The Internal Revenue Service is always on the lookout for taxpayers who fail to comply with tax laws, and it maintains a number of Large Business and International (LB&I) campaigns to address tax avoidance through unreported income or undisclosed assets. Foreign investments are an area that the IRS commonly examines, and one issue that has been highlighted is the holding of assets in trusts outside the United States. Failing to file the proper forms or making errors when reporting assets in foreign trusts can lead to tax audits and significant penalties.

Penalties for Errors in Form 3520 and 3520-A

There are a variety of reporting requirements that apply for U.S. citizens and companies or estates in the United States that are owners or beneficiaries of foreign trusts. The term “foreign trust” is broadly interpreted to include any trust that is not considered a domestic trust. Domestic trusts are trusts that are primarily controlled by people or entities in the United States and are supervised by a U.S. court. There is a lack of clarity concerning some financial accounts that may be treated by the IRS as a trust.

U.S. taxpayers who are considered the owner of a foreign trust or who engage in transactions with foreign trusts are required to file Form 3520 to report these transactions. These transactions may include creating a trust, transferring assets to a trust, receiving a distribution from a trust, or making or receiving a loan with a trust.

The federal government has long been concerned with assets and businesses based abroad but owned by United States citizens. The IRS regularly looks to address income that is purposefully generated outside the country to avoid taxation. As part of the efforts to ensure that foreign investments are taxed correctly, the Tax Cuts and Jobs Act (TCJA), which was passed last year, made sizable changes to taxation rules, such as the addition of regulations mandating that global intangible low-taxed income produced by controlled foreign corporations be included in a taxpayer’s taxable income.

What Is a Controlled Foreign Corporation?

A controlled foreign corporation (CFC) is an American corporation that operates in another country with U.S. shareholders who hold 50% or more of the control of that corporation. American shareholders, directors, or officers of one of these businesses must report their income from the foreign corporation and pay taxes on that income. 

New Laws Under the Tax Cuts and Jobs Act

The TCJA provides that a U.S. taxpayer who possesses at least 10% of the value or voting rights in at least one CFC must now report global intangible low-taxed income from these CFCs as currently taxable income. This holds true even if there are no distributions to shareholders. 

As tax season draws to an end, many taxpayers have scrambled to compile financial information and file their tax returns prior to this year’s extended deadline of April 18. During this time, many people worked with accountants or tax preparers to ensure they were able to obtain the largest possible tax refund. In many cases, however, the assistance of an experienced tax attorney can be essential when preparing your tax return, addressing complex legal issues, and avoiding potential tax penalties.

Benefits Provided By a Skilled Tax Lawyer

While a certified public accountant (CPA) will have knowledge of financial matters related to taxes, such as allowable deductions and tax credits, an experienced taxation law attorney will have a deep understanding of the legal issues related to tax audits and IRS collection. A tax attorney can help with the following: