Small Business Job Protection Act of 1996 (SBJPA) amended IRC Section 6048C and added Section 6039F to require U.S. persons to file information return annually if a U.S. person receives foreign trust distributions, has ownership of a foreign trusts, and/or receives gifts in excess of $10,000 from foreign persons. Penalty for failure to declare reportable trust transactions is severe. Amended section 6677(a)(2) provides a penalty of 35% of the gross reportable amount if a person fails to report the transfer of property to a foreign trust or a distribution by a foreign trust to a U.S. person. Further, Section 6039F imposes a penalty equal to 5 percent of the amount of foreign gifts for each month up to a maximum of 25 percent on the U.S. person. The effective date of these two provision is August 20, 1996. However, IRS has yet to issue new procedural guidance as to the method of reporting. As a result, many affected U.S. taxpayers did not comply with the filing requirement for their 1996 tax year.

Recently, the Service in Notice 97-34 issues guidance on the foreign trust and foreign gift reporting. The rules provided in the notice are expected to be in future regulations and for the transition period, taxpayers must comply with Notice 97-34.

Summary of Notice 97-34

Notice 97-34 clarifies the expected revisions to Form 3520, "Creation of or Transfers to Certain Foreign Trusts," and Form 3520-A, "Annual Return of Foreign Trust with U.S. Beneficiaries." Taxpayers shall use and file the existing forms in accordance with the modifications contained in Notice 97-34 until revised forms are available.

It also clarifies the terms "grantor," "beneficiary," and "obligation." A grantor is defined as any person who creates a trust directly or directly, such as an investor who invests in a trust; a person receives free trust interest transfer. A beneficiary includes any person who can be benefited, directly or indirectly, from the trust at any time. An "obligation" includes any bond, note, debenture, certificate, bill receivable, account receivable, note receivable, open account, or other evidence of indebtedness, and, to the extent not previously described, any annuity contract.

Transfer to Foreign Trusts

The Service provides numerous examples of situations to illustrate the reporting requirement according to Section 1494. Generally, under section 6048, U.S. persons should report all transfers to foreign trusts; however transfers for fair market value, free transfers, or a corporate or partnership distribution are not reportable transactions. In addition, if the U.S. transferor does not immediately recognize all of the gain on the transfer (or recognizes gain solely by reason of an election under section 1057), or the U.S. transferor is related to the trust , the transactions are reportable under section 1494. The transferor will not be required to file a separate Form 926 in additional to Form 3520 unless the transferor owes excise tax under section 1491 with respect to a transfer.

Owners of Foreign Trusts:

The Service spells out the requirement that U.S. owners of foreign trusts should file Form 3520-A annually to report a full and complete accounting of trust activities according to Section 6048(b)(1). The U.S. owners must

1. 1. files the original Form 3520-A,
   2. writes "FOREIGN GRANTOR TRUST" at the top of the form,
   3. completes the identifying information on the form as if the foreign trust were the U.S. owner required to file the form,
   4. signs the form,
   5. attaches a Foreign Grantor Trust Information Statement, which includes the foreign trust’s background, fair market value balance sheet, income statement, owner statement , beneficiary statements and appointment of U.S. agent, to the form,
   6. sends a Foreign Grantor Trust Owner Statement to each U.S. owner of a portion of the trust,
   7. and sends a copy of a Foreign Grantor Trust Beneficiary Statement to each U.S. beneficiary who received a distribution from the trust during the taxable year.

The Form 3520-A must be filed and the required statements furnished to the U.S. grantors and U.S. beneficiaries by the fifteenth day of the third month after the end of the trust's taxable year (or later, if pursuant to an extension of time to file). The 1996 filing deadlines for filing Form 3520-A is October 15, 1997.

U.S. Beneficiaries of Foreign Trusts

Generally, a U.S. person who receives a distribution, directly or indirectly, from a foreign trust after August 20, 1996, is required to report on Form 3520, the name of the trust, the aggregate amount of distributions received from the trust during the taxable year, and such other information as the Secretary may prescribe. Section 6048(c). Reporting is required under section 6048(c) only if the U.S. person knows or has reason to know that the trust is a foreign trust. A U.S. beneficiary who fails to report a distribution received after August 20, 1996, will be subject to a 35 percent penalty on the gross amount of the distribution. Section 6677(a).

A beneficiary can completely avoid default treatment when receiving a distribution from a trust, the beneficiary must obtain either a Foreign Grantor Trust Beneficiary Statement or a Foreign Non-grantor Trust Beneficiary Statement with respect to the portion of the trust from which the beneficiary received the distribution. The beneficiary must attach a copy of the relevant beneficiary statement(s) to his or her Form 3520.

A Foreign Non-grantor Trust Beneficiary Statement should contain the Foreign Trust Background Information, U.S. Beneficiary Information, all relevant information related to the distribution, Representation on Access to Books and Records and the name, address and EIN of the trust's U.S. agent.

New reporting rules for U.S. persons who receive large gifts from foreign persons.

As required by Section 6039F (a), if a U.S. person receives aggregate foreign gifts exceeding $10,000 in a taxable year, the U.S. recipient must provide such information as prescribed by the Secretary. "Foreign gift" means any amount received by a U. S. person from a foreigner. And the recipient treats it as a gift or bequest. Any qualified transfer within the meaning of section 2503(e)(2) (relating to certain transfers for educational or medical expenses) or any distribution properly reported under section 6048(c). Section 6039F(b) is not considered as foreign gift.

Reporting under section 6039F will be required on an annual basis on Form 3520. The only purpose of the reporting is to determine whether a purported gift is properly classified as a gift or income, therefore, only general information is necessary to report. Limited information will be requested by the Service, such as the type of entity of the foreign donor; whether the foreign donor was acting as a nominee or intermediary for another person, and a brief description of the property received. No identity of the foreign donor unless the foreign donor is a partnership or foreign corporation, or is acting as a nominee or intermediary for such an entity. However, the U.S. donee may be required to provide additional information, including the identity of the donor, to the IRS upon request.

The Service has the authority to determine the taxability of the receipt of gift, if it is not reported on Form 3520. In addition, the recipient is subject to a penalty equal to 5 percent of the value of the gift for each month in which the gift is not reported (not to exceed 25 percent). Section 6039F(c)(1)(B). Reporting is only required under section 6039F for gifts actually or constructively received by a U.S. person. Furthermore, reporting is required under section 6039F only if the U.S. person knows or has reason to know that the donor is a foreign person.

Threshold for Reporting Foreign Gifts

Notice 97-34 raises the reporting threshold for aggregate gifts from a nonresident alien or foreign estate from $10,000 as stated under Section 6039F, to $100,000 in a tax year. Once the $100,000 threshold has been met, it is expected that Form 3520 will require the donee to separately identify each gift in excess of $5,000, but will not require the identification of the donor. The reporting threshold for aggregate gifts received from foreign partnerships and corporations remain at $10,000 in a tax year, as modified by cost-of-living adjustments under section 6039F(d).

Aggregate Rules

A U.S. person must aggregate gifts from foreign persons that he knows or has reason to know are related, within the meaning of section 643(i)(2)(B), whether or not the gifts from a related person would independently exceed the above threshold limit for reporting of gifts from that foreign person. If the relevant reporting threshold is exceeded, the U.S. person is required to separately identify each aggregated gift in excess of $5,000 from a nonresident alien or foreign estate on the Form 3520, but will not require the identification of such a donor, and to separately identify each aggregated purported gift from a foreign corporation or foreign partnership, including the identity of the donor entity.

The Service offers the following examples.

1. GIFTS FROM RELATED FOREIGN INDIVIDUALS. A is a U.S. citizen who is married to B. B and all of B's brothers, C, D, and E, are not U.S. persons. In a single taxable year, B makes a gift of $90,000 to A, C makes a gift of $40,000 to A, D makes two gifts to A (one of $4,000 and one of $3,000), and E makes a gift of $4,000 to A. For that taxable year, A must report the receipt of $141,000 in gifts from foreign persons. A must separately identify the $90,000 gift from B, because B and his brothers gave gifts in excess of $100,000. A must also separately identify the $40,000 gift from C, because C and his brothers gave gifts in excess of $100,000. A must identify the receipt of $7,000 in total gifts from D because D and his brothers gave gifts in excess of $100,000, but is not required to separately list information about each transaction because no gift is in excess of $5,000. A is not required to separately identify transaction information about E's gifts, because gifts from foreign individuals of less than $5,000 are not required to be separately identified. Because B, C, and D are individuals, A need not identify these donors when reporting the transactions.
2. GIFTS FROM RELATED FOREIGN INDIVIDUAL AND CORPORATION. A is a U.S. citizen who is married to B. B is the sole shareholder of FC, a foreign corporation. B is not a U.S. person. In a taxable year, B makes a gift of $6,000 to A, and FC makes a purported gift of $8,000 to A. Because A knows or has reason to know that B and FC are related, A must aggregate gifts from B and FC ($14,000). Although the $14,000 aggregate amount deemed received from B does not exceed the $100,000 threshold with respect to gifts from nonresident aliens, the $14,000 aggregate amount deemed received from FC exceeds the $10,000 threshold with respect to gifts from foreign corporations. Accordingly, A must separately identify each gift from B and FC, and must provide identifying information about FC because it is a foreign corporation.

Notice 97-34 stated that the dead line for filing foreign gifts reporting is November 15, 1997 for the 1996 tax returns. However, the taxpayers previous filed a Form 3520 or Form 3520-A but not in conformance of Notice 97-34 requirement will not be considered as in compliance under SBJPA. Therefore, they should file an amended returns to include new required information.

Conclusion:

At last, the Service offers some guidance to taxpayers to clarify the procedural aspect of the foreign trust and gift reporting. The increased threshold of reporting gifts as well as the information necessary to report has relieved some of the taxpayers’ concerns. It is important for the practitioners to follow and advice their clients to comply with the new reporting requirement to avoid severe civil penalty.

About the Author:

Raymond Ho, CPA, CMA,MBA is a local practitioner located in Burlingame, Ca, specializing in individual and corporation taxation. His practice includes real estate developers, professional corporations, international trading and manufacturing companies and high networth individuals. He is also an adjunct faculty member at University of Phoenix and a California licensed real estate broker.