U.S. citizens and residents who own foreign trusts are often caught by the rules of the Internal Revenue Code section 6048, which requires those individuals to report transactions with, or ownership of, foreign trusts. This information is reported on Forms 3520 and 3520-A. Non-compliance with these laws comes with steep penalties starting at $10,000 per missed filing.
Often, U.S. citizens residing in Canada do not think of registered accounts as foreign trusts, but rather as savings accounts. U.S. reporting requirements for these registered accounts catch many off guard as they can be complicated and do not fit the typical mold for the types of trusts the IRS had in mind when drafting the forms. Registered Retirement Savings Plans (RRSPs) have been exempted from this foreign trust reporting for years. However, Registered Education Savings Plans (RESPs) and Registered Disability Savings Plans (RDSPs) have not been exempted.
In response to this problem, the IRS issued Revenue Procedure 2020-17 detailing the relief provided from those provisions for tax-favored foreign retirement trusts and non-retirement trusts. The relief comes in two parts: exemption from filing and abatement of formerly paid penalties.
Who gets relief?
Relief is provided to eligible individuals who own any tax-favored foreign trusts. An eligible individual is defined in Section 5.02 of the Revenue Procedure as an individual who:
- is a U.S. citizen or resident;1
- is compliant2 (or comes into compliance), for any period during which an amount of tax may be assessed, with all requirements for filing a U.S. federal income tax return(s) covering the period of U.S. citizenship or residency; and
- to the extent required under U.S. tax law, has reported as income any contributions to, earnings of, or distributions from an applicable tax-favored foreign trust.
For clarity, an individual is not required to file Form 3520 or Form 3520-A (related to the foreign trust) to be considered compliant.
If you are an eligible individual, you must determine if your trust qualifies as either a Tax-Favored Foreign Retirement Trust, or a Tax-Favored Foreign Non-Retirement Savings Trust. Sections 5.03 and 5.04 define which trusts qualify for these rules.
A Tax-Favored Foreign Retirement Trust3 qualifies if it meets all the following conditions:
- It is either exempt from income tax or otherwise meets tax-favored qualifications under Canadian law. Tax-favored qualifications under Canadian law means either:
- contributions to the trust are tax deductible or excluded from income, are taxed at a reduced rate, give rise to a tax credit, or are otherwise eligible for another tax benefit; or
- taxation of investment income earned by the trust is deferred until distribution or the investment income is taxed at a reduced rate.
- The tax authority receives annual information reporting.
- Only contributions with respect to income earned from the performance of personal services are permitted.
- Contributions to the trust are limited by a percentage of earned income of the participant, are subject to an annual limit of $50,000 USD or less to the trust, or are subject to a lifetime limit of $1,000,000 USD or less to the trust.
- There are penalties for withdrawals or distributions before you reach a certain age, are disabled or die. However, withdrawals for hardship, educational purposes, or the purchase of a primary residence are permitted.
- If the trust is employer-maintained, it must be non-discriminatory under special terms laid out by the IRS.
A Tax-Favored Foreign Non-Retirement Trust4 qualifies if it meets all the following conditions:
- It meets the same tax-favored qualifications as a Retirement Trust above.
- The tax authority receives annual information reporting.
- Contributions are limited to $10,000 or less annually or $200,000 or less on a lifetime basis.
- Withdrawals or distributions, without penalties, are only allowed for medical, disability, or educational purposes.
Notably, a trust would still qualify under the above rules if it received contributions on a rollover basis from another qualifying trust.
RESPs and RDSPs, in most cases, meet the criteria above and fall under the Tax-Favored Foreign Non-Retirement Savings Trust definition. Unfortunately, since a Tax-Free Savings Account has no retirement requirements and is not solely for the purpose of education or disability, it would not qualify for relief if considered a trust for purposes of reporting on Forms 3520 or 3520-A. We are still waiting for the IRS to comment on how it would like to see Tax-Free Savings Accounts treated under the U.S. tax system.
What relief is provided?
Relief is provided from the necessity of preparing and filing both Form 3520 and Form 3520-A. Though you may already have prepared and filed the Form 3520-A that would otherwise be due on March 16, 2020, this news is still welcome as you should not be required to file the forms in the future.
Relief is also provided from the risk of penalties associated with these forms. If you have filed these forms late in the past and were subject to late-filing penalties, and your plan qualified as a Tax-Favored Foreign Retirement Trust or a Tax-Favored Non-Retirement Savings Trust at the time of filing, you could receive abatement or refund of these penalties from the IRS. For penalty relief, the IRS requires Form 8435 to be filed. When preparing this form, write “Relief Pursuant to Revenue Procedure 2020-17” on line 7 of the form and mail to:
Internal Revenue Service
Ogden UT 84201-0027
What relief is not provided?
Relief from information reporting under Revenue Procedure 2020-17 is not extended to reporting on Form 8938, Statement of Specified Foreign Financial Assets6 or Form 114, Foreign Bank Account Report.7 These forms are still required to report the ownership of or access to these foreign accounts.
Further, this information reporting exemption under Revenue Procedure 2020-17 does not provide any relief for possible taxation of income earned by the foreign trust. It is possible that the tax-deferred or tax-free status of the trust in Canada is not tax free in the U.S.
If you have any questions related to this or other U.S. topics, please contact your Baker Tilly advisor.
- Within the meaning of section 7701(a)(30)(A).
- In relation to tax under IRC section 6501 (without regard to section 6501(c)(8)).
- Section 5.03 of Rev. Proc. 2020-17.
- Section 5.04 of Rev. Proc. 2020-17.
- Used for relief from penalties under IRC 6677.
- IRC 6038D.
- Required by 31 U.S.C. section 5314 and the regulations thereunder.