Proposed Treasury Regulations Will Update Rules for Foreign Trust Beneficiaries

Treasury recently issued proposed regulations (the “Proposed Regulations”) that are intended to update and clarify existing reporting obligations for U.S. persons who receive gifts from abroad or are owners or beneficiaries of foreign trusts.(1) Such gifts, ownership interests and distributions must be reported annually to the Internal Revenue Service (“IRS”) using Form 3520, Annual report on transactions with foreign trust funds and receipt of certain foreign giftsThe proposed regulations provide guidance under sections 643(i), 679, 6039F, 6048, and 6677 of the Internal Revenue Code (“IRC”) regarding reporting the receipt of large foreign gifts, transactions with foreign trusts, and loans from foreign trusts and the use of their assets.

Foreign gifts

IRC Section 6039F requires U.S. persons to report receipt of large gifts from a foreign person in the U.S. person’s taxable year on Form 3520. The reporting threshold is a gift or gifts, in the aggregate, of more than $100,000 received by the U.S. person from a foreign person and/or foreign estate in the applicable taxable year. Special rules apply to gifts from foreign partnerships and corporations. The proposed regulations would increase the threshold amount for reporting gifts from a foreign person or foreign estate to include a cost-of-living adjustment and clarify the rules for aggregating foreign gifts from related persons.

Receiving any gift or bequest from a foreign individual or estate that meets the reporting threshold requires the U.S. person to report the date of the gift or bequest, a description of the property received, and the fair market value of the property received. The proposed regulations would now also require disclosure of the donor of a reportable gift in all circumstances, removing the anonymity of the foreign individual donor or foreign estate under current law. Under current regulations, the IRS requires only the donor’s identifying information (name, address, and identification number) for gifts from a foreign partnership or corporation.

In addition, the proposed regulations include a new anticircumvention rule that allows the IRS to reclassify certain foreign loans to U.S. persons as reportable gifts. Section 1.6039F-1(b)(2) of the proposed regulations would require a gift to be treated as such if all of the following requirements are met: (i) the IRS determines that the amount received is in substance a gift based on the facts and circumstances; (ii) the recipient does not treat the amount received as a gift, bequest, gift, or inheritance; and (iii) the recipient does not treat the amount received as taxable income. As a result, taxpayers who receive bona fide loans from foreign persons should carefully substantiate the debt in a written loan agreement and promissory note and make the required interest and principal payments.

Failure to timely file and report gifts to a U.S. person from a foreign individual or estate is subject to civil penalties of up to 25 percent of the gift amount. The proposed regulations would allow the IRS to impose assessable penalties on the noncompliant taxpayer, putting the taxpayer on the defensive, rather than using deficiency procedures that provide the taxpayer with notice and an opportunity to challenge the penalty before the assessment.

Offshore trust funds

The proposed regulations provide guidance on reporting transactions with foreign trusts and include a broader exception for certain foreign trusts that enjoy tax advantages. A trust would be classified as a foreign trust for U.S. income tax purposes unless (i) all of the material decisions regarding the trust are made by one or more U.S. persons (commonly known as the “control test”) and (ii) a court in the United States can exercise primary supervision over the administration of the trust (commonly known as the “court test”). Generally, U.S. persons are required to report on Form 3520 under current regulations if they: (i) transfer property to a foreign trust or engage in certain other transactions with a foreign trust; (ii) receive distributions from a foreign trust; or (iii) are treated as an owner of a foreign trust.

In addition to the reporting obligations above, the proposed regulations provide additional guidance on the treatment of loans made through foreign trusts, the gratuitous use of foreign trust property, the application of the grantor trust provisions to foreign trusts, and relaxations in the rules for qualifying for reporting exceptions for foreign pensions and foreign retirement accounts of U.S. persons.

Date of entry into force

The proposed regulations are intended to apply to transactions with foreign trusts and receipts of foreign gifts in taxable years beginning after the date of publication of the final regulations. However, a taxpayer may rely on the proposed regulations in any taxable year ending after the date of publication (May 8, 2024) and beginning before the date of publication of the final regulations, provided that the taxpayer and related entities apply the proposed regulations in their entirety and consistently in all taxable years beginning with the taxable year of first reliance.

Regardless of the proposed regulations, the reporting requirements for a U.S. person’s involvement in a foreign trust or receipt of foreign gifts or bequests are burdensome and complex.

(1) Proposed Order No. 124850-08.