Does the IRS consider your non-US retirement, superannuation, or other accounts to be foreign trusts?
Do you need to file form 3520 and/or form 3520a?
Here’s what I know.
Non-US retirement accounts, foreign trusts, and form 3520/3520a
When it comes to non-US retirement accounts and trusts, the filing requirements are convoluted and confusing.
US retirement accounts and trusts are generally constructed according to the US tax code (or the US tax code is constructed according to retirement accounts).
Therefore, in the US, each account type falls fairly neatly into a defined set of rules for taxation and tax reporting.
For example, a 401K account has a certain set of rules, and a certain way to be reported on your tax return. Another example would be a simple trust that distributes all income to its beneficiaries. This organized entity would probably need an annual form 1041 filing with K1s to each beneficiary.
Simple enough (and kind of boring), right?
Non US trusts, on the other hand, are not designed around the US tax code (of course) and the US tax code is not designed to govern them.
That’s where things get muddy and this is why you may have found confusing or conflicting information on the subject.
And it can cost you.
The biggest tax issue for expat taxpayers with foreign retirement and superannuation accounts is if they need to file form 3520 and/or 3520a.
It’s a real bitch. I’ll tell you about it.
These forms are complex and expensive, and the penalties for not filing them properly are egregious, and the rules for whether they are needed are convoluted.
Penalties for not filing form 3520/3520a when required
The first thing I want to cover, briefly, is that the penalties for the failure to file these forms are absolutely ridiculous. They start at $10,000 per missing return but can also grab a chunk of the value of each account – for each year.
$10,000 per form, per year. It’s insanity.
The penalties are not like a speeding infraction in where they are tiered for severity, either. If a US taxpayer fails to report a foreign trust with a $1 distribution for 10 years, for example, they could legally be liable for $100,000 in penalties.
I think of the average middle class American living abroad who opened up a retirement account for himself, his spouse, and his two children – and then not filing as required for multiple years for all four “trusts”.
Now, it is possible (and even likely) that this average Joe would get out of such penalties for reasonable cause – but this will cost Joe in legal and professional fees to do it – not to mention all of the stress.
Lastly, it pays to mention that if these forms are not filed (or even not filed properly), that there is no statute of limitation on the requirements to file or on the penalties.
Complexity of filing form 3520 and 3520a
These forms are not simple and thus the professional fees for preparing them are not cheap. Taxpayers will have to find specialized preparers to file them.
In cases where both the employee and the employer contribute to a foreign trust, then the account is subject to bifurcated reporting, which is as bad as it sounds, and it gets worse.
There are also rules that the bookkeeping for the account reporting must be calculated under the US GAAP accounting procedures – but the non-US custodians of investments do not report according to US GAAP and provide them in their statements.
Let’s go back to Mr. Joe Taxpayer – a guy who makes $100,000 a year and supports a family. He ended up with “4 foreign trusts” to report in this fashion. He is expected to pay $5000 per year for tax preparation?
What a nightmare this subject is. I feel yucky just writing about it.
Also crazy about form 3520a… the due date
Poor old Joe. He contacted his tax preparer on the 12 of March as soon as he got most his documents. There are always some K1s that come in later – but he doesn’t want to cut it too close to the deadline and he is considerate to his tax person (hint, hint).
He really though he was doing the right thing when he filed on the 28th of March – more than 2 weeks from the deadline.
Or did he?
What Joe still doesn’t know is that form 3520a is due on the 15th of March.
You’ve got to be kidding me.
But again, it gets worse.
What most US expat taxpayers also don’t know is that the extension for form 1040 does not extend the 3520a return.
It needs it’ sown extension, LOL.
Who must file?
I recently attended a webinar hosted by three of the expat tax communities most esteemed attorneys who specialize in the reporting of non-US trusts.
It wasn’t cheap, by the way, you owe me a beer.
You know what they said about what non-US retirement accounts must file form 3520/3520a?
They said they didn’t know because the tax code is not clear.
Insert the “cricket” sound effects here.
They told the class that they sort of had a vague idea – and I will share that with you very soon – but that “the way that these accounts fall into the US tax code is argumentative at best”.
They have petitioned the IRS to provide guidance, but no one with the IRS seems to dare touch it (and I don’t blame them – it’s the policy makers I blame – but I’ll save that for another article).
According to these lawyers, and only generally, if an employer contributes the funds to an account, then under code 402b they are considered to be “employee trusts”.
Now don’t hold me to this, but Employee trusts do not require the filing of form 3520 or 3520a. They are (apparently) “exempt” because employees are not considered to be the owners of these trusts.
But if the employee contributes more than half of the funds to the trust, then it becomes a “grantor trust” instead of an “employees trust” – and these lawyers guess that that these account require the 3520/3520a filings.
This is not so easy to understand at first for some taxpayers and tax preparers so I will reiterate in different words:
According to these attorneys and generally, a 402b employees trust will not be treated as a foreign grantor trust unless the employee contributes more than half to the trust. In that case, it is treated as a foreign grantor trust. Foreign grantor trusts (apparently) must file forms 3520 and 3520a while employee trusts do not.
Also, it pays to mention that you have a foreign grantor trust when you have a plain vanilla trust with a US transferor/settlor, and US beneficiary (not a 402b plan). This requires the 3520/3520a filings as well.
With a grantor trust, the US person who transfers into the trust will be treated as the owner of that trust.
Thanks for reading and please leave a comment.