US tax question

[PeterR]

My wife is a US citizen (I'm from UK) and we have UK trustee accounts for our children who have dual citizenship. I don't believe that the accounts have any restriction of the nature that "The parents are not legally permitted to use any of the funds to support the child" (IRS publication 17), rather the account publicity states "Trustees are responsible for ensuring that all transactions are for the benefit of the child" while the official Terms and Conditions do not appear to say anything in this regard, but rather that they will accept any one signature for withdrawals etc.

The income is certainly the child's for UK tax purposes (not gifted by the parents) but this is no doubt irrelevant for USA. If this is treated as my wife's income, should all or half or what proportion be declared on the 1040? At present this would not affect the non-taxable situation, but as the accounts increase in size it might well so I want to get this right from the start.

[Bevdeforges]

This seems to be the most relevant page on the IRS site related to foreign trusts: Foreign Trust Reporting Requirements

Be careful, too, in that your wife needs to declare all foreign financial accounts that she has signature authority over (part of the Treasury filing - not necessarily part of her US income tax return).

If the children are US citizens, they will be subject to US tax filings should their income exceed the threshold limits. Check IRS Publication 54 for details on "filing from overseas."
Cheers,
Bev

[PeterR]

Bev

Thanks for that link. Hmmm... From the info on that page it looks like she only has to report on the form TD F 90-22.1 . She didn't give money to the trust (the money came from UK grandparents), nor does she receive a distribution from it. The interest hasn't left the account.

Thanks again, and if anyone else can shed any more light I'd still be pleased to have your contributions!

Peter

[Punktlich2]

Originally Posted by PeterR

Bev

Thanks for that link. Hmmm... From the info on that page it looks like she only has to report on the form TD F 90-22.1 . She didn't give money to the trust (the money came from UK grandparents), nor does she receive a distribution from it. The interest hasn't left the account.

Thanks again, and if anyone else can shed any more light I'd still be pleased to have your contributions!

Peter

There are several issues here. You need tol know whether the trust is deemed to be a foreign trust for purposes of US tax law. In which case form 3520 has to be filed. Penalties for nonfiling are onerous.

A trust such as a Totten Trust in the USA or a trust for sale of English property is probably not a trust necessitating such filing. But a FBAR report on D F 90-22.1 would have to be filed.

While pension benefits (including pension trusts) are dealt with in the current tax treaty, other savings schemes are not. Just as US mutual funds are not recognised as unit trusts (with adverse tax consequences in the UK), 529s and Child Trust Funds are currently taxable in the other country and potentially doluble-taxed.

As the grandparents provided the funds, your problem seems to be: Form 3520 and/or 3520A, interest on accumulations in the trust that can exceed earnings, UK penal tax on trusts maintained beyiond a beneficiary's 18th birthday, and other nasty tax anomalies and cross-border conflicts.

But I don't have all the facts, haven't researched anything, and wrote the above just to give you hints for further research. Presumably the interest is paid with deduction of UK tax. Whether for US tax the parents' (or parent's) higher rate applies may depend on the nature of the account and what you mean by "trust". It seems to me that it should have been possible to take the money out of the grandparents. estate for UK IHT as a Potentially Exempt Transfer while avoiding US taxation of the interest. Of course the interest is likely to be insignificant these days. But there are clever ways of avoiding all these traps. If the money is significant.

Whether interest left the account or not is irrelevant. Finally: if you are talking about a lot of money, get professional advice from one of the few experts in cross-border tax. Penalties can exceed the value of the account. Google 'GAO nonfiling' to download a USG analysis of the tax problem relating to the 90% of the estimated 2 million US citizens abroad.

[Bevdeforges]

Originally Posted by Punktlich2

Google 'GAO nonfiling' to download a USG analysis of the tax problem relating to the 90% of the estimated 2 million US citizens abroad.

Couldn't resist your suggested search... some interesting reading there. But when I was last active in some of the US expat groups, the estimate of US citizens abroad was more like 4 to 6 million. (As far as I know, the figure is based on compilation of US Embassy and Consulate estimations.)

I do wish they would actually do some research to see how much tax they get or could potentially get from overseas residents, given the various exclusions and tax credits available to most of us. I suspect there are only a handful of US expats who fit the "swilling champagne and caviar" stereotype the US government seems to have of us.
Cheers,
Bev

[PeterR]

Punktlich

Thanks for looking at this.

At present the amounts are pretty insignificant - interest of just under GBP 100 on the largest one in 2008 - but I want to get this right at an early stage as new gifts are being made to the children each year at present, and interest is also being added, so the accounts will get gradually bigger - and at some point my wife and children may inherit more money and have more complicated tax affairs.

What we have done this year is reported the existence of the children's accounts on the FBAR form for my wife, and not reported anything anywhere else.

For UK purposes no tax is being deducted as the children do not have enough income to be taxed and we have submitted the relevant tax exemption forms supplied by the building society. But this indicates that the income is definitely treated as being the children's for UK tax purposes.

There do not appear to be any legal restrictions in the terms and conditions of the child accounts opened for the two older children (I haven't checked the baby's - he's with a different building society). Presumably the income is the children's in the UK because of an implied term that the capital and income will be used for their benefit. So perhaps for US purposes this may in fact be a joint account rather than a trust as it doesn't have any legal terms in black and white - so far as I can see there is nothing but honesty stopping us using the money for whatever we want to, as either of us can withdraw money at any time.


Kind regards

Peter

[Punktlich2]

Originally Posted by PeterR

Punktlich

Thanks for looking at this.

At present the amounts are pretty insignificant - interest of just under GBP 100 on the largest one in 2008 - but I want to get this right at an early stage as new gifts are being made to the children each year at present, and interest is also being added, so the accounts will get gradually bigger - and at some point my wife and children may inherit more money and have more complicated tax affairs.

What we have done this year is reported the existence of the children's accounts on the FBAR form for my wife, and not reported anything anywhere else.

For UK purposes no tax is being deducted as the children do not have enough income to be taxed and we have submitted the relevant tax exemption forms supplied by the building society. But this indicates that the income is definitely treated as being the children's for UK tax purposes.

There do not appear to be any legal restrictions in the terms and conditions of the child accounts opened for the two older children (I haven't checked the baby's - he's with a different building society). Presumably the income is the children's in the UK because of an implied term that the capital and income will be used for their benefit. So perhaps for US purposes this may in fact be a joint account rather than a trust as it doesn't have any legal terms in black and white - so far as I can see there is nothing but honesty stopping us using the money for whatever we want to, as either of us can withdraw money at any time.


Kind regards

Peter

For the baby at least there will be a Child's Trust Fund. From asking around, it's my impression that people aren't reporting these. Perhaps the new penalties will frighten them into doing so. But a 529 account would potentially be penalised in the UK, and a Child's Trust Fund penalised in the US, both as foreign trusts and because the accumulations in any mutual fund-unit trust-SICAV not qualified in the taxing country is taxed on current accumulations, and then in the qualifying country taxed when sold or withdrawn -- unless tax exempt. I had a case of a decedent who'd been tax-shy and had set up a Liechtenstein Stiftung and then never returned to the USA. His American offspring had a terrible time with the IRS and spent a lot of money with lawyers sorting out the tax evasion issue. Under current law it would have been worse.

I think there's a decent workaround and that is for the Stiftung to have an operating company and to distribute money as wages for actual work, preferably performed abroad. But that's beyond the subject of this thread.

[PeterR]

No, I'm not talking about Child Trust Funds. Just ordinary common or garden children's accounts in a building society, where the parents' are also signatories.

[Punktlich2]

Originally Posted by PeterR

No, I'm not talking about Child Trust Funds. Just ordinary common or garden children's accounts in a building society, where the parents' are also signatories.

I knew that wasn't the question. But all babies whose parent gets child allowance begining in Sept. 2002 is entitled to a £250 baby bond and if the parent doesn't claim it the Government opens an account anyway.

It took years, decades, for the US and UK treasuries to negotiate a treaty acknowledging pension trusts and entitlements as taxable only when received. That right to defer taxation arises only from domestic law in every other case. Mostly the capital and interest in question do not justify the professional expertise required to deal with reporting requirements in the "other" country of taxation. That's why it is deplorable that there are automatic penalties of $1,000 and $10,000 etc. for nonreporting of foreign accounts, trusts, limited companies, etc.

As I wrote earlier, with a bit of advance planning you could have avoided some of the reporting requirements. A proper trust created by a US person would likely have entailed filing form 3520, which is not nice, but your arrangement doesn't seem to require it:
Instructions for Form 3520 (2008)
A child's trust fund might:

Reportable Event
A reportable event includes:
1. The creation of a foreign trust by a U.S. person.
2. The transfer of any money or property, directly or indirectly, to a foreign trust by a U.S. person, including a transfer by reason of death. This includes transfers that are deemed to have occurred under sections 679(a)(4) and (5).
3. The death of a citizen or resident of the United States if:
The decedent was treated as the owner of any portion of a foreign trust under the grantor trust rules or
Any portion of a foreign trust was included in the gross estate of the decedent.

Penalties
A penalty generally applies if Form 3520 is not timely filed or if the information is incomplete or incorrect. Generally, the penalty is:
35% of the gross value of any property transferred to a foreign trust for failure by a U.S. transferor to report the transfer,
35% of the gross value of the distributions received from a foreign trust for failure by a U.S. person to report receipt of the distribution, or
5% of the amount of certain foreign gifts for each month for which the failure to report continues (not to exceed a total of 25%). See section 6039F(c).