IRS issues filing guidance on SBJPA's foreign trust and gift reporting provisions.

The Small Business Job Protection Act of 1996 enacted extensive information reporting requirements for, among others, foreign trusts and gifts and trust beneficiaries.

Notice 97-34 fleshes out these rules, detailing the information to be filed, by whom and the filing deadlines.

This guidelines is certainly welcome; in some cases, filings must be made within the next two months.

On June 2, 1997, the IRS issued Notice 97 34,(1) which contains guidance on the foreign trust and gift reporting requirements enacted by the Small Business Job Protection Act of 1996 (SBJPA). This article presents a brief discussion of Secs. 6048, 6039F and 1494 as amended by the SBJPA, and a chart summarizing the related Notice 97-34 reporting requirements.

Background

Sec. 6048(a) and (c) generally require reporting in the case of certain transactions between U.S. persons and foreign trusts. Sec. 6048(b) requires a U.S. person who is the grantor of a foreign trust under the Code's grantor trust provisions(2) to ensure that the trust file an information return. Sec. 6048(b) also requires the appointment of a limited U.S. agent by a foreign grantor trust with a U.S. grantor.(3) Sec. 60396(4) requires that a U.S. person receiving gifts from foreign sources in excess of $10,000 per year file an information report with respect to those gifts containing any information required by the Service.

Sec. 1494 imposes a penalty for failure to file a return for any transfer described in Sec. 1491. Sec. 1491, in turn, imposes a 35% excise tax on the built-in gain of an asset transferred by a U.S. person to (among others) a foreign trust or estate. Notice 97-34 requires that certain transfers to foreign trusts by U.S. persons covered by Sec. 1491 be reported on Form 3520.(5)

Secs. 6677 and 6039F impose penalties ranging from 5% to 35% of the gross reportable amount (as defined in Sec. 6677(c)) for failure to meet Secs. 6048,1494 and 6039F reporting requirements. In some cases, additional penalties may be assessed or the income tax treatment of certain items may be subject to recharacterization under Secs. 6677 and 6039F if the required information returns are not filed.

SBJPA Effective Date

The SBJPA amended the reporting rules to substantially increase the reporting requirements for certain transactions between U.S. persons and foreign trusts, estates and donors. Under SBJPA Sections 1901(d) and 1905(a),the amendments to Secs. 6048(a) and (c),6039F and 1494 are effective for covered transactions occurring after Aug. 20, 1996.(6) Under SBJPA Section 1901 (d)(2), Sec. 6048(b) is effective for foreign grantor trusts in the first tax year of the U.S. grantor that begins after 1995, as a result, many affected U.S. taxpayers were required to file information returns for their 1996 tax year. Prior to the issuance of Notice 97-34, no filing guidance was available.

Notice 97-34 Highlights

Threshold for Reporting Foreign Gifts

Although Sec. 6039F requires reporting for foreign-source gifts if in any tax year the aggregate value of such gifts exceeds $10,000,(7) Notice 97-34 raises the reporting threshold for gifts from a foreign estate or individual. Now, gifts from a foreign individual or estate must be reported only if, in the aggregate, they exceed X100,000. Gifts received from foreign partnerships and corporations continue to be subject to reporting if, in the aggregate, the value of such gifts during the U.S. donee's tax year exceeds $10,000.(8)

Trust Obligations

A distribution from a trust to a U.S. person in return for that person's "qualified obligation" is not a distribution subject to reporting. Similarly, a transfer to a foreign trust by a U.S. person in exchange for the trust's qualified obligation is not subject to reporting. Notice 97-34 defines "qualified obligation" for this purpose.

Forms Revision

The Service intends to revise existing Form 3520, Creation of or Transfers to Certain Foreign Trusts, and Form 3520-A, Annual Return of Foreign Trust With U.S. Beneficiaries, to serve as the reporting forms for Secs. 6048, 6039F and 1494 transactions. Until revised forms are available, the existing forms should be used and filed in accordance with the modifications contained in Notice 97-34.

Filing Deadlines for 1996 Tax Year, Forms

Generally, Notice 97-34 requires U.S. persons who were involved in transactions described in Secs. 6048, 6039F and 1494 during their tax year that included Aug. 20,1996, to file a "1996 Form 3520" by Nov. 15,1997, or to ensure that covered foreign grantor trusts file a "1996 Form 3520-A" by Oct. 15, 1997.9 In addition, a foreign trust that made distributions to a U.S. beneficiary from Aug. 21, 1996-Dec. 31,1996 must supply the U.S. beneficiary with either a Foreign Grantor Trust Beneficiary Statement or a Foreign Nongrantor Trust Beneficiary Statement, by Oct. 15,1997. Notice 97-34 sets out the information required in the reporting statements. If a U.S. beneficiary who received distributions does not receive the appropriate statement, trust distributions that may have been income tax free to the beneficiary may be subject to income tax and an interest charge on accumulation distributions.

Previous Filings for 1996

Notice 97-34 states that taxpayers who file a Form 3520 (or Form 3520-A) that is not revised as described therein will not be considered to have complied with the revised Secs. 1494 and 6048 information reporting requirements.(10). Thus, taxpayers who may have attempted to comply with the Sec. 6048, 6039F or 1494 reporting requirements as amended by the SBJPA for their tax year that included Aug. 20,1996 will need to re-file in accordance with the notice's instructions to avoid penalties.

Notice 97-34 Reporting Chart

The chart on pages 578-579 summarizes the reporting requirements set forth in Notice 97-34.

(1) Notice 97-34, IRB 1997-25, 22.

(2) Sec. 671 et seq.

(3) According to Sec. 6048(b)(2)(A), if a foreign grantor trust fails to appoint a U.S. agent, the Service can determine the amounts that the U.S. grantor must take into income with respect to the trust.

(4) See note 2 in the accompanying chart.

(5) This article discusses Sec. 1494 only as it applies to transfers to foreign trusts; see Notice 97-18, IRB 1997-10, 35, modified by Notice 97-42, IRB 1997-29, 12. Notice 97-34, Section I, states that the current version of Form 3520, Creation of or Transfers to Certain Foreign Trusts, will be revised and retitled "Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts," and will generally allow U.S. persons to file a single form to comply with the SBJPA reporting requirements for foreign trusts and gifts.

(6) See Lifson and Guadiana, "REcent Legislation Imposes New Compliance and Tax Burdens on Individuals With Foreign Connections," 27 The Tax Adviser 676 (Nov. 1996).

(7) Sec. 6039(b) provides that, for this purpose, qualified payments for tuition or to medical providers are not gifts.

(8) Notice 97-37, not 1, provides that gifts from foreign partnerships and corporations are subject to recharacterization under new Sec. 672(f)(4).

(9) See note 1 in the accompanying chart.

(10) While Notice 97-34, note 1, does not explicitly refer to penalties under Sec. 6039F, presumably, the same result would obtain.

RELATED ARTICLE: EXECUTIVE SUMMARY

* Notice 97-34 raises the reporting threshold for gifts from a foreign individual or estate from $10,000 to $100,000.

* A distribution from a trust to a U.S. person in return for that person's "qualified obligation" (as defined in NOtice 97-37) is not a distribution subject to reporting.

* The IRS is revising Form 3520 to generally allow U.S. persons to file a single form to comply with the SBJPA reporting requirements for foreign trusts and gifts.

Notice 97-34 Reporting Rules (unless otherwise noted, all Section references are to the notice)

Code Sec.                    Event

6039F(2)      A U.S. person's receipt during the tax
              year from any nonresident individual
              or foreign estate of gifts valued in the
              aggregate at more than U.S. $100,000.
              A U.S. beneficiary may also have to
              report receipts from a domestic trust
              that received contributions from a
              foreign source or a domestic trust's
              receipts from a foreign sources.(3)
              Section VI.A and B)

              A U.S. person's receipt during the tax
              year from a foreign partnership or
              corporation (taking into account
              related-party aggregation rules in Section
              VI.B.3) of gifts valued in the aggregate
              at more than U.S.$10,000, adjusted
              annually for inflation. A U.S.
              beneficiary may have to report receipts
              from a domestic trust that received
              contributions from a foreign source or
              a domestic trust's receipts from foreign
              sources.(3) (Section VI.B.2)

6048(a)       (1) Creation of a foreign trust by a
              U.S. person; (2) transfer by a U.S.
              person to a foreign trust (including by
              reason of death); and (3) death of a
              U.S. citizen or resident if: (a) the decedent
              was a foreign trust grantor under
              the grantor trust rules (b) any part
              of a foreign trust was included in the
              decedent's gross estate.(4) (Section III.A)

6048(b)(1)    A U.S. person is treated as the grantor
              of a foreign trust (under the grantor
              trust provisions, Sec. 671 et seq.) at any
              time during his tax year. (Section IV)

6048(b)(2)    A foreign grantor trust as to a U.S.
              person must appoint a limited U.S.
              agent. (Section IV.B)

6048(c)       A U.S. person's receipt of a distribution(8)
              from any foreign trust during the tax year.(9)
              (Section V)

6048(c)       A foreign nongrantor trust with U.S.
(2)(A)        beneficiaries should consider appointing a
              limited U.S. agent.

1494          A U.S. person makes a nongratuitous
              transfer of appreciated property to a
              foreign trust, if (1) the transferor does
              not immediately recognize all of the
              gain at the time of the transfer (or
              recognizes gain only because of a Sec.
              1057 election) or (2) the transferor is
              related to the trust.(10) (Section III.D)

Code Sec.     Reporting form and requirement

6039F(2)      The U.S. person receiving the gift must file a
              revised Form 3520. In the case of reportable gifts
              from a foreign estate or individual, the donee must
              separately identify each gift in excess of $5,000,
              but the donor need not be identified.
              (Section VI.B.1)

              For a gift from a partnership, corporation or
              individual (when gifts from individuals or estates
              are aggregated with corporate and partnership gifts
              under the Section VI.B.3 aggregation rules), the
              donee must separately identify the gift and the
              donor entity. However, if a foreign individual's or
              estate's gift is included under the aggregation
              rules, the individual or estate need not be
              identified and the gift need be described only if
              its value exceeds $5,000. (Section VI.B.2)

6048(a)       In each case, the responsible party (as defined in
              Sec. 6048(a)(4)) must file a revised Form 3520.
              Until the revised form is available, existing Form
              3520 can be used, with the modifications required
              by Notice 97-34.(5) The completed form must be
              attached to the responsible party's income tax
              return and also filed with the Philadelphia Service
              Center. (Section VIII.A)

6048(b)(1)    A revised Form 3520-A must be signed by the trustee
              and filed by the trust. Until the revised form is
              available, the trustee must use existing Form
              3520-A, with "FOREIGN GRANTOR TRUST" written across
              the top; identifying information must be completed
              as if the foreign trust were the U.S. grantor.(6)
              (Section IV.A)

              Section IV.A contains a Foreign Grantor Trust
              Information Statement (FGTIS) to be completed
              and attached to the current version of Form
              3520-A until the revised form is available. The
              completed form and the attached statement must
              be filed by the trustee with the Philadelphia
              Service Center.

              The trust must supply a Foreign Grantor Trust
              Beneficiary Statement (contained in FGTIS,
              [paragraph] 5) to each beneficiary and a Foreign
              Grantor Trust Owner Statement (contained
              in FGTIS, [paragraph] 4) to each U.S. owner.
              (Section IV.A)

6048(b)       The trustee should appoint a U.S. person (i.e., a
(2)           U.S. citizen, resident alien or domestic
              corporation) as agent and execute an Authorization
              of Agent. (Section IV.B)

6048(c)       A revised Form 3520 must be filed with the
              Philadelphia Service Center by the U.S. person
              who received the distribution. Form 3520 must
              also be attached to the U.S. person's income
              tax return for his tax year that includes the
              date of the distribution. A Foreign Grantor Trust
              Beneficiary Statement (Section IV.A, [paragraph] 5)
              or Foreign Nongrantor Trust Beneficiary Statement
              (Section V.B) must be attached to the beneficiary's
              Form 3520.

6048(c)       Execute Authorization of Agent (Section IV.B).
(2)(A)        Presumably, a trust makes the election by
              appointing a U.S. agent, executing an agent
              authorization and completing the Foreign
              Nongrantor Trust Beneficiary Statement at
              Section V.B.

1494          In each case, file Form 3520 in a manner comparable
              to the manner for reporting transactions with other
              foreign entities on Form 926, Return by a U.S.
              Transferor of Property to a Foreign Corporation,
              Foreign Estate or Trust, or Foreign Partnership.
              Thus, (1) if all gain is not immediately
              recognized (or recognized only due to a Sec. 1057
              election), the transferred property must be
              separately identified;  or (2) if any gain is
              recognized and the transferor is a related
              party, the property transferred may be aggregated
              using the categories in Notice 97-18, Section
              III.C.(11) A separate Form 926 need not be filed
              unless a Sec. 1491 excise tax is due.(Section
              III.D)

Code Sec.     Due data(1)

6039F(2)      The due data of the U.S. person's
              income tax return
              (including extensions) for his
              tax year in which the gift was
              received. Attach Form 3520 to
              the income tax return and also
              file with the Philadelphia
              Service Center. (Section
              VIII.A)

              The due data of the U.S.
              person's income tax return
              (including extensions) for the
              tax year in which the gift was
              received. Attach Form 3520 to
              the income tax return and also
              file it with the Philadelphia
              Service Center. (Section
              VIII.A)

6048(a)       In each case, the due date is
              that of the responsible party's
              income tax return for the year
              of the reportable event.
              (Section VIII.A)

6048(b)(1)    The due data is the 15th day of
              the third month following the
              end of the trust's tax year
              (generally, March 15), unless the
              trust obtains an extension.
              (Section VIII.A)

6048(b)(2)    The authorization must be
              executed before the due date of
              the first required Form 3520.(7)
              (Section IV.B)

6048(c)       The due date is the same as
              that of the U.S. person's
              income tax return (including
              extensions). (Section VIII.A)

6048(c)       Consider appointing an agent
(2)(A)        before the due date of the beneficiary's
              first required Form 3520.

1494          Same as due date for Form
              3520 in the event of a Sec.
              6048(a) reportable event. (Section VIII.A)

(1) Notice 97-34, Section VIII.A, provides that for the tax year of a U.S. person that included aug. 20, 1996, who must file a Form 3520, the 1996 Form 3520 is due Nov. 15, 1997 and must be filed with the Philadelphia Service Center. Foreign trusts that were grantor trusts as to a U.S. person on any day after 1995 must file a 1996 Form 3520-A with the Philadelphia Service Center by Oct. 15, 1997, for the U.S. owner to meet his 1996 Sec. 6048(b) reporting requirement U.S. person's 1997 income tax return (including extensions); in the case of a Form 3520-A, by the due date of the affected foreign trust's 1997 Form 3520-A, but only if the U.S. person's 1996 income tax return contains all of the information required by Notice 97-34 to be contained in the 1996 Form 3520 or 3520-A. If a U.S. beneficiary must report a distribution from a foreign trust on his 1996 Form 3520, the foreign trust should supply him with the appropriate beneficiary statement by Oct. 15, 1997.

(2) The current Code contains two sections numbered 6039F. This article discusses Sec. 6039F, Notice of large gifts received from foreign persons, as enacted by SBJPA Section 1905(a). The Service had indicated that it will seek a technical amendment to change the numbering of Sec. 6039F, Information on individuals losing United States citizenship, to Sec. 6039G.

(3) Transfers by foreign persons to a foreign or domestic trust with a U.S. beneficiary are reportable by the latter under Sec. 6039F either (1) the the trust receives the transfer, if the trust is a grantor trust as to that beneficiary, or (2) if a domestic trust is not a grantor trust, on the beneficiary's receipt of a distribution from the trust; see Notice 97-34, Section VI.A.

(4) See Sec. 6048(a)(3)(A). An exception under Sec. 6048(a)(3)(B) applies to transfers to (1) trusts that are sales at full fair market (FMV) value or (2) certain "compensation" or charitable trusts; see Notice 97-34, Sect ion III.C.3, for an explanation of when a trust's obligation will be considered FMV. If a trust's obligation is not qualified (as defined in Section III.C.2), a transfer to the trust in return for such obligation is subject to reporting. Section III.E exempts transfers to foreign trusts that are Canadian Registered Retirement Savings Plans (RRSPs), provided the trust would qualify for treaty benefits. Any U.S. person relying on the treaty not to report a transfer to an RRSP must disclose this position.

(5) If the October 1992 revision of Form 3520 is used to report a Sec. 6048(a) event, it appears to contain spaces for all information required by the notice; however, the instructions to that form do not include all situations in which a Form 3520 must be filed under post-SBJPA Sec. 6048(a).

(6) Notice 97-34 does not explain how to provide this information if there are multiple grantors under the grantor trust rules; perhaps multiple Form 3520-As must be filed.

(7) Although Notice 97-34, Section IV.B, states that an agent need not be appointed until Form 3520 is due, the agent should be appointed prior to filing the first Form 3520-A, because it must contain information about the agent if the U.S. grantor wants to avoid application of Sec. 6048(b)(2)(A).

(8) Loans and "constructive distributions" from a foreign trust to a U.S. person who is a trust beneficiary are trust distributions subject to Sec. 6048(c), unless the loan is a qualified obligation (as defined in Notice 97-34, Section V.A); Section V.A provides examples of constructive distributions (e.g., a U.S. person's credit card secured by a foreign trust).

(9) See note 3.

(10) The U.S. transferor is related to the trust if the transferor is the trust grantor, a trust beneficiary or a person related to a grantor or a beneficiary (applying Sec. 643(i)(2)(B), as modified by Notice 97-18, IRB 1997-10, 35, Section II.A.2).

(11) See Notice 97-18, id., Section III.D. Sec. 643(i)(2)(B), as modified by Notice 97-18, Section II.A.2, should be applied in determining if a transferor is related to the trust grantor, beneficiary or a person related to either. A transfer may be gratuitous in part and for consideration in part; in such case, the transfer would be both a Sec. 6048(a)(3) reportable event and also reportable under Sec. 1494; see Notice 97-34, Section III.D. (Notice 97-18 is modified by Notice 97-42, IRB 1997-29, 12.)