A comparison of the Form filing requirements and the Form 8938 filing requirements follows:

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1 This week Mark Jennings, Assistant Vice President of Investments, at LOM Securities (Bermuda) Ltd. hosted a conference on International Taxes and Trusts for US Citizens Living in Bermuda and US Beneficiaries of Bermuda Trusts. The speakers were Dina Kapur Sanna, an International Trust and Estate specialist Partner, Day Pitney LLP, New York, NY and U.S. Tax Specialist James Paul Sabo CPA President, ETS Limited, Hamilton, in Bermuda. The speakers discussed the changes that have taken place over the past 10 years regarding tax law changes and information reporting requirements that affect US citizens abroad, Expatriation-Surrender of US citizenship, Grantor and Nongrantor Trusts, Estate, Gift and Generation-Skipping Transfer Tax Issues and a Case Study. Introduction Over the last 10 years, greater attention has been paid to U.S. citizens residing abroad or owning financial assets outside U.S.: Enactment of two successive and different laws governing taxation of U.S. citizens who give up U.S. citizenship Issuance of three different formal IRS voluntary disclosure initiatives for U.S. citizens with unreported foreign income or assets U.S. prosecution of foreign banks that facilitate the maintenance of unreported foreign accounts by U.S. citizens Enforcement of Form TDF , Report of Foreign Bank and Financial Accounts (FBAR), which was previously a widely ignored form Enactment of Foreign Account Tax Compliance Act of 2009 (FATCA), as part of 2010 legislation, the purpose of which is to give the IRS new tools to find and prosecute U.S. individuals who hide assets overseas in foreign accounts or in foreign entities James Paul Sabo emphasized that U.S. citizens must file a tax return if their gross income is equal to or greater than their personal exemption amount and standard deduction. There is a longstanding misconception in Bermuda that if your earned income is less than $80,000 that you do not have to file a US tax return. This is just plain wrong and can get you into serious trouble with the IRS. A comparison of the Form filing requirements and the Form 8938 filing requirements follows: FBAR Form 8938 Filing threshold is $10,000 Filing threshold is $50,000 Required if U.S. taxpayer has a Required if U.S. taxpayer has an financial interest or signature or other interest (not signature or other authority authority) Due date is June 30th and filed with the Internal Revenue Service in Detroit Due date is tied to income tax return and filed with applicable IRS service center

2 Financial interest is based on whether Financial interest is based on potential the person is the owner of record for tax attributes or transactions related to or holds legal title to the account or is the account that would be reported on the indirect beneficial owner. the individual s tax return. Required by persons who do not have a direct financial interest in a foreign financial account, e.g., an individual is required to report the foreign financial account of his or her wholly owned domestic or foreign corporation. If a domestic corporation has a direct or indirect financial interest in the foreign account, it will also be required to report the account, as would any individuals, such as employees, that have signature authority over the financial account. Does not toll or extend statute of limitations on assessment of tax if not filed. Civil penalties range from $10,000 to greater of $100,000 or 50% of account. If a foreign financial account is reported by a specific individual, the foreign account will not also be reported by a specified domestic entity, and vice-versa. Tolls statute of limitation on assessment of tax for relevant year until filed; can extend statute to 6 years if omission attributable to unreported financial account exceeds $5,000. Civil penalties range from $10,000 to $50,000 plus accuracy related penalty of 40% if underpayment of tax is attributable to undisclosed account Expatriation Rules enacted in 1966, revised in 1996, 2004 and 2008 Current rules impose same triggers as 2004 law but have dramatically different implications For expatriations occurring prior to 2008, there is 10-year reporting period on an expanded category of U.S. source income and an expanded category of U.S. situs assets For expatriations occurring after 2008, there is a mark-to market tax on worldwide assets, a 30% withholding tax on future distributions from nongrantor trusts, i.e., any trust of which expatriate is not grantor, and a succession tax on gifts or bequests from the expatriate to U.S. donees

3 Triggers to application of rules Expatriate has a net worth of $2 million or more on date of expatriation ( net north test ) or Expatriate has an average net income tax liability for the 5 years preceding expatriation of more than $151,000 (indexed for inflation, this is 2012 figure) ( income tax liability test ) or Expatriation fails to certify, under penalties of perjury, that he has complied with tax filing obligations for the 5 years preceding expatriation ( tax certification test ) Consequences of Expatriation Covered expatriate subject to tax on built-in gains in assets as if he sold them immediately prior to expatriation; can exclude $651,000 from gain (adjusted for inflation; this figure is 2012 figure) an individual is considered to own property included in his estate under estate tax provisions as if he died immediately prior to expatriation all nonrecognition deferrals and extensions of time for payment of tax are considered terminated as of the day before expatriation 30 day wash sale rules do not apply election available to defer tax on an asset-by-asset basis until asset is disposed of, if adequate security is provided, treaty benefits are waived and interest is paid on the deferred tax A succession tax applies in the hands of U.S. persons on gifts or bequests received from a covered expatriate at the highest applicable estate and gift tax rate there are exceptions for annual exclusion gifts, marital and charitable transfers but there is no offsetting gift or estate tax exemption available If a gift or bequest is made to a foreign trust, the succession tax applies to distributions made from the trust to U.S. beneficiaries a trust can elect to be a U.S. trust for this purpose the succession tax attributable to the income portion of the distribution can be credited against income tax imposed on same Grantor Trust or Nongrantor Trust? If a non-u.s. trust is established and funded by a non-u.s. person and qualifies as a grantor trust for income tax purposes, it is disregarded as a taxable entity and grantor is taxed on income of trust as its owner Correspondingly, if income of trust is not U.S.-source income or effectively connected income, grantor is not subject to income tax Distributions to U.S. beneficiary are treated as gifts from non-u.s. grantor and not taxed

4 A non-u.s. person is not treated as owner of trust under grantor trust rules generally, unless trust meets either Revocable Trust Exception or Trusts that Distribute only to Grantor and/or Grantor s Spouse Exception Grantor trust holding directly Non-U.S. Situs assets Benefits: 1. No income tax (except U.S. withholding on U.S. source income) paid by trust, non-u.s. grantor or U.S. beneficiary 2. No estate tax on death of non-u.s. grantor (because U.S.-situs assets held through non-u.s. corporation) or on death of U.S. beneficiary (if assets stay in trust) 3. No generation-skipping transfer tax if trust continues in perpetuity Death of Non-U.S. Grantor Trust becomes a non-grantor trust and distributions of distributable net income to U.S. beneficiary are taxable If the distributable net income is not distributed, it becomes undistributed net income Distributions in excess of distributable net income and fiduciary accounting income, are deemed to come from undistributed net income, i.e., no tracing rule, and subject to throwback rules: accumulated capital gains taxed as ordinary income throwback tax applies under a three-out-of-five year averaging method A nondeductible interest charge is imposed on the throwback tax under a weighted average method Unless the trust requires the income to be distributed to a beneficiary, each distribution carries out a pro-rata share of DNI for the entire year and if it exceeds DNI, a pro-rata share of UNI, to U.S. and non-u.s. beneficiaries alike A distribution equal to all DNI and UNI can be made to non-u.s. beneficiaries in one year followed by a distribution to U.S. beneficiaries in another year Broad intermediary rules exist to capture distributions made through non-u.s. intermediaries to U.S. persons U.S. Reporting For Gifts Received From Foreign Persons and Distributions From Foreign Trusts on Form 3520 U.S. reporting exists on Form 3520 with respect to aggregate gifts which exceed $100,000 in a calendar year from a non-u.s. donor: aggregation of gifts is required if donors are related within meaning of tax rules identify of donor is not disclosed failure to report results is a penalty equal to 5% of gift

5 Case Study a Beneficiary Statement from the non-u.s. trustee must be obtained to avoid default treatment as accumulation distribution that is subject to throwback rules failure to report results in a penalty equal to $10,000 or 35% of the value of the distributed property, whichever is greater (as amended by FATCA) The new client ( Mr. A ) is a Bermuda national who is married to a U.S. citizen and their adult child has dual Bermuda/U.S. citizenship. Mr. A has settled an irrevocable Bermuda trust that owns the Bermuda marital residence and a US stock portfolio. The trust has current and accumulated income. Mr. A has settled a revocable Bermuda trust that owns a BVI corporation with investments In Cayman Island based mutual funds as well as a US stock portfolio. Mr. A must obtain the trustee s consent to revoke the trust. The trust has current and accumulated income. The beneficiaries of both trusts are Mr. A, Mr. A s wife and their adult child, and the Trustee of both trusts has sole discretion to distribute or accumulate income among them. Analysis Of U.S. Tax Issues Related To Irrevocable Trust: No distributions have been made from the irrevocable trust except for an interest free loan of $50,000 to Mrs. A. Is the interest free loan a deemed distribution? A. A loan of cash or marketable securities is treated as a constructive distribution with limited exceptions What is the fair rental value of the Bermuda marital residence? A. $120,000. Why is this relevant? A.FATCA provisions of 2010 legislation amend the Code to provide that the uncompensated use of non-u.s. trust property by a U.S. beneficiary is a constructive distribution (effective for uses after March 18, 2010) Mrs. A must file Form 3520 to report the deemed distributions, and also obtain a Foreign Nongrantor Trust Beneficiary Statement from the Trustee. Mrs. A must file Form 8938, and perhaps Form if she is deemed to have a financial interest in more than 50% of the trust s income or assets. Analysis of U.S. Tax Issues Related To Revocable Trust: All distributions to date from the revocable trust have been made to Mrs. A. ($100,000), except for paying for graduate school ($30,000) for their child. Is there a deemed distribution to adult child for whose benefit graduate school was paid? A. Yes

6 Could this have been avoided? A. Yes Does the fact that Mrs. A receives more than 50% of the income have any other consequences? A. Yes Under the US allocation rules it is likely that Mrs. A. is the deemed owner of the underlying BVI entity that is likely a Controlled Foreign Corporation that would require Mrs. A. to now file Form 5471 and possibly result in her having a deemed dividend from the CFC. Are the foreign funds held by it PFIC? The likely answer is yes and that would require Mrs. A. to file Form 8621 in addition to filing Form and Form 8938 The child for whose benefit graduate school was paid must file form 3520 and obtain a foreign nongrantor trust beneficiary statement from the trustee. What Are the Obligations of the Bermuda Trustee When Distributions Are Made to a US Beneficiary? Under US tax law a US Beneficiary such as Mrs. A must obtain a Foreign Nongrantor Trust Beneficiary Statement from the Bermuda Trustee or face dire US tax consequences. A Bermuda trustee may furnish the US beneficiary with an accounting of income received from the trust under Generally Accepted Accounting Principles (GAAP), but for US tax return preparation purposes the US CPA needs fiduciary accounting statements. It is likely that the Bermuda trustee is unaware of the need for fiduciary accounting statements and if the US tax return preparer only occasionally deals with distributions from a foreign trust than the likelihood of the US beneficiaries US tax return being correctly prepared is remote. Pursuant to the requirements relating to practice before the Internal Revenue Service, any tax advice in this communication is not intended to be used, and cannot be used, for the purpose of (i) avoiding penalties imposed under the United States Internal Revenue Code, or (ii) promoting, marketing or recommending to another person any tax related manner. The tax advice given is, by necessity, general in nature. You should, of course, check with your own U.S. tax consultant as to how specific transactions affect you since tax advice varies with individual circumstances. James Paul Sabo, CPA, is the President of ETS Ltd., PO Box HM 1574, Hamilton HM GX, Bermuda. Questions should be sent to: jsabo@expatriatetaxservices.com

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