As the Internal Revenue Service continues to crack down on U.S. taxpayers who fail to report foreign-source income, a recent case illustrates the inherent reporting difficulties faced by individuals with foreign trusts. IN Geiger v. US, heirs to an estate are preparing to fight a $15 million tax bill stemming from the misclassification of a trust.

Grant Geiger's German grandfather formed the World Capital Foundation (WCF) in Lichtenstein. The beneficial interest in the trust was transferred to Grant's father, Gunter A. Geiger, several years later after his grandfather's death. Gunter took advantage of the now-defunct Offshore Voluntary Disclosure Program (OVDP), which allowed taxpayers to disclose previously unreported offshore accounts, assets, investments and income in exchange for penalty relief and reduced risk of the prosecution, paying $1.9 million for every liability other than filing Forms 1040, 3520 and 3520-A for 2003 through 2010. In filing those forms, Gunter falsely reported WCF as a grantor trust.

The difference in characterization makes a big difference for tax purposes—a grantor trust treats Gunter as the owner of all WCF income and requires reporting on his tax return, as well as requiring him to include the fair market value of the assets of WCF on his post-immigration tax exit (Gunter surrendered his US green card in 2010 and moved to Europe). A non-grantor trust, on the other hand, means that it is only liable for the taxable portions of distributions made and a 30 percent withholding tax on distributions made after extradition.

IRS backtracks

According to the complaint, the mistake was quickly caught and the IRS initially agreed that the WCF was a non-grantor foreign trust. After Gunter's death in 2015, assets from his estate were distributed to Grant and Gunter's widow, Margie. The complaint alleges that the IRS revoked its 2019 decision to treat WCF as a non-grantor foreign trust “without explanation” and continued to withdraw the estate from OVDP and initiate risk assessments, despite the estate cooperating in negotiations. (Tax records report that the IRS had provided the property three solution options: be treated as a grantor trust with more than $6 million in liability, remain in the OVDP as a non-grantor trust with terms that would result in a liability of $20 million, or be removed from the OVDP and subject to exam and penalties, leading to even more liability.)

Tax assessment of property disputes

Both Grant and Margie, who filed separate appeals, argue that risk assessments are a “drastic” procedure “reserved for situations” in which a taxpayer seeks to leave the country or hide assets, neither of which is the case here. The complaint further argues that WCF was not a grantor trust because Gunter never transferred funds to the trust and did not have sufficient control over the trust's income or principal until after he left.

“I'm not sure why a risk assessment was filed here since the taxpayer seems to be cooperating and responding,” said Harvey I. Bezozi, a tax expert based in Boca Raton, Fla.

Reporting requirements

The result of Geiger the case will depend on the characterization of the belief. The case highlights the complexities of foreign trust reporting, as well as reporting of income from sources outside the US in general, and the potentially costly consequences of incorrectly completing the required forms. Although it is not clear whether Gunter filed his forms in this case, an error of this caliber could subject a tax professional to a malpractice claim.

“Extremely complicated foreign trust cases like this show how important it is to accurately distinguish between a grantor trust and a non-grantor trust. And when tax returns and information are required about confusing tax structures, be sure to double and triple check things before filing,” Bezozi said.

Recognizing the difficulties taxpayers face in understanding how to properly comply with reporting requirements, the IRS has just issued proposed regulations that would provide guidance on reporting obligations for transactions with foreign trusts and the receipt of large gifts of foreign and in relation to loans from, and uses of property of, foreign trusts.