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Foreign Grantor Trusts - 2010 HIRE Act

The 1996 Small Business Job Protection Act (“1996 Act”)


established new reporting requirements for Foreign Gifts and Foreign
Grantor Trusts. The 2010 HIRE Act included the Foreign Account
Tax Compliance Act which imposed new foreign grantor trust
reporting obligations on U.S. owners (i.e., U.S. Settlor) of Foreign
Grantor Trusts.

The 1996 Act, under IRC §6048(b)(1) made U.S. owners of


foreign grantor trusts responsible to ensure that the foreign grantor
trust (Trustee) file the annual trust tax return (From 3520-A).

Under the 2010 HIRE Act, the U.S. government imposed a new
reporting obligation on the U.S. owners (of foreign grantor trusts) so
the IRS could obtain information about the foreign grantor trust, if the
trustee was not cooperative and refused to file the annual Form 3520-
A tax return for the Trust. Since the U.S. grantor has neither the legal
authority nor the ability to force foreign trustees to file the Form 3520-
A, the 2010 HIRE Act makes the grantor responsible to submit
information to the IRS with respect to the Trust.

(1) “1996 Act” - Prior Law


Prior to the Small Business Job Protection Act of 1996 (the
“Act”), there was no requirement that a recipient of a gift made by a
person other than a U.S. person, report the gift.
Foreign Grantor Trusts - 2010 HIRE Act
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New Law
Under the “Act”, if the value of the aggregate “foreign gifts”
received by a U.S. person during any tax year exceeds $10,000, the
U.S. person must report each foreign gift to the IRS. A “foreign gift” is
any amount received from a non-U.S. person which the recipient
treats as a gift or bequest. The term “foreign gift” does not include
qualified tuition or medical payments made on behalf of a U.S. person
or any distribution properly disclosed on a return.

If a U.S. person fails, without reasonable cause to report the


foreign gift within designated time, the IRS is authorized to determine
the treatment of the unreported gifts. The IRS’s authority to make a
determination of reasonableness will be subject to judicial review
under an arbitrary or capricious standard, which provides a high
degree of deference to its determination. In addition, the U.S. person
is subject to a penalty of 5% of the amount of the gift for each month
that the failure continues, limited to a total penalty of 25% of the
amount.

Effective Date

Amounts received after date of enactment of the 1996 Act in tax


years ending after date of enactment of the 1996 Act.

Small Business Job Protection Act of 1996, Sec. 1905. IRC §6939F.

Information Reporting Requirement and Penalties - Prior Law

Prior to the Act, any U.S. person who created a foreign trust or
transferred money or property to a foreign trust was required to report
that event to the IRS without regard to whether the trust was a
grantor or a nongrantor trust. Such persons were required to report,
Foreign Grantor Trusts - 2010 HIRE Act
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among other things, the name, address and identification number of


the transferor, the trust, the fiduciary and trust beneficiaries; the
interest of each beneficiary; the location of the trust records; and the
value of each item transferred. Similarly, any U.S. person who
transferred property-to a foreign trust that had one or more U.S.
beneficiaries was required to report annually to the Service. In
addition, if the transfer of any appreciated property by a U.S. person
was subject to the excise tax of Section 1491, the transferor was
required to report the transfer to the Service.

Any person who failed to file a required report with respect to


the creation of, or a transfer to, a foreign trust could be subjected to a
penalty of 5% of the amount transferred to the foreign trust. Similarly,
any person who failed to file a required annual report with respect to
a foreign trust with U.S. beneficiaries could be subjected to a penalty
of 5% of the value of the corpus of the trust at the close of the tax
year. The maximum amount of the penalty imposed under either case
could not exceed $1,000. A reasonable cause exception was
available. These civil penalties were determined separately from any
applicable criminal penalties.

New Law

The information reporting requirements relating to foreign trusts,


and the associated penalties, are expanded.

On or before the 90th day after any "reportable event," the


"responsible party" must provide written notice of the event to the
Service. The notice must include the following information: (1) the
amount of money or other property transferred to the trust in
Foreign Grantor Trusts - 2010 HIRE Act
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connection with the reportable event, and (2) the identity of the trust
and each trustee and beneficiary of the trust.

A "reportable event" means the creation of any foreign trust by


a U.S. person, the direct or indirect transfer of money or property to a
foreign trust, and the death of a U.S. resident or citizen who was
treated as the owner of any portion of a foreign trust under the
grantor trust rules or whose gross estate includes any portion of a
foreign trust. A reportable event does not include property transfers to
a foreign trust in exchange for consideration of at least the property's
fair market value (FMV). Consideration other than cash is taken into
account at its FMV. Also excluded from reportable events are
transfers to pension trusts and charitable trusts.

A "responsible party" includes a grantor of an inter vivos trust, a


transferor of a foreign trust, and the executor of a decedent's estates.

A U.S. person that is treated as the owner of any portion of a


foreign trust, the Service is entitled to determine the amount to be
taken into account by a U.S. person under the grantor trust rules of
Section 671 through Section 679, unless a U.S. person is authorized
by the foreign trust to accept service of process. The U.S. person
must be authorized to act as the trust's limited agent with respect to
any request by the Service to examine records or testimony in
connection with the tax treatment of any items related to the trust.
The appearance of persons or production of records by a U.S. person
acting as the limited agent will not subject that person or records to
legal process for any purpose other than determining the correct tax
treatment of the amounts required to be taken into account. A foreign
trust which appoint such an agent will not be considered to have an
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office or a permanent establishment in the U.S. or to be engaged in a


U.S. trade or business solely because of the agent’s activities.

Any U.S. person who receives any distribution from a foreign


trust is required to file a notice to report the name for the trust, the
aggregate amount of the distributions received during the tax year
and other information that the Service prescribes. If adequate
records are not provided to the Service, the distribution includible in
the distributee’s gross income will be treated as an accumulation
distribution subject to the throwback rules applicable to U.S.
beneficiaries of foreign trusts, unless the foreign trust elects, under
the Regulations, to have a U.S. agent for the limited purpose of
accepting service of process. In applying the accumulation
distribution rules, the applicable number of years is ½ the number of
years the trust has been in existence.

In determining whether a U.S. person receives a distribution


from, or makes a transfer to, a foreign trust, the fact that a portion of
the trust is treated as owned by another person under the grantor
trust rules is disregarded, to the extent provided in the Regulations, a
trust which is a U.S. person is treated as a foreign trust for purposes
of the information reporting requirements if the trust has substantial
activities, or hold substantial property, outside the U.S. In applying
this rule, the service is expected to take into account information
provided by a trust under the domestic trust reporting rules.

Any notice or return required must be made at the time and in


the manner as the Service prescribes. The Service can suspend any
of the above information reporting requirements if it determines the
Foreign Grantor Trusts - 2010 HIRE Act
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U.S. has no significant tax interest in obtaining the required


information.

A person who fails to comply with the above notification


requirements in cases involving the transfer of property to a new or
existing foreign trust, or a distribution by a foreign trust to a U.S.
person, is subject to an initial penalty equal to 35% of the gross
reportable amount. A failure to provide an annual reporting of trust
activities results in an initial penalty equal to 5% of the gross
reportable amount.

The gross reportable amount is the gross value of the property


transferred as of the date of the event. In cases where annual
reporting of trust activities is required, the gross reportable amount is
the gross value of the portion of the foreign trust’s assets treated as
owned by the U.S. grantor at the close of the year. In cases involving
a distribution to a U.S. beneficiary of a foreign trust, the gross
reportable amount is the amount of the distribution to the beneficiary.

An additional $10,000 penalty is imposed for the continued


failure for each 30-day period beginning 90 days after the Service
notifies the responsible party of the failure. However, the total
amount of penalties is limited to the gross reportable amount.

The above penalties are subject to a reasonable cause


exception. However, the fact that a foreign jurisdiction would impose
a civil or criminal penalty on the taxpayer or any other person for
disclosing the required information is not treated as a reasonable
cause.
Foreign Grantor Trusts - 2010 HIRE Act
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The deficiency procedures that apply to income, estate, gift and


certain excise taxes will not apply with respect to the assessment or
collection of the increased penalty provisions.

Effective Date

The reporting requirements and applicable penalties generally


apply to reportable events occurring or distributions received after the
date of enactment of the 1996 Act. The annual reporting requirement
and penalties applicable to U.S. grantors apply to tax years of U.S.
persons beginning after December 31, 1995.

Small Business Job Protection Act of 1996, Sec. 1901. IRC §§6048,
6677.

(2) “2010 HIRE Act”

HIRE Foreign Account Tax Compliance: Reporting Requirements


for U.S. Persons Treated as Owners of a Foreign Trust

A U.S. Person who is treated as the owner of any portion of a


foreign trust under the grantor trust rules, must submit any
information required by the IRS with respect to the foreign trust (in
addition to the current requirement that such U.S. Persons are
responsible for insuring that a foreign trust complies with his own
reporting obligations) (see IRC §6048(b)(1), as amended by the 2010
HIRE Act). This requirement to supply information about the trust
applies to tax years beginning after March 18, 2010 (Act §534(b) of
the 2010 HIRE Act).

The current reporting obligations for U.S. owners of foreign trust


include filing a tax return for the year and providing certain
information to each U.S. Person who is either treated as the owner of
Foreign Grantor Trusts - 2010 HIRE Act
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any portion of the trust, or who receives a direct or indirect distribution


from the trust (IRC §6048(b)(1)(A) and (B)).

HIRE Foreign Account Tax Compliance: Penalty for Failure to


Report Information or File Return Concerning Certain Foreign
Trusts

The minimum amount of penalty for failure to report information


or file returns for foreign trusts is increased to $10,000.

The maximum amount of the penalty has changed. The


penalty for failure to report information or file a return with respect to
certain foreign trusts cannot exceed the gross reportable amount
(IRC §6677(a)).

To the extent that the aggregate amount of penalties exceeds


the gross reportable amount, the IRS must refund the excess to the
Taxpayer (IRC §6677(a), as amended by the 2010 HIRE Act).

If any notice or return required to be filed under IRC §6048 is


not filed on or before the due date, or does not include all the
information that is required, or includes incorrect information, then the
person required to file such notice or return must pay a penalty equal
to the greater of:

1. $10,000, or

2. Form 3520 Filings: 35% of the gross reportable amount (or


Form 3520-A filings: 5% for U.S. Persons treated as owners
of the trust)(IRC §6677(a), as amended by the 2010 HIRE
Act).
Foreign Grantor Trusts - 2010 HIRE Act
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Previously, the penalty for failure to provide the required


information or file a return with respect to certain foreign trusts, Form
3520 Filings: 35% of the gross reportable amount (Form 3520-A
filings: 5% for U.S. Persons treated as owners of the trust).

With the new minimum amount, the IRS will be able to impose
a $10,000 penalty even when there is not enough information to
determine the gross reportable amount.

If the failure to report persists for more than 90 days after the
IRS has mailed notice of such failure to the person required to pay
such penalty, an additional penalty is imposed that is equal to
$10,000 for each 30 day period during which such failure continues
after the 90-day period expires.

The penalty imposed cannot exceed the gross reportable


amount (IRC §6677(a)). No penalty will be imposed if the failure to
report is due to reasonable cause and not willful neglect (IRC
§6677(d)).