1. Annual Accounting Treatment and Tax Filings of the Trust

2. Accounting Treatment
The accounting treatment of BVI assets, which are T1 subsidiary (manufacturing), T2 subsidiary (investment holding company) and T3 subsidiary (investment company), held by a U.S. irrevocable trust is described as follows:

3. U.S. Tax Filing
(1) Before the establishment of the trust This election has been available to enterprise since January 1st, 1997 and is intended to reduce disputes between the IRS and enterprise.
Under Section 7701 of the U.S. Tax Code (the “Check-the-box Regulations”), certain business entities are permitted to “check-the-box” by filing Form 8832 (Entity Classification Election) to select entity classification for U.S. federal income tax purposes. Under Form 8832, eligible entities include LLCs, partnerships, disregarded entities, foreign entities, and business entities that are not considered a per se corporation.

• What is a Per Se Corporation?

Form 8832 lists the business entities that must be recognized as “Per Se Corporations” (PSCs). For U.S. federal tax purposes, a per se corporation should be treated as a “corporation” at all times and cannot be changed (Treasury Regulation § 301.7701-2(b)); that is, the corporate form cannot be changed through the check-the-box election. This classification includes entities or corporations formed under federal or state law, insurance companies, and entities incorporated in both the U.S. and other jurisdictions whose foreign incorporated entities are listed on the “Per Se Corporations” list for foreign or U.S. entities.
A foreign corporation may also choose other classifications of corporations through the election other than the ones under the Default Rules. For example, a wholly foreign-owned corporation (only one owner, 100% ownership) or an LLC may choose to become a “Disregarded Entity” in the U.S. through the election, which is a “Tax Transparent Entity”.

(i) Occasions for filing Form 8832:

• When you want to change the entity’s classification: ①original classification → new classification; ② old classification → new classification (previously elected).
• If a corporation wants to file a tax return using its original classification, it does not need to file Form 8832.

(ii) Effective date specified on Form 8832:

• No earlier than 75 days and no later than 12 months on the effective date of which the election is filed. 
• If the effective date is 75 days earlier than the date on which the election is filed, it will be effective 75 days prior to the date it was filed. If the effective date is 12 months later than the date on which the election is filed, it will be effective 12 months after the date it was filed.
• If no effective date is specified in the form, effective date equal to election date.

(iii) 60-month limitation rule: If you have previously made an election, you may not make another election for another 60 months (5 years) after the election.
Exception: The 60-month limit may be waived unless① the company is newly formed and ② the effective date equal to the date of incorporation.
If you really want to re-elect within five years, you can apply for a Private Letter Ruling from the IRS for a fee if you meet some criteria.
The following is the actual process for an inter vivos transfer of offshore holding assets into a U.S. irrevocable trust:
If a foreign holding company has a multi-tier ownership structure, it is advised that they should file Form 8832 (check-the-box election) from lower-tier to their upper-tier corporation, thus allowing the upper-tier holding company to create their relevance so that the assets held by the entire company are adjusted to the market value (Stepped-up Basis).
The term “relevance” can be exemplified as the following: A foreign entity can be deemed as relevant to a U.S. individual or business entity for federal tax purposes when it could impact tax returns of the U.S. individual or business entity. In practice, once a foreign entity earns interest income on treasury bills or receives dividend income, it will be deemed as relevant to the U.S. individual or business entity. Therefore, it will be subject to federal taxes and its classification will also be changed. Once a holding company files Form 8832 (check-the-box election), it is regarded as a new business after asset liquidation (asset value adjusted to market price). At this moment, if there is only one shareholder in this business entity, the holding company would be considered as the Disregarded Entity. Therefore, the assets held by the companies under the holding company tier would pass through to the trust. Then, the capital gains on the sale of assets would be lowered when the assets held by the trust are disposed in the future. Furthermore, surplus earnings distribution would not be seen as the dividend distribution before the distributions are transferred into the trust, leading the accrual income tax be lowered.

Please refer to the following table, which suggests when to generate relevance to check-the-box. This time schedule is only for reference. As the pandemic severely affects the operational procedure of the IRS in recent years, it is recommended to communicate with a professional U.S. accountant to ensure a more appropriate setup process for your trust.

• When the trust is established, the grantor remits Foreign funds into a U.S. irrevocable trust.
• Fees paid by the grantor but not paid by the trust are deemed as gifts.
• Form 3520, Part IV, column 54 and 55 should be reported respectively to the IRS if the following conditions are met:
• Taxpayers should complete Form 3520, Part IV, column 54, if the aggregate value of gifts or bequests he or she receives from nonresident alien or foreign estate exceeds US$100,000 during the taxable year. 
• Taxpayers should complete Form 3520, Part IV, column 55, if the aggregate value of gifts or bequests he or she receives from foreign corporation or partnership exceeds US$16,649 during the taxable year. 

What are the penalties for failing to report foreign gifts on time? This depends on the source of the gift, as explained below.

• If Form 3520 is not reported, a penalty of 5% per month of the total value of the foreign gift or bequest is levied (but not more than 25% of the gift).
• If a U.S. individual fails to report the distribution received by the foreign trust, a penalty of 35% of the total value of the distribution received from the foreign trust is levied. (Section 6677)

It is important to note that if a large amount of money is remitted to the trust in the year of its establishment and exceeds the threshold for filing Form 3520, it must be reported in accordance with the regulations. Due to the large amount of money, it is recommended to have a U.S. accountant assist in the filing process. Otherwise, the IRS is currently conducting a rigorous audit, which may pose a certain degree of risk to taxpayers who are not familiar with the filing methods and procedures, or who have filed incorrectly.
Usually, the capital invested in the beginning of the year after the trust is established will not generate much income. However, if the following conditions are met, taxpayers are required to file Form 1041: (3) Operation Phase
The establishment of a U.S. irrevocable trust and arrangement of the BVI into the trust will involve in U.S. trust tax filing obligations, which will be illustrated by this structure and the following consolidated statements below.

The reporting of U.S. irrevocable trust holding foreign assets is complex. It is recommended that the following tax forms are filed by a professional U.S. accountant. The relevant reporting requirements are the same as those for U.S. assets held in a U.S. irrevocable trust.
After the BVI’s consolidated financial statements are combined with the trust accounts, various types of income can be accounted on Form 1041 for trust tax purposes and trust tax can also be calculated.
Example of Form1041.
Assuming there are no trust transactions and no related deductions, the trust tax return is filed as follows: Failure to file the correct Form 8938 in a timely manner or miscalculation of  tax liability due to undisclosed specified foreign asset may result in penalties.

• Failing to file Form 8938

If you are required to file Form 8938 but do not file a complete and correct Form 8938 by due date, you may be subject to US$10,000 penalties.

• Continuing fail to file

If a complete and correct Form 8938 is not filed within 90 days after the IRS mailed the notice of not receiving the form, an additional penalty of US$10,000 for each consecutive 30-day period (or less) in continuance of  failing to file Form 8938 may be imposed after 90 days and may be up to a maximum of US$50,000. In the case of a U.S. irrevocable trust, if the trust itself, the trustee of the trust, or the agent of the trust meets the following condition, then the beneficiary of the trust is directly or indirectly entitled to more than 50% of the economic benefits of the trust’s assets or income and would not be required to report FBAR:

• a U.S. person
• files a FBAR to disclose foreign financial accounts info of a trust 

U.S. persons holding foreign disregarded entities are required to report Form 8858 (e.g., profit and loss summary, simplified balance sheet, etc.) Definition of a U.S. person: A U.S. person includes a U.S. citizen or tax resident, a U.S. C corporation, a U.S. partnership, U.S. domestic estate or trust under the relevant reporting requirements. A U.S. domestic trust referred here must meet the following conditions:

• U.S. court test
• One or more U.S. persons have substantial control over the trust

A U.S. person is required to file Form 8858 (Schedule M) if their FDE or FB had made transactions with the related entities mentioned in Form 8858 during the taxable year.  The primary purpose of this form is to monitor the tax liability of U.S. corporations or U.S. shareholders who invest in or operate through subsidiaries in low-tax or tax-exempt countries, trying to retain their foreign revenue from the subsidiaries without distributing them back to the U.S., which may raise concerns regarding incorrect tax disclosure from U.S. taxpayers. Hence, the regulations governing the CFCs (Controlled Foreign Corporations) were enacted and Form 5471 is required to be filed annually by the U.S. shareholders to disclose specific information regarding the CFCs.

The following are the definitions of the five category filers on Form 5471, with the first category divided into 1a, 1b, and 1c and the fifth category divided into 5a, 5b, and 5c in the 2020 tax year. ① Definition of a U.S. Person 
Under the relevant reporting requirements, a U.S. person should include: a U.S. citizen or tax resident, a U.S. C corporation, a U.S. partnership, a U.S. estate or trust.

② Definition of a U.S. Shareholder
A U.S. Shareholder is any U.S. person who owns 10% of a foreign corporation, including individuals, corporations, trusts, and partnerships.

③ Definition of a Specified Foreign Corporation (SFC)

• If a foreign corporation is a Controlled Foreign Corporation (CFC), it will be considered as a Specified Foreign Corporation (SFC); or
• A foreign corporation is a Specified Foreign Corporation (SFC) if it is owned by a U.S. domestic corporation.

④ Definition of a CFC (Controlled Foreign Corporation)
In practice, one of the most common situations in which U.S. persons are required to file Form 5471 is when they hold equity interests in a CFC (“Controlled Foreign Corporation”), which qualifies as Category 4 or 5 filers.
To determine if an offshore U.S. corporation is a CFC, it must meet both of the following tests:

• U.S. Shareholder Test: Under IRC §957, if a U.S. person who owns or is deemed to own 10% or more of the total combined voting power of all classes of voting stock of a CFC, then it is considered as a U.S. shareholder.
• 50% Shareholding Test: If the U.S. shareholders own more than 50% of the total combined voting power of all classes of voting stock or owned more than 50% of the total value of the stock of the corporation.

Under U.S. tax law, to prevent U.S. taxpayers from retaining their business profits abroad and thereby deferring or avoiding U.S. tax liability, U.S. shareholders are required to include the portion of the undistributed foreign income of the CFC that is deemed as Subpart F Income when filing them in their U.S. tax return based on the shareholding ratio in the current year.¹

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¹  Internal Revenue Code §952: SUBPART F INCOME DEFINED.參考美國《國內稅收法》§952：定義SUBPART F INCOME DEFINED。

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Subpart F Income has a complex classification, and it is mainly classified according to IRC section 952 regulations as follows:

• FPHCI (Foreign Personal Holding Company Income) 
• Foreign base company sales income
• Foreign base company service income
• International Boycott Income as defined in IRC Section 952(a)(3)
• Illegal bribes, kickbacks or other payment as defined in IRC Section 952(a)(4) 
• Income described in IRC Section 952(a)(5) derived from any foreign country that complies with IRC Section 901(j)

The undistributed profits mentioned above are specified in 26 U.S. Code Part III, Subpart F and is therefore referred to as Subpart F Income.

Deduction of Subpart F Income
When calculating the Subpart F income, the cost of goods sold and the operating expenses of the CFC can be deducted from the Subpart F income. However, it is recommended that readers consult a professional accountant in advance.

Allowance of Subpart F Income If the total annual insurance income (IRC Section 953) and the foreign company income (IRC Section 954) is less than 5% of the CFC’s total annual income or if the total annual foreign company income does not exceed US$1 million, the CFC may exclude the foreign company income from the Subpart F Income in the current year. Let’s assume Company A is a CFC and qualifies as a foreign personal holding company and the company has an annual revenue of US$5 million with a rental income of US$150,000. Since its rental income only represents 3% of its total annual revenue, its rental income qualifies under the “de minimis” rule and can be excluded from the Subpart F income.  CFC’s annual insurance income (IRC Section 953) and foreign company income (IRC Section 954) would qualify for the high tax rate exclusion if the tax paid abroad exceeds 90% of the 21% of the maximum U.S. corporate tax rate. Assuming  that CFC’s effective foreign tax rate is 19%, which has already reached 90% of the U.S. corporate tax rate, then the high tax exclusion would apply, but only if the CFC shareholder is a U.S. corporation.
When a CFC distributes dividend, the dividend distribution is excluded from the Subpart F Income calculation because the distribution of the proceeds from the CFC back to the U.S. shareholder would not result in deferral of income, and the dividend distribution is reported by the U.S. shareholder on his or her individual tax return on a pro rata basis.
The application of the above allowances requires a complex and technical process. Hence, readers are advised to consult and discuss with a professional accountant.

• Calculation of the Subpart F Income Threshold

When calculating Subpart F income, apart from what’s mentioned above, it is also necessary to consider the undistributed income of the tax year of the CFC and whether there are any losses in the prior period that needs to be covered. Therefore, the maximum threshold for calculating Subpart F income is the undistributed income of the tax year of the CFC plus the accumulated losses in the prior period, and the so-called accumulated losses must be caused by the above mentioned operating activities.
(i) Insurance income losses
(ii) Foreign personal holding company income losses
(iii) Foreign company sales revenue losses
(iv) Foreign company service income losses

The following is Schedule I of Form 5471: GILTI was added after the TCJA to prevent U.S. persons from deferring or avoiding U.S. tax liability by retaining non-foreign generated business profits abroad. 26 U.S. Code § 951A regulates the taxation of global intangible low-taxed income (GILTI) for U.S. foreign corporations with intangible assets above certain thresholds. The U.S. person shareholders of the CFC are required to include GILTI in their income where the gross income of the CFC (Net CFC Tested Income) exceeds the proposed Net Deemed Tangible Income Return (NDTIR).