as here, the trust or the trustee is a United States person and reports the account on an FBAR. (Note, the Swiss account owned by the BVI corporation should not be an issue for the trust beneficiaries since “the owner of record or holder of legal title” to the account is not the trust, but rather is the BVI corporation which is owned by the trust).
Hamad would not have to report the trust’s brokerage account for the year in issue since he only received 40% of the current trust income. If, in a later year, Hamad received over 50%, FBAR issues would arise but he could also rely on the exception mentioned above in the case of Salem. One has to be very careful with this reporting exception. A US beneficiary cannot rely on the exception if the trust is created under foreign (as opposed to US) law and has a foreign trustee. It applies only if the trust or the trustee is a United States person and reports the account on an FBAR.
The children of Salem and Hamad are US citizens, and are remaindermen of the trust. They have no current FBAR reporting duties since they do not have any present beneficial interest in the assets or income of the trust for the calendar year.
Abdulla, the creator of the trust is a NRA and not a US person; he would not have any FBAR duties. If Abdulla was a US person the result would be very different. In that case, he would have a “financial interest” in a foreign account for which the “owner of record or holder of legal title” is a grantor trust in which he has an “ownership interest” for US tax purposes.
As grantor of a revocable trust, Abdulla as a US person, would indeed have an ownership interest for US tax purposes in the trust. Under the IRC, he would be treated as the tax owner of the trust and taxed on its worldwide income. As such, Abdulla would have to file an FBAR reporting the trust’s brokerage account since he would be deemed to have a “financial interest” in the account to which the trust is the “owner of record or holder of legal title”. This is a personal FBAR filing obligation for Abdulla and would be in addition to the trust’s FBAR filing obligations.
The question arises if Abdulla, as a US person would be treated as having a “financial interest” in the Swiss account owned by the BVI corporation? Would he be deemed to have an indirect ownership (through the trust) of over 50% of the corporation? We know from the Title 31 FBAR Regulations that by reference to IRC Sections 671 to 679 Abudulla has to report the accounts owned by the trust. Nothing in the Regulations specifically states that because Abdulla owns the trust and the trust owns the BVI corporation that Abdulla is deemed to own the corporation, and therefore must report the Swiss account on FBAR.
However, uncertainty nonetheless arose for me. Here’s why: Under the FBAR rules, a United States person has a “financial interest” in a foreign account for which the owner of record or holder of legal title is a corporation in which the United States person owns directly or indirectly: (i) more than 50 percent of the total value of shares of stock or (ii) more than 50 percent of the voting power of all shares of stock.
For US tax purposes, Abdulla would be treated under the IRC as owning the shares in the BVI corporation that are owned by the foreign grantor trust. However, for FBAR purposes it is not clear whether this Title 26 ownership counts. Use of the word “indirectly” may possibly mean it does. In an abundance of caution and in light of the possible severe penalties, perhaps it would be wise to take a defensive position and for Abdulla to report the UBS account on his FBAR. Remember, the helpful reporting exception mentioned earlier would not apply to Abdulla, who is the grantor or creator of the trust. That exception applies only to a trust beneficiary who escapes having to report a foreign account owned by a trust if the trust or the trustee (or other agent of the trust) is a United States person and reports the account on an FBAR.
If you need help with FBAR matters, we have the experience you need. Noncompliance issues can usually be resolved without imposition of penalties if action is taken before the IRS comes calling.
US and Canadian attorney John Richardson and I discuss this topic in a podcast – listen to it here.
Posted March 3, 2022
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