Entity Classification of foreign companies and trusts in the US and penalties associated with getting it wrong!

In our experience the area that carries the most risk is the failure of a taxpayer to properly classify an Australian entity under US law.

By way of example:

  • a discretionary trust that is controlled by a US taxpayer will, in many cases, be classified as a grantor trust, and income derived by it will be attributed to the US taxpayer;
  • a unit trust in which a US taxpayer is an owner may be classified as a corporation, and therefore possibly a controlled foreign corporation (CFC) or a passive foreign investment company (PFIC). It follows that there may be circumstances in which income derived by a unit trust could be attributed to a US taxpayer; and
  • a self-managed superannuation fund can be classified as a grantor trust or a non-exempt employee trust, again the outcome being that income derived by the fund would be currently attributed to a US taxpayer.

The impact of this is that investment structures that are tax effective under Australian law are tax neutral or defective under US law. Income that can be distributed to a broad range of beneficiaries under Australian law may be attributable to a single US taxpayer (with or without a credit for the tax paid in Australia) under US law. Furthermore, if you are a grantor or owner of any of the abovementioned entities, you will be required to complete information returns on which you report the income and activities of such entities. These forms are in addition to the FBAR and the IRS Form 8938 and failure to properly complete them can result in substantial financial penalties (see our blog post Penalties for non-disclosure of foreign financial assets.)

Far too often we see foreign individuals living in the US fail to properly classify and report their foreign companies, trusts and superannuation. This leads to hefty penalties from the IRS and increase in professional services fees with the need for tax attorneys and experienced tax advisors to rectify the misreporting.

If you have any questions about how your foreign assets or holdings should be treated for US purposes please reach out to someone in our team today!