Glossary

Accumulation distribution

A distribution from a foreign trust that exceeds the trust’s distributable net income (DNI) for the current year. The excess is treated as coming from the trust’s undistributed net income (UNI) of prior years. Accumulation distributions trigger the throwback tax under §§665–668, which recomputes the beneficiary’s tax as though the income had been distributed in the year the trust earned it, plus an interest charge for the deferral.

See also: Throwback tax (§§665–668, Form 4970), Undistributed net income (UNI), Interest charge (§668)

Beneficiary statement

The Foreign Grantor Trust Beneficiary Statement, issued as page 5 of Form 3520-A for trusts that have a U.S. owner. It reports each U.S. beneficiary’s share of trust distributions and the character of those distributions. A beneficiary who receives this statement attaches it to their Form 3520 (Part III, line 29) and does not complete the remainder of Part III for that distribution, because the distribution is treated as coming directly from the trust’s owner (for example, as a gift that is not included in gross income). This statement is distinct from the Foreign Nongrantor Trust Beneficiary Statement (line 30), which drives the default/actual method choice.

See also: Default method (Schedule A), Actual method (Schedule B)

Credit adjustment (Form 4970, line 20)

When an accumulation distribution is thrown back to a prior year, the recomputed taxable income is higher, which may increase the tax liability enough to free up nonrefundable credits (such as the general business credit) that were previously limited by the tax. The credit adjustment on line 20 reflects the increase in allowable credits. The foreign tax credit portion of line 20 is computed separately under §667(d).

See also: Throwback tax (§§665–668, Form 4970), Foreign tax credit (§667(d))

Default method (Schedule A)

The method used to compute the taxable portion of a foreign nongrantor trust distribution when the beneficiary does not have a Foreign Nongrantor Trust Beneficiary Statement from the trustee. Schedule A of Part III splits the distribution into current-year income (up to 125% of the trust’s average distributions for the prior three years) and any excess, which is treated as an accumulation distribution subject to throwback. Most filers of Part III use the default method because foreign trustees rarely issue a beneficiary statement.

See also: Actual method (Schedule B), Beneficiary statement

Actual method (Schedule B)

The alternative method for computing the taxable portion of a foreign nongrantor trust distribution, available only when the beneficiary has a Foreign Nongrantor Trust Beneficiary Statement from the trustee. Under the actual method the distribution is characterized according to the trustee’s statement: current-year income and gains are taxed as such, any portion drawn from prior-year undistributed net income is an accumulation distribution (line 41a) subject to the throwback tax and §668 interest on Schedule C, and only the portion identified as trust corpus (line 43) is not taxable. Schedule B may be used only if you answered ‘Yes’ to line 30, attach the statement, and have never used Schedule A for that trust (or the trust terminated during the year).

See also: Default method (Schedule A), Beneficiary statement

Distributable net income (DNI)

A tax concept defined in §643(a) that limits the amount of a trust distribution that is taxable to the beneficiary. DNI is roughly the trust’s taxable income for the year, adjusted for certain items. Distributions up to DNI carry out income to the beneficiary; distributions exceeding DNI come from corpus or from accumulated income of prior years.

See also: Undistributed net income (UNI), Accumulation distribution

Foreign trust

A trust that fails either the “court test” (no U.S. court has primary supervision over administration) or the “control test” (no U.S. person has authority to make all substantial decisions) under §7701(a)(31)(B) and Treas. Reg. §301.7701-7. Many foreign retirement accounts, pensions, and savings vehicles are classified as foreign trusts under this broad definition, even if the account holder does not think of them as “trusts.” A trust that passes both tests is a domestic trust.

Foreign tax credit (§667(d))

When a foreign trust paid foreign taxes on accumulated income that is later distributed and thrown back to a beneficiary, the beneficiary may claim a credit for those taxes under §667(d)(1)(A). The credit is subject to the §904 limitation applied separately to each computation year under §667(d)(1)(C)(i); for a computation year in which the beneficiary did not claim the foreign tax credit on their own return, the trust's taxes may instead be deducted (§667(d)(1)(B)).

See also: Throwback tax (§§665–668, Form 4970), Credit adjustment (Form 4970, line 20)

Grantor trust

A trust whose income is taxed to the grantor (the person who created or funded the trust) rather than to the trust itself, under the grantor trust rules of §§671–679. Many individually funded foreign retirement accounts held by U.S. persons are grantor trusts (the account holder is the owner under §679); employer-funded plans described in §402(b) generally are not, and Canadian plans and certain tax-favored plans are exempt from reporting. A U.S. owner of a foreign grantor trust files Form 3520 (Part II) and Form 3520-A each year unless an exemption applies.

See also: Foreign trust, Substitute Form 3520-A

Information return

A tax form that reports information to the IRS but does not itself compute or impose a tax. Forms 3520 and 3520-A are information returns. The one exception is the throwback tax on accumulation distributions, which is computed on Form 4970 (§667) and then reported and paid on the filer’s Form 1040. The distinction matters because penalties for information returns (§6677, §6039F) are assessed for failure to report, not failure to pay.

Interest charge (§668)

When the throwback tax applies, §668 imposes an interest charge on the tax to compensate the government for the deferral period. The charge is computed at the §6621 underpayment rate (compounded daily for periods after 1995, and at a simple 6% for 1977–1995) over the applicable number of years (§668(a); Form 3520 instructions, line 51). This is reported on Part III, Schedule C (lines 48–53; the interest charge itself is line 52).

See also: Throwback tax (§§665–668, Form 4970), Accumulation distribution

Penalties (§6677 and §6039F)

Penalties for failure to file or for incomplete filing. For Form 3520 Part I (trust events under §6048(a)) or Part III (distributions under §6048(c)), the penalty under §6677(a) is the greater of $10,000 or 35% of the gross reportable amount. For Part II (U.S. owner reporting under §6048(b)) and Form 3520-A, the rate under §6677(b) is 5% instead of 35%. Continued failure after a 90-day notice adds $10,000 per 30-day period; the aggregate cannot exceed the gross reportable amount. For foreign gift failures (Part IV), §6039F imposes 5% per month up to 25% of the gift amount. Reasonable-cause abatement is available, but a foreign jurisdiction's penalties for disclosure are not reasonable cause.

Substitute Form 3520-A

When a foreign trust’s trustee does not file Form 3520-A (which is nearly always the case with foreign pensions and retirement accounts), the U.S. owner must file a “substitute” 3520-A to avoid penalties. The substitute contains the same information - income statement, balance sheet, and beneficiary statements - prepared by the U.S. owner from the institution’s annual statements.

See also: Grantor trust

Throwback tax (§§665–668, Form 4970)

A tax regime that applies when a beneficiary receives an accumulation distribution from a foreign trust. The tax is computed as if the accumulated income had been distributed ratably over the prior years it was earned (the “throwback”). Form 4970 performs this calculation: it takes the 5 preceding years’ taxable incomes, drops the highest and lowest, adds the averaged distribution to each of the 3 remaining years, recomputes the tax, averages the increase (line 25), multiplies the average by the number of throwback years (line 26), and subtracts the taxes the trust already paid on that income (line 27). The result is the partial tax on line 28, carried to Part III, Schedule C, line 49, where the §668 interest charge is added.

See also: Accumulation distribution, Interest charge (§668), Computation years

Computation years

The 3 years (out of the 5 preceding the distribution) used to compute the throwback tax. The years with the highest and lowest taxable income (before adding the throwback amount) are dropped; the remaining 3 are the computation years. Taxable income for each year includes amounts thrown back to that year by any earlier accumulation distribution (Form 4970, line 13 instructions). AMT adjustments, credit adjustments, and the foreign tax credit are applied only to the computation years, not all 5.

See also: Throwback tax (§§665–668, Form 4970)

Undistributed net income (UNI)

The trust’s distributable net income for a year minus any distributions actually made that year, minus taxes paid by the trust on that income. UNI accumulates over time; when a distribution exceeds current-year DNI, the excess is drawn from the oldest UNI first (§666(a) FIFO ordering). The UNI history is what makes the throwback tax possible; it tells you which years the income came from.

See also: Distributable net income (DNI), Accumulation distribution

U.S. person

For Form 3520 purposes, a U.S. citizen, lawful permanent resident (green card holder), or resident alien who meets the substantial presence test. The Form 3520 instructions also treat domestic partnerships, corporations, estates (other than foreign estates), and domestic trusts as U.S. persons, and a dual resident who claims treaty benefits as a nonresident remains a U.S. person for Form 3520 purposes. U.S. persons have a filing obligation when they engage in transactions with foreign trusts or receive large foreign gifts. Nonresident aliens are generally not required to file Form 3520.

FBAR (FinCEN 114)

The Report of Foreign Bank and Financial Accounts, filed with FinCEN (not the IRS). Required when a U.S. person has a financial interest in or signature authority over foreign financial accounts with an aggregate value exceeding $10,000 at any time during the year. A foreign trust account may trigger both an FBAR and a Form 3520/3520-A, but they are separate filings with different rules, thresholds, and deadlines. The FBAR is filed electronically by April 15 (automatic extension to October 15).

Form 8938 (FATCA)

Statement of Specified Foreign Financial Assets, filed with the IRS as part of the income tax return. Required for U.S. persons whose specified foreign financial assets exceed certain thresholds ($50,000–$600,000 depending on filing status and residency). Foreign trust interests may be reportable on both Form 8938 and Form 3520; the “Excepted Specified Foreign Financial Assets” checkbox on Form 3520 (Item C) coordinates the two.