A recent case, Geiger v. U.S., highlights the complexities associated with reporting foreign trusts for U.S. federal tax purposes. In this case, the personal representative of an estate is contesting the IRS’s characterization of a Liechtenstein foundation as a foreign grantor trust rather than a foreign non-grantor trust, a distinction that could have significant financial implications.
The foundation, known as World Capital Foundation (WCF), was created by a German national in 1982 and passed down to his son. The son, Gunter, surrendered his U.S. green card in 2010 and moved to Europe. Initially, Gunter claimed that WCF was a foreign grantor trust in his submissions to the IRS under the Offshore Voluntary Disclosure Program (OVDP). However, he later changed his position, arguing that WCF was a foreign non-grantor trust after consulting with advisors.
Following Gunter’s death in 2015, his son Grant took over as the estate’s personal representative. The IRS initially agreed that WCF was a foreign non-grantor trust but later changed their determination, leading to tensions between the IRS and the estate. The IRS sought jeopardy assessments against the estate and heirs, prompting Grant to file a complaint with the federal district court to challenge the IRS’s decision.
Grantor and non-grantor trusts are treated differently for federal income tax purposes. Grantor trusts attribute the trust’s assets to the grantor, who must report the trust’s income on their tax return, while non-grantor trusts are taxed separately. The complaint in Geiger argues that WCF should be classified as a non-grantor trust because Gunter did not transfer funds to the trust and did not have control over its income until after he expatriated.
If the court sides with the IRS and classifies WCF as a grantor trust, the estate could face significant tax consequences, including income tax liabilities, penalties for late information returns, and a higher exit tax under section 877A. On the other hand, if WCF is deemed a non-grantor trust, the tax implications for the estate would be less severe, with Gunter only being taxed on distributions received from the trust.
The case highlights the importance of correctly characterizing foreign trusts for tax purposes and the potential penalties for misreporting. Taxpayers dealing with foreign trusts should be diligent in understanding the rules and requirements for reporting on their U.S. tax returns, including filing the necessary information returns such as Forms 3520 and 3520-A. As seen in Geiger, mistakes in reporting foreign trusts can result in significant financial consequences.
