Grantor Trust Mischaracterization Might Cost Heirs $15M

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

Grant Geiger’s German grandfather formed the World Capital Foundation (WCF) in Lichtenstein. The beneficial interest of the trust was transferred to Grant’s father, Gunter A. Geiger, several years later after the death of the grandfather. 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 leniency on penalties and a reduced risk of criminal prosecution, paying $1.9 million toward any liability in addition to filing forms 1040, 3520, and 3520-A for 2003 to 2010. In filing those forms, Gunter incorrectly reported WCF as a grantor trust.

The difference in characterization makes a huge difference for tax purposes—a grantor trust treats Gunter as the owner of all of WCF’s income and requires reporting on his tax return, as well as subjects him to include the fair market value of WCF’s assets in his exit tax upon expatriation (Gunter surrendered his U.S. green card in 2010 and moved to Europe). A non-grantor trust, on the other hand, would mean he’s only responsible for taxable portions on distributions made and a 30 percent withholding tax on distributions made after expatriation.

IRS Backtracks

According to the complaint, the mistake was caught quickly and the IRS initially agreed that WCF was a foreign non-grantor trust. Following Gunter’s death in 2015, the 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 foreign non-grantor trust “without explanation” and proceeded to pull the estate out of the OVDP and commenced jeopardy assessments, despite the estate cooperating in negotiations. (Tax Notes reports that the IRS had offered the estate three settlement options: be treated as a grantor trust with more than $6 million liability, stay in the OVDP as a non-grantor trust on terms that would lead to a $20 million liability, or be removed from the OVDP and be subject to exam and penalties, leading to even more liability.)

Estate Disputes Tax Assessment

Both Grant and Margie, who filed separate complaints, argue that the jeopardy assessments are a “drastic” procedure “reserved for situations” in which a taxpayer is looking to flee the country or conceal assets, neither of which is the case here. The complaint further argues that WCF wasn’t a grantor trust because Gunter never transferred funds to the trust nor had sufficient control over the trust’s income or principal until after he expatriated. 

"I’m not sure why a jeopardy assessment was filed here since the taxpayer seems to be cooperating and responsive," opined Harvey I. Bezozi, a tax expert based in Boca Raton, Fla.

Reporting Requirements

The outcome of the Geiger case will hinge on the characterization of the trust. The case highlights the complexity of foreign trust reporting, as well as the reporting of non-U.S. source income in general, and the potentially costly consequences of incorrectly filling out the required forms. Though it’s not clear whether Gunter filed his own forms in the case, a mistake of this caliber could potentially subject a tax professional to a malpractice claim.

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

Recognizing the difficulty taxpayers face with figuring out how to properly comply with the reporting requirements, the IRS has just released proposed regulations that would provide guidance on the reporting obligations for transactions with foreign trusts and receipt of large foreign gifts and regarding loans from, and uses of property of, foreign trusts.