Filing a foreign trust form 3520 and 3520-A for a Tax Free Savings Account
US citizens living abroad can legally create tax free savings accounts, also known as a TFSA in Canada. A big question for many American expats living in Canada is whether they need to file for the IRS forms 3520 and 3520-A as a result of owning their TFSA.
Revenue Procedure 2020-17 came out at the beginning of the year and specifically covers foreign trusts that are allowed to forgo the forms 3520 and 3520-A. These are funds that are set up for a specific reason, such as a college or a disability fund. Unfortunately, TFSAs do not meet the requirements laid out in revenue procedure 2020-17, meaning that if your TFSA meets the below conditions then you will have to file the forms 3520 and 3520-A
Luckily for most expats with a TFSA, the forms 3520 and 3520-A only need to be filed if your savings account meets the definition of a trust. However, this leaves many people unsure of their taxation requirements as the IRS has never actually stated whether a TFSA is a trust or not. This means that a TFSA’s status as a trust is dependent on the specific clauses laid out when you opened your savings account.
The two types of TFSAs
For the majority of TFSAs, the owner of the account is the only person reaping the benefits of the account and also makes all financial decisions for the account, such as the decision of whether or not to invest the savings held within the account. Because there is no third party involved, this type of tax free savings account does not meet the definition of a trust and as such does not need to file the forms 3520 and 3520-A.
However, some TFSAs will be held in what is known as “in trust”. This means that there is a third party on your account, also known as a trustee, who is able to make financial decisions surrounding your savings for you. This means that you are giving up part of the control of the decision making for your savings, and somebody else may invest your savings for you in an attempt to grow them. Whether or not this applies to your savings account will have been laid out in the initial documents that were provided by your bank or other financial institution when you opened the account. If this applies to your TFSA then it is considered a trust.
If your TFSA is considered a trust, then you will need to annually look over and file the forms 3520 and 3520-A with the IRS as well as add the interest accrued to your personal tax return form.
I’m not sure if my TFSA is a trust or not:
If you are unsure as to whether your TFSA counts as a trust or not, the first step would to be to go back through the initial documents that you received when you set up the account and look for clauses stating that a third party has partial control of your finances or the phrase “in trust”. If you cannot find these documents, going onto the bank’s website should bring up a virtual copy of these documents, and you can search there.
How will my TFSA impact my US tax return if it is not a trust?
Even if your TFSA is not considered a trust by the IRS, you will still need to include it on your personal tax return form, as you are earning money on the interest that you will accrue on your savings which must then be taxed.
For example, if you earned $500 in interest through your TFSA, you would need to declare that $500 on your personal tax return form before the end of the tax year.
What if I haven’t been submitting the forms 3520 and 3520-A when I should have been?
If you have discovered that your tax free savings account is considered a trust fund by the IRS and you should have been filing forms 3520 and 3520-A and including this source of income on your personal tax returns form, then you will need to rectify this as soon as possible. There is currently an amnesty programme known as the streamlined tax amnesty process(see below) which will allow you to fix any mistakes without penalty.
The IRS will allow you to amend previous tax returns and declare this new source of income as well as submit the returns from your TFSA through the forms 3520 and 3520-A for previous years.
Even though this scheme protects you from penalty fees, it is important to note that you would still be liable for any taxes that you have avoided paying due to this error.
What is the Streamlined Tax Amnesty Process?
The streamlined tax amnesty process is a process implemented by the IRS which allows US citizens and green card holders to rectify issues on previous tax returns without incurring a penalty fee, as long as they can prove that they had a “reasonable cause” to have incorrectly filed these taxes in the first place.
This applies to TFSA owners who have not been filing the forms 3520 and 3520-A. If they submit outstanding taxation forms, adjust their personal tax return and submit a letter to the IRS explaining that they did not know that these forms were required of them, then they can avoid penalisation and simply pay the outstanding taxes and interest owed.
What if I have been filing the forms 3520 and 3520-A in the past but now don’t need to?
The role of the IRS is to ensure that everyone who needs to fill in their forms does so in order to ensure that all necessary taxes are paid correctly. Part of this role involves penalising those who fail to file the forms that they are required to, such as the 3520 and the 3520-A.
If you have previously been submitting these forms without issue, and have now found out that you do not need to fill out these forms, it may be a safer path to continue to file these forms anyway. This is because it is far more difficult to appeal tax penalties once they have been issued, so the safest route would be to avoid incurring these penalties by continuing to file the forms. Additionally, filing these forms can aid in the peace of mind for expats as it ensures that they will not be met with these significant financial penalties.
What professional help can you receive with your TFSA?
You can request that a professional look over your bank documentation to determine whether or not filing the forms 3520 and 3520-A will be necessary if you are still unsure.
If you are finding yourself needing to go through the streamlined tax amnesty process, iit is recommended that you seek professional advice to help you draft the letter to the IRS as a professional will be more able to prove “reasonable cause” and as such will help you to avoid a penalty fee.
Additionally, you can seek professional help in filling out and filing the 3520 and 3520-A forms, as a professional can help ensure that your forms are both correct and submitted on time.
A recap on the TFSA
If you have found out that you have the type of TFSA that counts as a foreign trust fund, then you must correct any previously submitted personal tax returns with this additional income included and submit the forms 3520 and 3520-A for the previous years. The streamlined tax amnesty program ensures that you will not be penalised for this oversight, but you will still have to pay any outstanding tax payments that are due.
Contact us at Expat Tax Online to find out some of the general rules around the new revenue procedure and see if you meet the criteria for not fling and 3520 or 3520-A.