Foreign Trust Reporting Penalties: Is It 5% or 35%?

The Internal Revenue Code requires US owners of a foreign trust to ensure it files an annual return. Meanwhile, US beneficiaries of a foreign trust must file a return reporting any distributions they receive.

The tax code imposes different penalties for the late filing of those two types of foreign trust-related returns:

  1. A 5% penalty for owners who fail to ensure their trust timely files an annual return.
  2. A 35% penalty for beneficiaries who fail to timely report their distributions.

In the recent case of Wilson v. US, the plaintiff was both an owner and a beneficiary. The US Court of Appeals for the Second Circuit weighed in on which penalty should apply — and, in doing so, overturned a district court’s decision.

How the Case Unfolded

The plaintiff was the US owner and beneficiary of a foreign trust. He filed both the annual return and distribution report for the 2007 tax year late. The Internal Revenue Service (IRS) assessed a 35% penalty against the plaintiff for failing to timely disclose the distribution he received as a trust beneficiary. He paid it and then filed for a refund, arguing he should have been charged only the 5% penalty that applies to trust owners.

The district court sided with the plaintiff, finding only the 5% penalty applied when a person is both the owner and beneficiary of a foreign trust. However, on appeal by the government, the Second Circuit vacated the district court’s judgment.

The appeals court found “the plain language” of the tax code requires anyone who fails to timely report distributions from a foreign trust is subject to the 35% penalty. Concurrent status as a trust owner doesn’t change this rule. The Second Circuit did not address the possibility the plaintiff could be liable for both the 5% and 35% penalties.

Late Filing of Foreign Trust Reporting

If you are party to a foreign trust — whether as an owner, beneficiary or both — be sure to comply with the filing requirements. It is not uncommon for US beneficiaries of foreign trusts to think they do not have to file any report with the IRS related to the distribution because either they believe the owner will file any required returns or the distributions is not income to them, so there is no Form 1040 reporting required.

Its important you understand the US tax consequences related to foreign trust filings because the applicable penalties can be quite expensive. Contact a Moore Doeren Mayhew tax advisor to learn more about how this might impact your unique situation.



Mia Yun


Ahmed Cassim


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