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Taxpayer Didn’t Report His Liechtenstein PF as a Foreign Trust

If a structure isn’t reported properly from the beginning, the resulting tax liability can undermine all other substantive goals. 

In the recent decision of Rost v. U.S., No. 21-51064 (5th Cir. 2022), the U.S. Court of Appeals for the Fifth Circuit upheld tax penalties against a taxpayer who failed to report his personal-use Liechtenstein “Stiftung” (that is, a noncharitable private foundation (PF)) as a foreign trust.  The taxpayer argued that the penalties were improper because the reporting requirements for the PF were unclear.  After all, it’s possible for a PF to be taxed as a trust or as a business entity.  The court reviewed the facts and circumstances of this case in detail and showed the law was clear.  The taxpayer who created and funded the PF should have reported it as a foreign trust.

Forming the Foundation

The decedent, John Rebold, was a U.S. citizen and an oil executive who traveled extensively for work.  In 2005, John formed the Enelre Foundation under the laws of Liechtenstein as a “Stiftung,” or noncharitable PF.  The PF was created to provide resources for the general support and education of John and his children.  John transferred $2 million to the PF in 2005 and $1 million in 2007.  He didn’t disclose the transactions to the Internal Revenue Service. 

When John formed his PF, he may have been seeking protection from potential future creditors.  Liechtenstein has strong creditor protection laws, and for many years, U.S. persons have used the noncharitable PF as an offshore asset protection vehicle.  These PFs are also often used as trust substitutes by U.S. persons who reside in civil law jurisdictions, including much of Europe.  In fact, U.S. persons have used foreign noncharitable PFs as trust substitutes for so long that there’s a Second Circuit case from 1957 clarifying their taxation as foreign trusts under certain facts and circumstances (Estate of Swan v Comm’r, 247 F.2d 144 (2d Cir. 1957).

The taxation of John’s PF was never in doubt.  In 2010, counsel for the PF told John he likely had an obligation to file Forms 3520 and 3520-A to report his contributions to the PF.  As the counsel explained to John, finding any other tax reporting position would be “not easy.”  The counsel recommended entering a voluntary disclosure program to resolve John’s missed filings.  (In 2010 there was no available voluntary disclosure program but in 2011, the IRS announced a new Offshore Voluntary Disclosure Initiative (OVDI) with maximum penalties of 25% of the highest unreported account balance.  The OVDI allowed penalties of 12.5% and 5% under certain circumstances.  Since John had learned in 2010 that UBS intended to turn over the Foundation’s account records to the IRS, he may not have qualified for the OVDI when it was reinstated in 2011.)  After receiving this advice John still didn’t file until 2013, when his daughter filed as his attorney-in-fact. 

Filing Obligations and Penalties for Foreign Trusts

Under Internal Revenue Code Section 6048, a U.S. person must report: (1) the creation of a foreign trust, (2) transfers to a foreign trust; and (3) distributions received by a foreign trust.  Any owner of a foreign trust must also disclose such ownership.  This information is reported annually on Forms 3520 and 3520-A, respectively, and additional reporting obligations may apply. 

The penalty for failing to file Form 3520 is the greater of $10,000 or 35% of the gross value of property contributed to a foreign trust.  The IRS may assess this penalty if a U.S. person contributes to a foreign trust and doesn’t report the contribution on a timely-filed Form 3520.  John was assessed $1,380,252.35 in penalties and successfully negotiated to reduce these penalties by half in the IRS administrative appeals process.  He then paid the reduced penalties and filed for an administrative refund claim, which was ultimately taken over by his estate after his death. John’s daughter then continued the case as personal representative for the estate.

Estate’s Arguments

The estate’s primary argument was that the PF wasn’t a foreign trust.  After all, the rules defining trusts are vague, and IRS has never specifically designated that a “Stiftung” was a foreign trust.  The Fifth Circuit exposed the flaw in this argument.  The rules defining trusts are intentionally vague.  They involve tests of facts and circumstances because if rules defining trusts were rigid, they would generate unfairness and taxpayers would thwart them through technicalities.  The law currently provides that when a U.S. taxpayer creates a structure by any name, anywhere in the world, that structure will report as a trust if it meets certain facts and circumstances.  The court found the result in John’s case was unambiguous.    

The estate argued that the penalties for failing to report the PF as a foreign trust are unjust, raising many different arguments.  For example, the estate argued the penalties violate: (1) the due process clause, (2) the Administrative Procedure Act, (3) the excessive fines clause of the Eighth Amendment, and (4) the duty of clarity.  The court concluded that the estate’s argument is essentially the same for all of these claims, namely, that the IRS hasn’t specifically designated foreign PFs as foreign trusts, but has created an unwritten rule that all foreign PFs are foreign trusts for reporting requirements.  The Fifth Circuit swiftly dismissed this idea for all the reasons mentioned above.  While a foreign PF could certainly be a foreign trust, it also could be a “corporation, partnership or other entity” depending on the facts and circumstances.  There can be no single rule for determining the U.S. taxation of a foreign PF because each one is different. 

When is a PF a Foreign Trust?

The Fifth Circuit cited well-established law and walked through the process of identifying a foreign trust.  The taxpayer must start by considering whether the entity is a trust or a business entity pursuant to the IRC.  If the structure is a trust, then consider whether it’s domestic or foreign.  Both of these analyses focus on facts and circumstances. 

The Fifth Circuit described a trust as an arrangement in which a donor gives property to a trustee to manage for the benefit of beneficiaries.  A trust relationship is created to vest the “responsibility for the protection and conservation” of the trust property in the trustee, not the beneficiaries.  In contrast, in a business relationship, decisions are made by “associates in a joint enterprise for the conduct of business for profit.”  In John’s case, the PF was clearly a trust arrangement and not a business relationship.  The beneficiaries, all family members, didn’t even know about the PF for years.  The PF’s organizational documents prohibited it from engaging in business activities.  The Fifth Circuit succinctly states, “[The Foundation’s] familial purpose, lack of business objective, and bar on commercial activity render it a trust.”

Once the court found that the PF was a trust, it was easy to determine that the trust was foreign.  To be domestic, a trust must pass each of two tests: (1) the court test (a U.S. court processes supervision over the trust administration), and (2) the control test (a U.S. person controls every substantial decision of the trust).  The PF failed both of these tests.  The organizational documents required that any disputes must be resolved by arbitration under Liechtenstein law and granted all decision-making authority to the PF’s board, which presumably held a majority of non-U.S. members.  Therefore, the PF was a foreign trust.

Taxpayer Controlled the PF’s Formation

The court didn’t mention this, but even if John’s PF had been reportable as a business entity, it would have been a foreign business entity subject to U.S. information reporting requirements from 2005 forward.  This further undermines John’s argument that he should face no penalties due to his PF’s ambiguous character. 

John voluntarily formed the PF, so he controlled the facts and circumstances that generated his U.S. tax reporting obligations.  John held the power to arrange his structure in any number of ways.  If he wanted to create an entity taxed as a business under U.S. law, he could have done so. 


Rost v. U.S. reminds us to think carefully about the income tax and information reporting consequences of the estate planning structures that we use and recommend.  It can be easy to focus on the client’s substantive goals, such as asset protection or support for non-U.S. family members.  If the structure isn’t reported properly from the beginning, the resulting tax liability can overwhelm and undermine all of those valuable substantive goals. 


Matthew Leonard and Ruth Mattson are partners at Verrill Dana, LLP in Boston

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