Tax obligations for a Cook Islands trust

The fundamental point

A Cook Islands trust is a foreign grantor trust for US tax purposes. The settlor reports the trust's income on their own US return as if the trust did not exist for income tax purposes. The trust changes who holds legal title to the assets. It does not change where the income is taxed, how much tax is owed, or what must be reported to the IRS. A US person who settles a Cook Islands trust and fails to file the required forms faces penalties that are substantially worse than the original tax obligation.

This is not a nuance. It is the central fact of Cook Islands trust tax treatment that anyone considering the structure must understand before settling anything. The asset protection the structure provides is real and valuable. It has nothing to do with tax reduction, and treating it as a tax reduction tool is both incorrect and creates the kind of compliance failure that produces the most severe IRS penalties.

Annual filings

A US person who is the settlor of a foreign grantor trust must file two forms annually with the IRS regardless of whether any distributions were made, any transactions occurred, or the trust had any activity in the year. Form 3520 reports transactions with the foreign trust including the original creation and funding, subsequent contributions, and distributions received. Form 3520-A is the trust's annual information return covering its assets, income, and distributions for the year. Both are due by the personal tax return due date with the same extension provisions.

The penalties are severe. Failure to file Form 3520 carries a penalty of the greater of $10,000 or 35 percent of the gross reportable amount. Form 3520-A carries similar penalties. These are not proportionate to the size of the error. A missed filing on a substantial trust generates a penalty that dwarfs the cost of having filed correctly. A CPA who prepares these forms regularly for Cook Islands trust clients should handle both, every year.

Automatic reporting

The Cook Islands participates in the OECD Common Reporting Standard. Banks holding Cook Islands trust account balances automatically report account information to the FSC, which exchanges it with the tax authorities of account holders' home countries. A US settlor's trust account information is reported to the IRS through CRS regardless of whether the settlor files voluntarily. A trust not disclosed on the Forms but visible through CRS is a trust the IRS has information about from two inconsistent sources.

FBAR and FATCA reporting obligations attach independently. A US person with a financial interest in or signature authority over a foreign financial account with a value exceeding $10,000 at any point during the year must file an FBAR. FATCA requires disclosure of specified foreign financial assets above defined thresholds on Form 8938.

In this section

• Form 3520 — the annual return for transactions with foreign trusts
• Form 3520-A — the trust annual information return
• FBAR and FATCA — foreign account and asset reporting
• CRS reporting — automatic exchange and what it means

General information only. Tax law changes and individual circumstances vary. Confirm all obligations with a CPA with specific Cook Islands trust filing experience before settling a trust and annually thereafter.