Cook Islands Trust IRS Tax Reporting Requirements

U.S. persons who establish or maintain Cook Islands trusts must file several IRS information returns annually regardless of whether any tax is owed. These forms exist because the Internal Revenue Code imposes heightened reporting requirements on foreign trust arrangements to ensure the IRS has visibility into offshore structures. The reporting obligations are separate from, and in addition to, the income tax reported on the grantor’s Form 1040.

Cook Islands trusts do not reduce U.S. tax obligations. Most are structured as grantor trusts under IRC Section 679, meaning all trust income, gains, and losses pass through to the grantor’s personal tax return. The trust provides asset protection, not tax benefits. But the reporting requirements carry severe penalties for non-compliance, and those penalties apply even when no tax is due and the trust is fully transparent to the IRS.

This article explains the tax treatment of Cook Islands trusts, the specific forms that must be filed, filing deadlines, and the consequences of non-compliance. For detailed treatment of individual forms, see Forms 3520 and 3520-A and the FBAR requirements pages.

Grantor Trust Classification Under IRC Section 679

The starting point for understanding Cook Islands trust taxation is IRC Section 679. This provision creates an automatic grantor trust rule for foreign trusts that is broader than the domestic grantor trust rules under IRC Sections 671 through 678.

Under Section 679, any foreign trust with a U.S. transferor is treated as having a U.S. owner if the trust has or may have a U.S. beneficiary. Because Cook Islands trusts almost always include the U.S. settlor as a beneficiary (and typically include other U.S. family members as contingent beneficiaries), Section 679 applies to virtually every Cook Islands trust established by a U.S. person.

This classification is automatic. It does not depend on whether the settlor retained any traditional grantor trust powers such as revocability, substitution rights, or administrative control. Even a completely irrevocable Cook Islands trust where the settlor retains no powers whatsoever is treated as a grantor trust under Section 679 if the settlor is a U.S. person and U.S. persons are among the potential beneficiaries.

The consequence is tax transparency. All trust income, capital gains, losses, deductions, and credits are reported on the grantor’s Form 1040 as though the trust did not exist for income tax purposes. The trust does not file Form 1041 as a separate taxpaying entity. The grantor pays tax at individual rates on all trust income as earned, regardless of whether any distributions are made.

Section 679 also covers indirect transfers. Under the HIRE Act provisions effective after March 18, 2010, if a foreign trust that is not already classified as a grantor trust makes a loan of cash or marketable securities to a U.S. person, or allows a U.S. person to use trust property without adequate compensation, the trust is treated as having acquired a U.S. beneficiary and becomes a grantor trust. This prevents end-runs around grantor trust classification through loan or use-of-property arrangements.

Form 3520: Reporting Trust Transactions

Form 3520 (Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts) must be filed by U.S. persons who create a foreign trust, transfer property to a foreign trust, or receive distributions from a foreign trust.

For Cook Islands trust grantors, Form 3520 is required in the year the trust is created and funded. If additional assets are transferred to the trust in subsequent years, Form 3520 must be filed for those years as well. The grantor must also file Form 3520 annually as the U.S. owner of a foreign grantor trust, reporting the trust’s income and attaching the Foreign Grantor Trust Owner Statement (pages 3 and 4 of Form 3520-A) received from the trustee.

The form requires detailed information including the trust’s name, jurisdiction, date of creation, trustee contact information, trust EIN (or the grantor’s SSN), a description and fair market value of property transferred, cost basis, and whether the transfer constitutes a completed gift. It also requires information about the U.S. agent for the trust (if designated), related parties, and whether the trust has U.S.-source income.

Form 3520 is due with the grantor’s individual income tax return, typically April 15, with an automatic six-month extension to October 15 if requested by the original due date. It is filed as an attachment to Form 1040.

The penalty for failing to file Form 3520 is the greater of $10,000 or 35% of the gross reportable amount. For transfers to a trust, the gross reportable amount is the value of the property transferred. For a trust funded with $1 million, the penalty for failing to report the transfer could reach $350,000. For annual owner reporting, the penalty is the greater of $10,000 or 5% of the gross value of the portion of the trust treated as owned by the U.S. person. These penalties apply for each year the form is not filed.

If non-compliance continues for more than 90 days after the IRS mails a notice of failure to comply, additional penalties of $10,000 per 30-day period accrue, subject to a cap.

Form 3520-A: Annual Trust Information Return

Form 3520-A (Annual Information Return of Foreign Trust with U.S. Owner) must be filed for every foreign trust with a U.S. owner. The trustee is technically responsible for filing, but in practice, the U.S. grantor’s CPA coordinates preparation and the trustee signs the completed form.

Form 3520-A requires a trust income statement showing all income, gains, deductions, and credits for the year; a balance sheet listing all trust assets and liabilities as of year end; foreign bank account information including institution names, account numbers, and maximum balances; and identification of all U.S. owners and beneficiaries with amounts distributed.

The form also generates the Foreign Grantor Trust Owner Statement and the Foreign Grantor Trust Beneficiary Statement, which the trustee furnishes to the U.S. owner and any U.S. beneficiaries who received distributions. The grantor attaches the Owner Statement to Form 3520, and the information flows through to the grantor’s Form 1040.

Form 3520-A is due on March 15 for calendar-year trusts (the 15th day of the third month after the trust’s year end), with a six-month extension available. This deadline is earlier than the individual return deadline, requiring advance coordination with the trustee to gather the necessary financial data.

The penalty for failing to file Form 3520-A is the greater of $10,000 or 5% of the gross value of the trust assets treated as owned by the U.S. person at the close of the tax year. Additional penalties accrue if non-compliance continues after IRS notice. Under Section 6662(j), if the U.S. owner is also subject to the 20% accuracy-related penalty under Section 6662, that penalty can be increased to 40% for any portion of an underpayment attributable to assets that should have been reported on Form 3520-A.

If the Cook Islands trustee refuses or fails to file Form 3520-A, the U.S. owner can avoid the penalty by completing a substitute Form 3520-A to the best of the owner’s ability and attaching it to the owner’s timely filed Form 3520. This substitute filing procedure is described in the Form 3520-A instructions and is an important safeguard for U.S. owners whose foreign trustees are slow to cooperate with U.S. filing requirements.

FBAR: FinCEN Form 114

U.S. persons with signature authority or other authority over foreign financial accounts exceeding $10,000 in aggregate at any time during the calendar year must file FinCEN Form 114 (Report of Foreign Bank and Financial Accounts, commonly called the FBAR) electronically through the BSA E-Filing System.

Grantors of Cook Islands grantor trusts are generally considered to have a financial interest in trust bank and investment accounts because they are treated as the owner of the trust for tax purposes. Even if the trustee has formal signatory authority, the grantor’s status as tax owner and practical ability to influence the trustee (often through a trust protector) establishes the financial interest triggering FBAR filing.

The FBAR requires reporting each foreign financial account including bank accounts, brokerage accounts, and mutual funds held outside the United States. For each account, the filer must report the financial institution name, account number, type of account, and maximum value during the calendar year.

The aggregate threshold is $10,000. If the combined maximum value of all foreign accounts at any point during the year exceeds this amount, every foreign account must be reported, not just those exceeding $10,000 individually. For Cook Islands trusts holding significant assets, this threshold is nearly always exceeded.

The FBAR is due April 15, with an automatic extension to October 15. It is filed separately from the income tax return and submitted electronically to FinCEN rather than to the IRS.

FBAR penalties are among the most severe in the tax code. Non-willful violations carry penalties up to $10,000 per violation, which the IRS may assess per account per year. Willful violations carry penalties up to the greater of $100,000 or 50% of the account balance per violation. Criminal penalties including fines up to $250,000 and imprisonment up to five years apply to willful FBAR violations.

Form 8938: FATCA Reporting

Under the Foreign Account Tax Compliance Act (FATCA), U.S. taxpayers with specified foreign financial assets exceeding certain thresholds must file Form 8938 (Statement of Specified Foreign Financial Assets) with their income tax return.

For unmarried taxpayers living in the United States, Form 8938 is required if the total value of specified foreign financial assets exceeds $50,000 on the last day of the tax year or $75,000 at any time during the year. For married taxpayers filing jointly, the thresholds are $100,000 and $150,000 respectively. Taxpayers living abroad have substantially higher thresholds.

Specified foreign financial assets include foreign bank accounts, foreign brokerage accounts, interests in foreign entities, and interests in foreign trusts. For grantor trusts, the grantor reports the trust’s foreign financial assets on their personal Form 8938 as if they owned the assets directly.

Form 8938 requires for each asset a description, identifying number, name and address of the financial institution, maximum value during the year, and whether income from the asset was reported on the tax return. The form is attached to the individual’s Form 1040 and filed with the tax return.

The penalty for failing to file Form 8938 is $10,000, with additional penalties up to $50,000 for continued non-compliance after IRS notice. Perhaps more importantly, failure to file Form 8938 keeps the statute of limitations open indefinitely for the entire tax return, meaning the IRS can audit any aspect of the return, not just foreign assets, regardless of how many years have passed.

Form 8938 and the FBAR overlap significantly. Many foreign accounts must be reported on both forms. The forms have different thresholds, different filing addresses, different formats, and different deadlines, so both must be filed even when the same accounts are reported on each.

Recent Change: IRS Penalty Assessment Policy

In late 2024, the IRS announced a significant procedural change affecting Forms 3520 and 3520-A. Previously, the IRS automatically assessed penalties for late-filed forms without reviewing reasonable cause statements. Under the new policy, the IRS will review reasonable cause statements submitted with late-filed Forms 3520 and 3520-A before assessing penalties, rather than imposing the penalty automatically and requiring the taxpayer to seek abatement afterward.

This change does not eliminate the penalties. It changes the procedural sequence: the IRS now considers the taxpayer’s explanation before issuing a penalty notice, rather than issuing the penalty first and requiring the taxpayer to contest it. The underlying penalty provisions, amounts, and statutory framework remain unchanged.

The practical significance is that taxpayers who file late but have a legitimate reasonable cause explanation (such as reliance on professional advice, trustee delay in providing information, or other documented justification) now have a better procedural path to avoiding penalties. Under the prior automatic-assessment regime, many penalties were eventually abated but only after prolonged disputes, collection notices, and administrative burden for both the taxpayer and the IRS.

Notwithstanding this procedural improvement, timely filing remains essential. Reasonable cause is applied narrowly, and the IRS has specifically stated that a foreign country’s penalties for disclosure, reluctance by a foreign trustee to provide information, and trust instrument provisions restricting disclosure do not constitute reasonable cause.

Coordination with Tax Professionals

The complexity of foreign trust reporting makes experienced professional assistance essential. Most CPAs do not routinely prepare Forms 3520 and 3520-A, and general practitioners may lack familiarity with the specific issues these forms raise.

Effective compliance requires a CPA with specific experience in foreign trust reporting, early coordination with the Cook Islands trustee to gather financial data (beginning in January or February to meet the March 15 Form 3520-A deadline), and coordination between the CPA and trustee to ensure Form 3520-A information reconciles with the grantor’s Form 1040.

The trustee prepares much of the underlying data for Form 3520-A, including the trust income statement, balance sheet, and account information. The U.S. CPA uses this data to complete the form, prepare the grantor statement, and ensure consistency with the individual return.

Because grantor trust income flows through to the grantor’s Form 1040, the grantor must make quarterly estimated tax payments covering trust income. Investment income earned by the trust creates taxable income for the grantor whether or not any distributions are made, and failure to pay estimated taxes results in underpayment penalties and interest.

Annual Filing Summary

For a typical Cook Islands grantor trust, the U.S. grantor files the following forms each year:

Form 3520 is due April 15 (or October 15 with extension) and is attached to Form 1040. It reports the grantor’s ownership of the foreign trust, any transfers made during the year, and attaches the Foreign Grantor Trust Owner Statement from Form 3520-A.

Form 3520-A is due March 15 (or September 15 with extension) and is filed separately. It provides the trust’s income statement, balance sheet, and account details, and generates the statements furnished to the U.S. owner and beneficiaries.

FinCEN Form 114 (FBAR) is due April 15 (automatically extended to October 15) and is filed electronically through the BSA E-Filing System. It reports all foreign financial accounts over which the grantor has authority or a financial interest.

Form 8938 is due with Form 1040 and is attached to the income tax return. It reports specified foreign financial assets exceeding the applicable threshold.

In addition, the grantor reports all trust income on Form 1040 (Schedule B for interest and dividends, Schedule D for capital gains, and other applicable schedules) and completes Schedule B Part III indicating the existence of a foreign trust.

These forms report overlapping information through different channels to different agencies. The redundancy is intentional. Each form serves a different statutory purpose and carries independent penalties for non-filing.

For detailed treatment of individual forms, see Forms 3520 and 3520-A and FBAR requirements. For the broader compliance framework, return to the compliance overview. For comprehensive information about Cook Islands trust structure and implementation, see the Cook Islands trust overview.