On March 2, 2020, the IRS released an advanced version of Revenue Procedure (Rec. Proc.) 2020-17. It is expected that the final regulations will be issued on March 16, 2020 and will be effective as of the date of publication in the Internal Revenue Bulletin. To summarize, Rev. Proc. 2020-17 states that the U.S. Treasury and the IRS intend to issue proposed regulations that will impact the U.S. information reporting requirements with respect to the reporting of certain “foreign trusts”.
IRC §6048, in general, requires certain U.S. citizens and resident individuals (in the U.S.) to file Form 3520, “Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts” and/or Form 3520-A, “Annual Information Return of Foreign Trust With a U.S. Owner”, depending on whether the taxpayer made a transfer to/from a foreign trust or whether the taxpayer was considered to own all or a portion of the foreign trust (as determined under U.S. tax law). The filing of these forms was a costly and time consuming exercise. Failure to accurately and timely file these forms, if required, can lead to substantial penalties.
What does this mean?
Canada has five tax favored/deferred accounts being: (1) a Registered Retirement Savings Plan (RRSP); (2) a Registered Retirement Income Fund (RRIF); (3) a Registered Education Savings Plan (RESP); (4) a Registered Disability Saving Plan (RDSP); and (5) a Tax Free Savings Account (TFSA).
In Notice 2003-75, issued on December 15, 2003, the IRS provided guidance which specifically eliminated the need to file Form 3520 and Form 3520-A with respect to Canadian RRSPs and RRIFs. The IRS, however, had never issued any guidance as to the “correct” characterization of the remaining plans for U.S. tax purposes and whether, as a result, the above forms were required to be filed. Given the potential penalties many taxpayers choose to file these forms as a protective measure.
As part of their crackdown on potential off-shore tax abuse, the IRS Large Business and International (LB&I) division launched a number of international compliance campaigns. One such program, entitled Forms 3520/3520-A Non-Compliance and Campus Assessed Penalties, was launched on May 21, 2018.
According to the IRS website
“This campaign will take a multifaceted approach to improving compliance with respect to the timely and accurate filing of information returns reporting ownership of and transactions with foreign trusts. The Service will address noncompliance through a variety of treatment streams (PDF) including, but not limited to, examinations and penalties assessed by the campus when the forms are received late or are incomplete.”
It has been our experience that the IRS had begun to routinely issue US $10,000 penalties against many taxpayers for filing “incomplete” forms. This caused many taxpayers a significant amount of anguish and resulted in additional compliance costs in challenging these assessments. In many cases, these was a long and drawn out process.
In our opinion (and our opinion only) the LB&I division was becoming overwhelmed with requests for penalty abatements and had the common sense to actually determine what information they actually needed to enforce U.S. tax laws.
What still needs to be reported
Rev. Proc. 2020-17, when enacted appears to eliminate the need to file either Form 3520 or Form 3520-A (to be confirmed once the final guidance has been issued). Relevant information that was disclosed on those forms was, in many ways, also reported on other disclosures. These other disclosures will not be eliminated and, as such, the IRS feels that there is unnecessary duplication that can be eliminated.
If applicable, the following forms will still need to be filed to report the taxpayer’s interest in these “foreign trusts”.
- FinCEN Form 114, “Report of Foreign Bank and Financial Accounts” and
- Form 8938, “Statement of Specified Foreign Financial Assets”
Income earned in an RESP, RDSP and/ or a TFSA is not exempt from U.S. taxation. There are no provisions in the U.S. Internal Revenue Code to exempt income earned in any of these plans from current U.S. taxation nor are there any provisions in the Canada-United States Tax Convention (1980) to exempt the income.
Tax-Free Savings Account
We do not believe, at this time, that the Rev. Proc. 2020-17 applies to a Tax-Free Savings Account.
Rev. Proc. 2020-17 discusses a “Tax-Favored Foreign Retirement Trust”, which should include an RRSP and a RRIF, and a “Tax-Favored Foreign Non-Retirement Savings Account”. These latter plans are defined “… exclusively to provide, or to earn income for the provision of medical, disability, or educational benefits,…”. As such, it would appear that Canadian RESPs and RDSPs would also be exempt from the requirement to file Form 3520 or Form 3520-A.
It is hoped that the IRS could provide some guidance and certainty with respect to TFSAs.
Abatement of penalties
As mentioned above, the IRS has already assessed penalties. Rev. Proc. 2020-17 provides guidance on how to request an abatement of assessed penalties that the IRS imposed on a “tax-favored foreign trust”. Form 843, “Claim for Refund and Request for Abatement” must be filed pursuant to the Rev. Proc. The Rev. Proc., once published, applies to all open taxable years subject to the limitations of IRC §6511.
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