Looking for MR FBAR: When is a trust required to file?
Responsibility for filing the Foreign Financial Accounts Report Form 114, or FBAR, is governed by the rules set forth in Title 31 of the U.S. Code, commonly referred to as the Bank Secrecy Act, or BSA, and implementing regulations issued by the Financial Crimes Enforcement Network, or FinCEN, of the US Treasury. It is important to understand that the BSA is a separate set of laws from the Internal Revenue Code, or IRC, which is found in Title 26 of the US Code. We will come back to this point later. The BSA itself provides very little information; consult the regulations and Form 114 instructions for guidance.
Severe penalties apply for non-rankings and FBAR incidents. Theirs was very aggressive in assessing sanctions. The agency’s position was bolstered by a recent court blessing. US Court of Appeals for the Ninth Circuit Law Now Clear: FBAR’s Unintended Sanction can be claimed on an account by rather than a per-form basis.
There is a lot of misunderstanding about FBAR filing requirements, especially when it comes to trusts holding foreign accounts. Trustees, beneficiaries and settlors who are related to a trust may also have personal FBAR filing obligations with respect to foreign accounts held by the trust. Monsieur FBAR is full of surprises! Today’s article will look at FBAR rules as they relate strictly to the trust entity.
Let’s break it down.
Who should file an FBAR?
According to the regulations and current FBAR instructionsa U.S. person who has a financial interest or signing authority in foreign financial accounts must file an FBAR if the total value of the foreign financial accounts exceeds $10,000 at any time during the calendar year.
The trust as an entity and FBAR
If the trust in question is a US person, it will be responsible for filing an FBAR with respect to all foreign accounts it owns or is deemed to own, assuming the $10,000 threshold is met. The Trust will have a financial interest in an Account when it is the legal owner or holder of the Account, regardless of whether the Trust holds the Accounts for the benefit of its beneficiaries.
A trust that is a US person will also be deemed to have a financial interest in a foreign account held by another party related to the trust. Specifically, a U.S. Person will have a financial interest in a foreign account for which the record owner or legal title holder is:
- an agent, nominee, attorney, or person acting in another capacity on behalf of the U.S. Person with respect to the Account;
- a corporation in which the U.S. Person holds, directly or indirectly, more than 50% of the voting rights or the value of the shares;
- a partnership in which the U.S. Person owns, directly or indirectly, more than 50% of the profits or capital interest;
- an assignee trust of which the U.S. Person is the assignor and holds an interest in the trust;
- a trust in which the US Person has a current beneficial interest greater than 50% in the assets or income of the trust for the calendar year;
- or any other entity in which the U.S. Person owns, directly or indirectly, more than 50% of the voting rights, the aggregate value of equity interests or assets, or a profit interest.
Categories 2, 3 and 6 are frequently encountered in the case of a trust. For example, if the trust owns more than 50% of a corporation or partnership that itself has a foreign account, the trust must report not only the foreign accounts of which it is the holder or the registered owner. It must also report all foreign accounts for which the corporation or partnership is the holder or official owner.
Is the trust a US person? What about foreign trusts?
Much confusion is generated regarding the US status of a trust for FBAR purposes. It is important to remember that the BSA is found in Title 31 of the US Code and is distinctly separate from the IRC, found in Title 26 of the US Code.
For tax purposes under the IRC, a trust is defined as a US person, not a foreign person.—whether a court in the United States is able to exercise primary control over the administration of the trust, i.e. the court test; and whether one or more U.S. persons have the power to control all important decisions confidence, that is to say the test of control. My blog post here helps readers understand when a trust is considered foreign under the IRC.
These criteria can be manipulated so that a trust created under the laws of a US state can still be treated as a foreign trust for US tax purposes. This is often done by manipulating the test of control such that an outside person has the power to control one or more significant trust decisions. Because all major decisions must be made by a U.S. person, by choosing a non-U.S. person—for example, a non-U.S. citizen, nonresident alien, or foreign corporation—as trustee, or by giving that person veto power over the same a single substantial decision, means the trust would fail the test of control.
Many trusts are organized in the United States under the laws of a particular US state. Typical states include Wyoming, South Dakota, Nevada, and Delaware. These jurisdictions are chosen due to the fact that the United States has excellent, substantive trust laws that offer, for example, strong asset protection and anonymity. These US-formed trusts may still be treated as foreign trusts under IRC, thus paying no US tax on foreign-source income, as they are deliberately formed to create foreign status.
Foreign Trusts and Treatment as a US Person with FBAR Obligation
These foreign trusts are not U.S. taxpayers, but that is not the litmus test for FBAR because the FBAR rules are in Title 31, not Title 26. Can foreign trusts be treated for FBAR purposes in under the BSA as American persons?
For purposes of FBAR, a US person is defined to include “trusts or estates constituted under the laws of the United States”. In other words, FBAR obligations arise for the trust once the trust is formed under the laws of a US state. This is regardless of whether it is treated as a foreign trust – for example, a trust that fails the control test – or as a so-called ignore entity, for US tax purposes.
With respect to a trust being treated as a disregarded entity, there are many foreign constituent trusts created by non-resident alien individuals who are formed under the laws of one of the various US states. These trusts are not considered from an income tax perspective, so the NRA is treated as the tax owner of the trust with no US income tax implications for the trust as a ‘entity. However, the trust itself is indeed a US person for FBAR purposes. So while the trust may be disregarded for income tax purposes, it is not for FBAR purposes.
Many foreign trusts are unaware of these rules. The FBAR situation should be corrected as soon as possible and can probably be done without imposing FBAR penalties. We can help!
The lesson here: First look at heading 31 regarding FBAR issues. Title 26 may also be involved, but the first port of call is the BSA and its regulations. The other lesson: it’s complicated. Hire a tax professional with the appropriate international experience to help you with these US and FBAR tax matters.
This article does not necessarily reflect the views of the Bureau of National Affairs, Inc., publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Virginia La Torre Jeker, JD, is a US tax attorney and member of the New York Bar for over 35 years. A recognized American international tax professional, she has been in Dubai since 2001.
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