New expanded Form 3520 reporting requirements are coming

Hello friends, and welcome once again to your every-other-Friday inoculation against international tax ignorance. I’m your doctor . . . Dr. . . . ummm . . . Phil.

Upcoming presentations

April 25, 2025, noon Pacific time – International Tax Lunch online and free. Stay subscribed to get the updates and the link for how to watch. This month is all about foreign disregarded entities and Form 8858.
May 15, 2025 – I am speaking at the Washington Society of Certified Public Accountants’ International Tax Conference in Bellevue, WA. Attend online or in person. Show up IRL! We will be having a small event at the bar after the conference on Thursday evening. My topic is foreign disregarded entities again, but more as a strategic tool rather than the nuts and bolts of Form 8858 and assorted paperwork.

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Email me if you want to ask me questions before making a decision. We can get on a video call.

Attend the International Tax Summit – June 27, 2025 – London

For those of you in the U.K. and Europe, consider attending the International Tax Summit in London on June 27, 2025. It is a one-day event. Presentations will be by members of the International Tax Professionals community, including:

Christine Dahl – https://www.dahltaxlaw.com/ – Practice Management and AI
Christie DuChateau – https://bnctax.com – Penalty Abatement for Form 5472 and Form 5472
Christian Gulizzi – https://gulizzi-consulting.de/ – Italian Tax Incentives for New Residents, Foreign Workers, and Foreign Business Owners
Marek Krawczyk – https://uk.andersen.com/team/ – Topic TBD
Alexander McGowin – https://mcgowintax.com/ – U.S. Ownership of Foreign Real Estate
Natalia Mityaeva – https://beaconhilltax.com – Personal Services CFCs

Tickets are currently limited to members of the International Tax Pros community, but will be available to nonmembers on April 25, 2025. Stay subscribed here to get more announcements and to receive the email on April 25, 2025 with the “click here to buy” button.

There are only 28 tickets left as of today.

I will be there and I look forward to meeting you in person.

(For what it’s worth I will be in London all week, so if you want to meet up, send me an email).

New Reporting Requirements for Foreign Grantor Trusts and Use of Trust-Owned Property

Finally we get to the good stuff.

If you deal with foreign grantor trusts, the paperwork is about to become even more worse, thanks to the Foreign Trust Proposed Regulations published in 2024.

IRC Section 6048 is where you find the rules requiring U.S. persons to provide information to the IRS, and there are Proposed Regulations which increase the paperwork requirements for foreign trusts. Here’s what the Proposed Regulations do:

“Any” U.S. person who uses trust-owned property (whether the person pays full value or gets to use it free) of “any” foreign trust (whether grantor or nongrantor) will have to file Form 3520 and report that use as a trust distribution.

This will come into effect when the Proposed Regulations are finalized.

Background: IRC Section 643(i) for foreign nongrantor trusts

IRC Section 643(i) says that if a U.S. person is allowed to use property owned by a foreign nongrantor trust, then that use creates a deemed trust distribution equal to the fair market value of that use minus payment made by the U.S. person using the property.

Example. A foreign nongrantor trust owns a condo in Vail. If the right kind of U.S. person (a grantor, beneficiary, or person related to the grantor or beneficiary) goes and uses the condo for a week of skiing and pays no rent, then that’s a deemed trust distribution equal to what the condo would have cost if it had been rented out to an unrelated person.

A deemed trust distribution from a nongrantor trust can carry the trust’s DNI and UNI to a blissfully ignorant U.S. taxpayer, who will have a rude shock on that year’s personal income tax return.

That’s why foreign grantor trusts are good

That’s why I like foreign grantor trusts—to eliminate the unpleasantries of IRC Section 643(i), which applies only to foreign nongrantor trusts.

Another example. A U.S. citizen living abroad creates a normal trust for normal reasons. It is created under foreign law, so it’s a foreign trust, and it happens to have U.S. beneficiaries (kids!), so it’s a grantor trust (IRC Section 679). The trust owns a beach home and the family piles into the station wagon every summer and spends a few weeks at the shore.

IRC Section 643(i) can’t create deemed income from the uncompensated use of the trust-owned beach house by the U.S. grantor and the U.S. beneficiaries.

A third example. A defective grantor trust (assets outside the grantor’s gross estate for estate tax purposes, but assets deemed owned by the grantor for income tax purposes) happens to be foreign and owns a vacation home in the United States. The grantor parent is a nonresident, but the kids are U.S. citizens. The kids, of course, are with the parent when the family goes and spends time in the vacation home.

IRC Section 643(i) can’t apply to a foreign grantor trust, so the U.S. kids living in the house will not cause a deemed trust distribution.

Point is: IRC Section 643(i) is a vampire, and grantor trust status for a foreign trust is the clove of garlic that wards off IRC Section 643(i).

But!

There’s always paperwork

Right now, since there is no IRC Section 643(i) application to foreign grantor trusts creating a deemed trust distribution, there is no reporting requirement for a U.S. person who uses trust-owned property (like real estate) for free. IRC Section 6048 reporting requirements are triggered by “distributions” (among other things).

The Proposed Regulations will change all that. For foreign grantor trusts and IRC Section 6048, “distribution” now includes use of trust-owned property.

You know how the IRS likes matchy-matchy paperwork? You get a Form W-2 to show your wage income, and your employer tells the IRS what you were paid. Now the IRS compare what you said and what the employer said and see if your Form 1040 is right.

Well, matchy-matchy is coming to foreign grantor trusts.

Prop. Reg. Section 1.6048-4(a):

Unless an exception in § 1.6048-5 applies, any U.S. person who receives directly or indirectly any distribution from a foreign trust (without regard to whether any person is treated as the owner of the foreign trust under the rules of subpart E of part I of subchapter J of chapter 1) must file Part III of Form 3520, Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts. . . .

See that?

A Form 3520 filing requirement exists for a distribution to “any U.S. person.” This is not limited to a trust’s beneficiary or grantor. ANY U.S. person who receives a distribution from a foreign trust. ANY foreign trust—whether grantor or nongrantor.
From “any” foreign trust–grantor or nongrantor.

What’s a “distribution?”

A distribution includes use of trust-owned property. Prop. Reg. §1.6048-4(b)(6)(i):

A distribution includes the fair market value of the direct or indirect use of any property of a foreign trust by a U.S. person.

Note—it doesn’t limit “distribution” to uncompensated or below-market use of trust-owned property. Compare this to IRC Section 643(i)(5), which says that use of trust-owned property isn’t a “distribution” if you pay full price for it.

It’s ANY use of ANY property of a foreign trust by a U.S. person.

The reporting of this distribution is required even if there is no tax impact to a U.S. grantor or a U.S. beneficiary under IRC Section 643(i). Prop. Reg. Section 1.6048-4(b)(6)(iii):

The use of trust property must be reported by the U.S. person described under paragraph (b)(6)(i) of this section and by the U.S. grantor or beneficiary described under paragraph (b)(6)(ii) of this section on Part III of Form 3520, Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts, without regard to whether the use of trust property would be treated as having any income tax consequences to a U.S. grantor or beneficiary (within the meaning of § 1.643(i)-1(d)(11) or (1), respectively) of the foreign trust.

What I think this means

What this tells me is that any use of foreign trust-owned property by any U.S. person (“the U.S. person described under paragraph (b)(6)(i) of this section”) will trigger a Form 3520 filing requirement for that U.S. person. It will NOT trigger a Form 3520 reporting requirement for the grantor of the foreign grantor trust or for any U.S. beneficiary of the foreign grantor trust—because these people only report the use of trust-owned property because of “paragraph (b)(6)(ii) of this section” which refers to foreign nongrantor trusts.

Example. My client is a nonresident alien individual and owns a Vail condo in a foreign grantor trust. He tells me to go use the place for free for a week. I, a U.S. citizen, am a U.S. person. I am not named as a beneficiary in the trust. Yet, I apparently must file Form 3520 to report the rent-free use of the Vail condo for the week. Prop. Reg. Section 1.6048-4(b)(6)(iii) says so.

New: “Foreign-Owned Grantor Trust Beneficiary Statement”

A new trustee reporting form is in the works to enable this reporting obligation: the Foreign-Owned Grantor Trust Beneficiary Statement. Prop. Reg. Section 1.6048-4(c)(3):

A foreign trust that is treated as owned by a foreign person under the grantor trust rules may issue, by the fifteenth day of the third month after the end of the trust’s taxable year, a Foreign-Owned Grantor Trust Beneficiary Statement to each U.S. person who receives a distribution.

Any U.S. person (not just a beneficiary) who uses trust-owned property receives a distribution. Any U.S. person (not just a beneficiary) who receives a distribution from a foreign grantor trust gets this new Statement.

It doesn’t matter whether the U.S. person using the trust-owned property pays full value for that use or not: it’s still a distribution.

Example. My nonresident alien client is the grantor of a foreign grantor trust that owns a Vail condo. I rent the condo from him for a week and pay fair market value rent for my stay. I used trust-owned property. I must report this use on Form 3520, Part III. The trustee of the foreign grantor trust will presumably issue me a Foreign-Owned Grantor Trust Beneficiary Statement reporting my use of the condo.

Conclusion

For those of you who deal with foreign trusts—or who have U.S. clients whose lives might potentially touch a foreign trust—the Proposed Regulations (when finalized) will mean more paperwork, more trouble, and more opportunities for penalties.

What could possibly go wrong? 🙂

Talk to you in a couple of weeks.

Phil.