Unlike a domestic trust, an offshore trust offers you full asset protection because your assets are no longer physically tied to the United States. Therefore, they are no longer under the legal jurisdiction of the United State court system. This is why your assets are protected from unexpected lawsuits and creditors.
Properly implemented offshore trusts are tax-neutral. In other words, the jurisdiction where the trust is established should not impose taxes on the trust’s income and capital gains, avoiding a duplicative layer of taxes for the investor to pay. However, this does not mean that investors with offshore trusts don’t pay taxes. Therefore, when it comes to tax planning, it is essential that you know the rules put forth by the IRS with regard to the reporting requirements for offshore trusts to avoid penalties.
What You Owe the Government
Citizens and residents of the U.S. are taxed on their worldwide income. Over the years, reviewing offshore trusts has become a major focus of the IRS. Because there are a number of tax transparency initiatives such as the automatic exchange of information, the IRS will have the data required to make sure taxpayers with offshore trusts will pay the correct taxes on their investment returns.
For tax planning with an offshore trust, it is prudent to know all offshore trusts with U.S. owners are grantor trusts, the grantor being the person(s) creating and funding the trust. All income earned within the trust is taxable to the grantor. Taxes aren’t deferred until the profits are brought into the U.S. and are due when the gains are realized.
U.S. tax law imposes various requirements for reporting information on offshore trusts. There are (two) forms you need to use when reporting income from your trust (interest, dividends, capital gains, etc.). Failure for late or incomplete filing of these forms can result in costly penalties:
- Form 3520: Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts
- Form 3520-A: Annual Information Return for Foreign Trust with a U.S. Owner
Other tax forms that could be required include:
- 1040, Schedule B, Part III, Foreign Actions and Trusts
- Report of Foreign Bank and Financial Accounts (FBAR)
- Form 709, U.S. Gift ( and Generation-Skipping Transfer) Tax Return
- 1040-NR, U.S. Nonresident Alien Income Tax Return
- Form 8938, Statement of Specific Foreign Financial Assets
Offshore trust tax planning is multifaceted, involving complicated rules, a variety of tax forms and the threat of severe penalties for mistakes, as well as for late or incomplete filing. Therefore, it’s critical that you engage the services of an asset protection lawyer to design and establish your offshore trust.
What You Owe Yourself
Jeffrey M. Verdon, California assets protection lawyer, has practiced taxation and comprehensive estate planning with asset and lifestyle protection planning since 1978. At the Jeffrey M. Verdon Law Group, with offices in Newport Beach, we can address all issues surrounding taxation with foreign trusts for our clients who have established asset protection trusts.