Advocating for the Canadian Registered Education Savings Plan and Registered Disability Savings Plan to Be Exempt from Annual Foreign Trust Reporting Requirements (irc Sections 6048, 6677)
| Publication year | 2020 |
| Author | By Marsha Laine Dungog & Liguo Cooper Xu |
By Marsha Laine Dungog & Liguo Cooper Xu2
The U.S. taxation of contributions, accruals and distributions from foreign plans that are structured as foreign trusts ("Foreign Plans") with U.S. person3 ("USP") owners or beneficiaries remains a controversial area of U.S. tax law that requires definitive guidance as both the number of USP residing outside and foreigners relocating to the United States increases. The complexity arises in part because many Foreign Plans do not fit squarely with the types of plans available to U.S. residents in the United States. Until the U.S. tax classification and treatment of such Foreign Plans is addressed by the U.S. Congress in the Internal Revenue Code of 1986, as amended4 (the "Code") or by the Department of Treasury by administrative or legislative regulations, the annual U.S. tax reporting of USP outside the United States (collectively, "U.S. expats") and foreign persons who are tax residents in the U.S. with respect to their interests in certain Foreign Plans remains fraught with proverbial traps for the unwary.
Many Foreign Plans that are foreign trusts would generally fall within the parameters of Code section 6048, which would cause USP owners and beneficiaries of such Foreign Plans to file the Form 3520, Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts, and Form 3520-A, Annual Information Return of Foreign Trust with a U.S. Owner. In the absence of specific guidance from federal tax authorities on many Foreign Plans, tax practitioners have defaulted to reporting Foreign Plans owned by USPs (either directly or beneficially) as foreign trusts subject to U.S. foreign trust reporting requirements, as well as under the Report of Foreign Bank and Financial Accounts ("FBAR") and Foreign Account Tax Compliance Act ("FATCA").
Yet not all Foreign Plans that are foreign trusts are subject to reporting requirements under Code section 6048 itself. For example, certain Foreign Plans that constitute Code section 402(b) nonqualified deferred compensation trusts are exempted from section 6048 reporting requirement under section 6048(a)(3)(B) as non-qualified foreign trusts under a plan that provides for pensions, profit-sharing, stock bonus, sickness, accident, unemployment welfare, and similar benefits.
The Treasury Department should reconsider whether Code section 6048 applies to the Canadian Registered Educational Savings Plan ("RESP") and Canadian Registered Disability Savings Plan ("RDSP"). The Internal Revenue Service ("IRS") has precedent for exempting other Canadian plans from this requirement, specifically with respect to USP owners and beneficiaries of a Canadian Registered Retirement Savings Plan ("RRSP") and Registered Retirement Income Fund ("RRIF"). Consequently, USP owners and beneficiaries of Canadian RESPs and RDSPs should have no affirmative obligation to file Form 3520 or Form 3520-A because these plans also arguably fall within the exemptions to Code section 6048(3)(B)(ii) as plans that provide for unemployment welfare and similar benefits.
Moreover, there are sound administrative reasons for exempting RESPs and RDSPs from foreign trust reporting. At the risk of stating the obvious, requiring all foreign trusts to file information reporting returns simply because they are a foreign trust with a USP owner or USP beneficiary only increases the complexity of U.S. tax return administration and compliance, and unduly strains IRS resources with arguably decreasing results in terms of the revenue generated from such foreign trust filings.5
[Page 4]
As a case in point, in May 21, 2018, the IRS Large Business and International ("LB&I") division launched six campaigns which included a campaign to improve Form 3520/Form 3520-A compliance which utilized a variety of approaches to noncompliance through examinations and penalties assessed by the IRS Campus when the forms are received late or incomplete. This campaign is only one of 40 active campaigns launched by the IRS since January 31, 2017 to make the best use of IRS knowledge and resources by focusing on compliance issues that represent a high risk of non-compliance among taxpayers.
With respect to the Form 3520/3520-A campaign, the intent was to improve the taxpayer's and practitioner's knowledge of a U.S. person's requirement to report ownership of, and transactions with, foreign trusts, as well as decrease the percentage of late filed and incomplete Forms 3520/3520-A and, as a corollary, increase the number of properly filed Forms 3520/3520-A. The IRS scope for implementing the campaign includes IRS outreach and education, the issuance of soft letters, the conduct of examinations, and issuance of Campus Penalty Assessments.
To date, we are aware that USPs who are resident in Canada who have filed Form 3520s/3520 to report their respective RESPs and RDSPs have already received letters from the IRS under the above-mentioned campaign initiative. We query the effectiveness of such assessments, given that RESPs and RDSPs are low-balance depositary accounts that would be an unlikely offshore vehicle for U.S. tax avoidance by USPs resident in Canada. Further, these accounts have already been specifically excluded from the definition of a Financial Account and therefore not treated as a U.S. Reportable Account for purposes of FATCA reporting requirements for Canadian financial institutions.6
In general, Code section 6048(a) provides that a USP grantor, transferor, or executor must provide written notice of a "reportable event" with the IRS on or before the 90th day after occurrence of such event, or such later date as the Secretary may prescribe.7 A reportable event means (a) the creation of a foreign trust by the USP inter vivos; (b) the transfer of money or property to a foreign trust by a USP (either directly or indirectly); and (c) the death of a USP citizen or resident if the trust was a foreign grantor trust or any portion of such trust is included in the decedent's gross estate.8 However, transfers of property to a trust within the context of a sale for fair market value ("FMV")9 or as contributions made to a nonqualified deferred compensation under a plan that provides for pensions, profit-sharing, stock bonus, sickness, accident, unemployment welfare, and similar benefits (as in Code sections 402(b), 404(a)(4), or 404A), or a charitable trust under Code section 501(c)(3) are not required to be reported under Code section 6048.10
Current U.S. tax laws do not provide any definitive guidance on whether Canadian registered educational savings plan ("RESP") and registered disability savings plan ("RDSP") that have a USP grantor, transferor or beneficiary would constitute foreign trusts exempt from the foreign trust reporting requirements under Code sections 6048 and 6677. As the statutory "responsible party" for such filings, USP owners, beneficiaries and executors of RESPs and RDSPs are subject to the same requirements or risk of incurring civil penalties directly. This reporting requirement persists notwithstanding previous requests made by various interest groups in Canada to the U.S. Department of the Treasury to seek relief from this reporting requirement for RESPs and RSPDs.11
Failure to file the report under Code section 6048 would trigger the imposition of penalties under Code section 6677. The statute of limitations for assessment of penalties under Code sections 6677(a) and 6677(b) ends three years only after a complete and accurate Form 3520/3520-A is filed. The penalties are severe if a Form 3520 is not filed on or before the due date (including extensions) of the USP's income tax return, or the Form 3520-A is not filed on or before the 15th day of the 3rd month after the end of the trust year (including extensions), or if the applicable form does not include all the information required or includes incorrect information.12 Failure to file Form 3520 may subject a USP transferor to a penalty equal to 35 percent of the amount transferred, and for reports filed after December 31, 2009, there is a minimum penalty of $10,000, not to exceed the gross reportable amount.
B. Canadian Treatment of RESP as a Domestic TrustPrior to 1998, RESPs were mere product offerings between private sector providers and client subscribers. However, in 1998, the Canadian parliament enacted the Canada Education Savings Act ("CESA") which introduced CES grants to incentivize deposit-taking financial institutions to enter the RESP market such that lower-income families already saving for a child's education could do so using an RESP as a savings vehicle.13 In 2004, the Canadian Federal Budget announced the creation of the Canada Learning Bond ("CLB") and the A-CESG to kick-start education savings for post-secondary education for low-income families.14 In 2017, RESP assets reached CDN $55.9 billion, compared to CDN $23.4 billion in 2007. However, of these amounts, only CDN $4.67 billion constituted personal contributions from families. The remaining assets comprised of federal and provincial educational savings incentives and accumulated earnings.15
[Page 5]
The Canadian tax rules offer other tax-deferred or even tax-free treatment for savings vehicles created pursuant to CESA. The confusion arises because these same savings vehicles are not entitled to the same treatment for U.S. tax purposes when a USP grantor, transferor, or beneficiary is involved.
1. Canadian RESP Is Structured as a Domestic TrustAn RESP is a contract between an individual (the "Subscriber") and a person or organization (the "Promoter") to provide funds for post-secondary education financial assistance to...
To continue reading
Request your trial