What is the Taxable Year of a Foreign Grantor Trust on Form 3520-A?

The tax pro’s problem: crippling doubt

If you are like me, there are a lot of tax questions where you know the right answer off the top of your head. But you don’t know why the answer is right.

Then . . . you start to doubt yourself. Because you can remember fifty times when you answered a question on the fly without checking—only to be wrong later. I’ve done it.

Of such moments are malpractice nightmares born. Not to mention it’s a profound act of anti-marketing to give your clients the wrong answer.

The Form 3520-A preparation problem

Here’s one such situation. When preparing Form 3520-A, everybody knows that correct accounting period to use is the U.S. owner’s taxable year. But why is that the right answer?

You are asked to insert the appropriate accounting period near the top of Form 3520-A. That’s the puzzle to be solved.

The government tells you what to do in Instructions for Form 3520-A (rev. December 2023), page 5:

But who is the “filer”? There are two possible answers to that:

• The trust itself must file Form 3520-A. IRC §6048(b)(1)(A), Prop. Reg. §1.6048-3(a)(1).
• If the trust doesn’t file, then the U.S. owner of the trust must file a “substitute” Form 3520-A. IRC §6048(b)(1), Prop. Reg. §1.6048-3(a)(2).

It is entirely possible for two different filers to have different taxable years. What do you do?

Foreshadowing the answer: use the U.S. owner’s taxable year, no matter what.

This will be explained below.

Taxable year defined

First, let’s take care of a little bit of semantic sloppiness.

The Instructions for Form 3520-A consistently use the phrase “tax year.” The Code and Regulations use the phrase “taxable year.” I am going to use “taxable year” because that is the technically correct phrase, and technically correct is the best type of correct.

IRC §441(a) defines “taxable year” and tells you how to figure it out what it is. Basically, you will use whatever natural accounting period the taxpayer uses for its books and records. IRC §441(c).

But there are overrides: for some taxpayers, the Code requires the taxpayer to use something else. The list of taxpayers that have required taxable years is at Reg. §1.441-1(b)(2).

Some trusts have a required taxable year: they are required to use a calendar year. IRC §644(a), Reg. §1.441-1(b)(2)(F).

Taxable year of a foreign grantor trust

In the interests of brevity, I will assert that we use the same rules for determining the taxable years of foreign and domestic taxpayers.

And also in the interests of brevity, I will assert that a grantor trust is an actual “thing” for U.S. income tax purposes. It exists. And since it exists, it must have an accounting period.

So, for a foreign grantor trust:

• If it is the kind of trust that is required by IRC §644(a) to use the calendar year as its taxable year, so be it.
• If the foreign grantor trust is not required by IRC §644(a) to use the calendar year for its taxable year, we must determine its taxable year using the normal rules of IRC §441. That will default to the “how does it keep its books and records?” rule of IRC §441(c).

IRC §644(a) does not force a 12/31 taxable year

IRC §644(a) says that a trust must use the calendar year for its taxable year.

The income tax rules for trusts are in Subchapter J, Part I, Subparts A through E.

IRC §644(a) is in Subpart A.

The grantor trust rules (IRC §§671-679) are in Subpart E.

IRC §671 (in Subpart E) says (my translation):

• For you identify an “owner” of a portion of the trust under the rules of Subpart E then compute the income tax results the way that Subpart E tells you to.
• For the portion of the trust that is not “owned” by someone because of the grantor trust rules, use Subparts A through D to compute the income tax results.

This means that if the trust is a foreign grantor trust and you are preparing Form 3520-A, the rules in Subpart A through D are out of bounds. That includes the IRC §644(a) rule forcing the calendar year as the taxable year of a trust.

Therefore, we know that IRC §644(a) does not apply to foreign grantor trusts and the correct answer on Form 3520-A is not controlled by IRC §644(a).

If you need to put a citation in your memorandum to the file, use Rev. Rul. 90-55, which says:

IRC §441 determines the foreign grantor trust’s taxable year

Since the foreign grantor trust does not have a required taxable year, it must determine its taxable year using the standard rules of IRC §441.

The taxable year is the taxpayer’s annual accounting period, if it uses a calendar or fiscal year. IRC §441(b)(1). “Annual accounting period” is the annual period on the basis of which the taxpayer regularly computes its income in keeping its books and records. IRC §441(c).

But that’s not what you fill in on the very first question of Form 3520-A.

Use the U.S. owner’s taxable year

Instead of using the foreign grantor trust’s taxable year as determined under IRC §441, use the U.S. owner’s taxable year.

Why?

It’s logical. The owner of a grantor trust is treated as receiving the income items belonging to the trust. Functionally, the grantor trust is disregarded.

So why would you want to interpose a taxable year for the trust that is different from the owner’s taxable year? That would only introduce bookkeeping nightmares (taxpayers care about the professional fees) and the potential for income deferral (the government hates deferral).

The government’s position is that the foreign grantor trust’s taxable year—whatever it is—is irrelevant and ignored. You can find this in Rev. Rul. 57-390 and Rev. Rul. 90-55. And you can see it in Reg. §1.671-3(a)(1), if you squint and hold it up to the light at the right angle.

Rev. Rul. 57-390 says:

Reg. §1.671-3(a)(1) gives you the authoritative underpinning for pretending that the trust had not been created (emphasis added):

If you are taking income items into your account as the owner of a trust, timing questions (your taxable year vs. the trust’s taxable year) and accounting methods (cash vs. accrual) must not enter into consideration. That’s why you simply ignore the trust’s taxable year and use the owner’s taxable year.

Scheft v. Commissioner, 59 T.C. 428, 433 (1972) considered exactly this type of problem. The taxpayer had a grantor trust operating on a fiscal year. This had the effect of changing the timing of when income was realized. The trust sold property in 1968. The taxpayer argued that he should take the income in 1969 because of the end of the trust's tax year. The Tax Court shot down that argument, citing Rev. Rul. 57-390, and ruled that capital gain should have been reported by the owner of the grantor trust when the property was sold--in 1968.

Conclusion

The relevant accounting period for Form 3520-A purposes is the taxable year of the U.S. owner of the foreign grantor trust. Put that date into the question at the very top of Form 3520-A. Also use the same taxable year on the Foreign Grantor Trust Owner Statement, line 5, and the Foreign Grantor Trust Beneficiary Statement, line 5.