Responsibility for filing the Report of Foreign Financial Accounts Form 114, or FBAR, is governed by the rules set out in Title 31 of the U.S. Code, commonly called the Bank Secrecy Act, or BSA, and implementing regulations issued by the Financial Crimes Enforcement Network, or FinCEN, of the U.S. Treasury. It is important to understand that the BSA is a separate body of law from the Internal Revenue Code, or IRC, found in Title 26 of the U.S. Code. We will get back to this point later. The BSA itself provides very little information; one must look to the regulations and Form 114 instructions for guidance.
Severe penalties apply for non-filing and FBAR mishaps. The IRS has been very aggressive in assessing penalties. The agency’s position has been strengthened with a recent court blessing. The law in the U.S. Court of Appeals for the Ninth Circuit is now clear—the FBAR nonwillful penalty can be asserted on a per account rather than a per form basis.
There is a lot of misunderstanding regarding FBAR filing duties, especially when it comes to trusts holding foreign accounts. Trustees, beneficiaries, and grantors who are connected to a trust may also have personal FBAR-filing duties with regard to the foreign accounts owned by the trust. Mr. FBAR is full of surprises! Today’s article will look at the FBAR rules as they relate strictly to the trust entity.
Let’s break it down.
Who Must File an FBAR?
Under the regulations and the current FBAR instructions, a U.S. person that has a financial interest in or signature authority over foreign financial accounts must file an FBAR if the aggregate 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 U.S. person, it will have responsibility for filing an FBAR regarding any 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 owner of record or holder of legal title to the account, regardless of the fact that the trust holds the accounts for the benefit of its beneficiaries.
A trust that is a U.S. person will also be deemed to have a financial interest in a foreign account owned by another party related to the trust. Specifically, a U.S. person will have a financial interest in a foreign account for which the owner of record or holder of legal title is:
- an agent, nominee, attorney, or a person acting in some other capacity on behalf of the U.S. person with respect to the account;
- a corporation in which the U.S. person owns, directly or indirectly, more than 50% of the voting power or value of the shares;
- a partnership in which the U.S. person owns, directly or indirectly, more than 50% of the interest in profits or capital;
- a grantor trust of which the U.S. person is the grantor and has an ownership interest in the trust;
- a trust in which the U.S. person has a greater than 50% present beneficial interest 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 power, total value of the equity interests or assets, or interest in profits.
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 a partnership that itself has a foreign account, the trust must report not only the foreign accounts to which it is the title holder or owner of record. It also must report all foreign accounts to which the corporation or partnership is a title holder or owner of record.
Is the Trust a U.S. Person? What About Foreign Trusts?
A lot of confusion is generated concerning the U.S. status of a trust for FBAR purposes. It is important to remember that the BSA is found in Title 31 of the U.S. Code and is distinctly separate from the IRC, found in Title 26 of the U.S. Code.
For tax purposes under the IRC, a trust is defined as a U.S. person—therefore, not foreign—if a court within the U.S. is able to exercise primary supervision over the administration of the trust, i.e., the court test; and if one or more U.S. persons has the authority to control all substantial decisions of the trust, i.e., the control test. My blog post here helps readers understand when a trust is treated as foreign under the IRC.
These tests can be manipulated so that a trust created under the laws of a U.S. state can still be treated as a foreign trust for U.S. tax purposes. This is often done by manipulating the control test such that a foreign person has the authority to control a substantial decision(s) of the trust. Because all substantial decisions must be made by a U.S. person, choosing a non-U.S. person—e.g., a non-U.S. citizen, a nonresident alien individual, or foreign corporation—as trustee, or giving that person a veto power over even a single substantial decision, means the trust would fail the control test.
Many trusts are organized in the United States under the laws of a particular U.S. state. Typical states include Wyoming, South Dakota, Nevada, and Delaware. Such jurisdictions are chosen due to the fact that the U.S. has excellent substantive trust laws in place that provide, for example, strong asset protection and anonymity. These U.S.-formed trusts can nonetheless be treated as foreign trusts under the IRC, thus not paying U.S. tax on foreign source income, because they are purposely set up in such a manner to create foreign status.
Foreign Trusts and Treatment as a U.S. Person With FBAR Duty
These foreign trusts are not U.S. taxpayers, but this is not the litmus test for FBAR, as the FBAR rules are found in Title 31 and not Title 26. Can foreign trusts be treated for FBAR purposes under the BSA as U.S. persons?
For FBAR purposes, a U.S. person is defined to include “trusts or estates formed under the laws of the United States.” In better words, FBAR obligations arise for the trust once the trust is formed under the laws of a U.S. state. This is regardless of its treatment as a foreign trust—e.g., a trust that fails the control test—or as a so-called disregarded entity, for U.S. tax purposes.
With respect to a trust treated as a disregarded entity, there are many foreign grantor trusts created by nonresident alien individuals that are formed under the laws of one of the various U.S. states. These trusts are disregarded from an income tax perspective such that the NRA is treated as the tax owner of the trust without U.S. income tax implications for the trust as an entity. However, the trust itself is indeed a U.S. person for FBAR purposes. Thus, although the trust may be ignored for income tax purposes, it is not ignored for FBAR purposes.
Many foreign trusts are not aware of these rules. The FBAR situation should be rectified as soon as possible and likely can be done without imposition of FBAR penalties. We can help!
The lesson here: Look first to Title 31 when it comes to FBAR issues. Title 26 may be implicated as well, but the first port of call is the BSA and its regulations. The other lesson: It’s complicated. Engage a tax professional with the proper international experience to assist with such U.S. tax and FBAR matters.
This article does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Virginia La Torre Jeker, J.D., is a U.S. tax consultant and member of the New York Bar for over 35 years. A renowned U.S. international tax professional, she has been in Dubai since 2001.
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