Reporting your gifts

WEDNESDAY, JULY 11: This is the third in a series of articles dealing with American residents based in Bermuda and their taxes.

US reporting exists on Form 3520 with respect to aggregate gifts which exceed $100,000 in a calendar year from a non-US donor:

• aggregation of gifts is required if donors are “related” within meaning of tax rules identify of donor is not disclosed failure to report results is a penalty equal to 5 per cent of gift
• a “Beneficiary Statement” from the non-U.S. trustee must be obtained to avoid default treatment as accumulation distribution that is subject to throwback rules
• failure to report results in a penalty equal to $10,000 or 35 per cent of the value of the distributed property, whichever is greater (as amended by FATCA)

Case Study

The new client (“Mr. A”) is a Bermuda national who is married to a US citizen and their adult child has dual Bermuda/US citizenship.

Mr. A has settled an irrevocable Bermuda trust that owns the Bermuda marital residence and a US stock portfolio. The trust has current and accumulated income.

Mr. A has settled a revocable Bermuda trust that owns a BVI corporation with investments In Cayman Island based mutual funds as well as a US stock portfolio. Mr. A must obtain the trustee’s consent to revoke the trust. The trust has current and accumulated income.

The beneficiaries of both trusts are Mr. A, Mr. A’s wife and their adult child, and the Trustee of both trusts has sole discretion to distribute or accumulate income among them.  

Analysis of US tax issues related to irrevocable trust: no distributions have been made from the irrevocable trust except for an interest free loan of $50,000 to Mrs. A. 

• Is the interest free loan a deemed distribution?

A. A loan of cash or marketable securities is treated as a constructive distribution with limited exceptions

• What is the fair rental value of the Bermuda marital residence?

A. $120,000.

• Why is this relevant? 

A. FATCA provisions of 2010 legislation amend the Code to provide that the uncompensated use of non-US trust property by a US beneficiary is a constructive distribution (effective for uses after March 18, 2010)

Mrs. A must file Form 3520 to report the deemed distributions, and also obtain a Foreign Nongrantor Trust Beneficiary Statement from the Trustee.  Mrs. A must file Form 8938, and perhaps Form 90-22.1 if she is deemed to have a financial interest in more than 50 per cent of the trust’s income or assets.

Analysis of US tax issues related to revocable trust: all distributions to date from the revocable trust have been made to Mrs. A. ($100,000), except for paying for graduate school ($30,000) for their child. 

• Is there a deemed distribution to adult child for whose benefit graduate school was paid? 

A. Yes

• Could this have been avoided?

A. Yes

• Does the fact that Mrs. A receives more than 50 per cent of the income have any other consequences?

A.  Yes

Under the US allocation rules it is likely that Mrs. A. is the deemed owner of the underlying BVI entity that is likely a controlled foreign corporation that would require Mrs. A. to now file Form 5471 and possibly result in her having a deemed dividend from the CFC. 

Are the foreign funds held by it PFIC? 

The likely answer is yes and that would require Mrs. A. to file Form 8621 in addition to filing Form 90-22.1 and Form 8938

The child for whose benefit graduate school was paid must file form 3520 and obtain a foreign nongrantor trust beneficiary statement from the trustee.  

What are the obligations of the Bermuda trustee when distributions are made to a US beneficiary?

Under US tax law a US Beneficiary such as Mrs. A must obtain a foreign nongrantor trust beneficiary statement from the Bermuda trustee or face dire US tax consequences.

A Bermuda trustee may furnish the US beneficiary with an accounting of income received from the trust under Generally Accepted Accounting Principles (GAAP), but for US tax return preparation purposes the US CPA needs fiduciary accounting statements.

It is likely that the Bermuda trustee is unaware of the need for fiduciary accounting statements and if the US tax return preparer only occasionally deals with distributions from a foreign trust then the likelihood of the US beneficiaries US tax return being correctly prepared is remote.

Pursuant to the requirements relating to practice before the Internal Revenue Service, any tax advice in this communication is not intended to be used, and cannot be used, for the purpose of (i) avoiding penalties imposed under the United States Internal Revenue Code, or (ii) promoting, marketing or recommending to another person any tax related manner.

The tax advice given is, by necessity, general in nature.

You should, of course, check with your own U.S. tax consultant as to how specific transactions affect you since tax advice varies with individual circumstances.

James Paul Sabo, CPA, is the president of ETS Ltd., PO Box HM 1574, Hamilton HM GX, Bermuda. Questions should be sent to: [email protected].