On May 7, 2024, the US Treasury and IRS release proposed regulations for the taxation and reporting of foreign trusts. These extensive regulations, spanning over 150 pages, are particularly relevant for the US citizens in Australia and Australians residing in the US.
US foreign trust regime
As a result of some taxpayers using foreign trusts to evade tax in the 1990s, the US views non-US trusts, commonly used in Australia for wealth accumulation, as potential tax avoidance tools. Consequently, strict rules apply, often classifying Australian discretionary trusts funded or controlled by US taxpayers as ‘grantor’ trusts, taxable in the US.
The US has a comprehensive foreign informational reporting regime for the reporting of foreign trusts and other entities. Taxpayers who do not properly disclose their association with a foreign entity can face large fines.
An Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts (Form 3520) is often required for US taxpayers with Australian discretionary trusts, and some superannuation funds. If a taxpayer doesn’t file a Form 3520 on time, they might have to pay a fine of at least $10,000 USD, up to 35% of any money they put into or took out of the trust that year, or 5% of the trust’s total value.
Many such harsh penalties exist within the US foreign informational reporting regime, serving as a ‘big stick’ to encourage compliance with the rules. In practice, the IRS doesn’t seek to enforce these penalties often, especially for investments in countries like Australia where taxes are already high. However, since 2018 there’s been a rise in fines relating to not filing Form 3520 properly, showing that the IRS is paying more attention to this form lately.
New foreign trust regulations
The new proposed regulations expand the already complicated and comprehensive tax and reporting required for US taxpayers with foreign trusts.
The key impacts are summarised below:
Reporting requirements
The regulations clarify potential uncertainty under the current law regarding reporting requirements. Specifically, they confirm that taxpayers excluded from US tax residency under a double tax treaty need not file Form 3520. This will be welcome news for some Australians spending time in the US who are still considered Australian tax residents under ATO rules.
However, additional reporting in respect of certain foreign gifts and loans from foreign trusts is mandated.
Taxation of loans
Loans and use of property from foreign trusts are already treated as income distributions unless they qualify as ‘qualified obligations’. These regulations go further, stating that this recharacterisation will now apply retroactively for two years before US tax residency, affecting Australians moving to the US.
Exemptions and limitations
While some previously announced[1] reporting exemptions have been expanded, they unfortunately do not extend to Australian superannuation funds deemed grantor trusts, nor would they typically apply to other Australian domiciled trusts. Retirement accounts in other jurisdictions may qualify for relief.
Gifts and loans to US residents
When a non-resident of the US gives more than $100,000 USD to someone in the US, it must be reported on Form 3520. The proposed regulations target gifts that are disguised as loans to circumvent this rule. Additional analysis and disclosures may be required as a result.
Key take-aways
US taxpayers in Australia
For US taxpayers in Australia thinking of using an Australian discretionary trust to accumulate wealth, talk to a US tax expert. Any Australian tax savings and asset protection benefits needs to be balanced against the US tax costs and work involved in additional US tax filings.
Australians in the US
For Australians relocating to the US with trusts, engage and plan ahead to restructure and avoid unexpected tax liabilities. This is especially important if the trust holds assets that may be sold whilst outside of Australia.
Australians giving or loaning money to a US taxpayer should also seek advice to correctly structure the transaction to not complicate matters for the recipient.
Final thoughts
The regulations strengthen the comprehensive anti-avoidance and disclosure rules already in place, making even harder to utilise foreign trusts to shield assets from US tax.
Any transaction with a foreign trust is going to be heavily scrutinised and requiring full disclosure, especially where a loan arrangement is involved.
The regulations will apply to tax years after they are finalised (expected to be 2024), however may be relied upon by taxpayers for any tax year that ends after May 8, 2024, in the meantime.
For assistance, contact Pitcher Partners’ US tax team in Australia.
[1] ‘Revenue Procedure 2020-17’, IRS, p.10, https://www.irs.gov/pub/irs-drop/rp-20-17.pdf, (accessed 9 May 2024).
