A Civil Form 3520 Noncompliance Penalty Can be Substantial

A Civil Form 3520 Noncompliance Penalty Can be Substantial

Civil Form 3520 Noncompliance Penalties 

It is very common for U.S. taxpayers across the globe who are U.S. citizens, lawful permanent residents, or foreign nationals who need the substantial presence test to receive a gift or inheritance from a foreign person — or distributions out of a foreign trust, and/or may even have ownership or partial ownership of the assets of a foreign trust. In any one of these types of situations — as well as some additional less common situations — taxpayers may have to file a Form 3520, Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts. It is important to note, that Form 3520 does not necessarily relate to income per se. Many taxpayers are required to file Form 3520 simply because they received a gift or inheritance from a foreign person (even a foreign parent or grandparent), which is not categorized as income for U.S. tax purposes. Unfortunately, the Internal Revenue Service has significantly increased enforcement of form 3520 penalties. Ever since the IRS modified the DIIRSP in 2020, the number of taxpayers who were assessed Form 3520 penalties has increased significantly. Let’s take a brief look at what type of civil penalties taxpayers may have to face if they are issued a Form 3520 fine.

Trust Penalties Section 6677

Internal Revenue Code section 6677 refers to the failure to file information with respect to certain foreign trusts. These penalties can be significant, especially depending on the value of the trust.

26 U.S.C. Section 6677

• • • (a) Civil penalty

      • In addition to any criminal penalty provided by law, if any notice or return required to be filed by section 6048—

        • (1) is not filed on or before the time provided in such section, or

        • (2) does not include all the information required pursuant to such section or includes incorrect information, the person required to file such notice or return shall pay a penalty equal to the greater of $10,000 or 35 percent of the gross reportable amount.

        • If any failure described in the preceding sentence continues for more than 90 days after the day on which the Secretary mails notice of such failure to the person required to pay such penalty, such person shall pay a penalty (in addition to the amount determined under the preceding sentence) of $10,000 for each 30-day period (or fraction thereof) during which such failure continues after the expiration of such 90-day period. At such time as the gross reportable amount with respect to any failure can be determined by the Secretary, any subsequent penalty imposed under this subsection with respect to such failure shall be reduced as necessary to assure that the aggregate amount of such penalties do not exceed the gross reportable amount (and to the extent that such aggregate amount already exceeds the gross reportable amount the Secretary shall refund such excess to the taxpayer).

As provided by the IRS:

• • • “Penalties Section 6677. A penalty applies if Form 3520 is not timely filed or if the information is incomplete or incorrect (see below for an exception if there is reasonable cause). Generally, the initial penalty is equal to the greater of $10,000 or the following (as applicable).

      • 35% of the gross value of any property transferred to a foreign trust for failure by a U.S. transferor to report the creation of or transfer to a foreign trust in Part I.

      • 35% of the gross value of the distributions received from a foreign trust for failure by a U.S. person to report receipt of the distribution in Part III.

      • 5% of the gross value of the portion of the foreign trust’s assets treated as owned by a U.S. person under the grantor trust rules (sections 671 through 679), if the foreign trust (a) fails to file a timely Form 3520-A and furnish the required annual statements to its U.S. owners and U.S. beneficiaries, or (b) does not furnish all of the information required by section 6048(b) or includes incorrect information.

      • If a foreign trust fails to file Form 3520-A, the U.S. owner must complete and attach a substitute Form 3520-A to the U.S. owner’s Form 3520 by the due date of the U.S. owner’s Form 3520 (and not the due date for the Form 3520-A, which is otherwise due by the 15th day of the 3rd month after the end of the trust’s tax year) in order to avoid being subject to the penalty for the foreign trust’s failure to timely file Form 3520-A.

      • For example, a substitute Form 3520-A that, to the best of the U.S. owner’s ability, is completed and attached to the U.S. owner’s Form 3520 by the due date for the Form 3520 (such as April 15 for U.S. owners who are individuals), is considered to be timely filed. See section 6677(a) through (c) and the instructions for Part II of this form and Form 3520-A. Additional penalties will be imposed if the noncompliance continues for more than 90 days after the IRS mails a notice of failure to comply with the required reporting. If the IRS can determine the gross reportable amount (defined later), then the penalties will be reduced as necessary to assure that the aggregate amount of such penalties does not exceed the gross reportable amount. For more information, see section 6677.”

Foreign Gift or Inheritance Penalties

The penalties related to section 6039F refer to foreign gifts and specifically notice of large gifts received from foreign persons.

26 U.S.C. Section 6039F

• • • (a) In general

      • If the value of the aggregate foreign gifts received by a United States person (other than an organization described in section 501(c) and exempt from tax under section 501(a)) during any taxable year exceeds $10,000, such United States person shall furnish (at such time and in such manner as the Secretary shall prescribe) such information as the Secretary may prescribe regarding each foreign gift received during such year.

    • (b) Foreign gift

      • For purposes of this section, the term “foreign gift” means any amount received from a person other than a United States person which the recipient treats as a gift or bequest. Such term shall not include any qualified transfer (within the meaning of section 2503(e)(2)) or any distribution properly disclosed in a return under section 6048(c)

    • (c) Penalty for failure to file information

      • (1) In general

        • If a United States person fails to furnish the information required by subsection (a) with respect to any foreign gift within the time prescribed therefor (including extensions)—

          • (A) the tax consequences of the receipt of such gift shall be determined by the Secretary, and

          • (B) such United States person shall pay (upon notice and demand by the Secretary and in the same manner as tax) an amount equal to 5 percent of the amount of such foreign gift for each month for which the failure continues (not to exceed 25 percent of such amount in the aggregate).

As further provided by the IRS:

• • • ” In the case of a failure to timely report foreign gifts described in section 6039F, the IRS may determine the income tax consequences of the receipt of such gift, and a penalty equal to 5% of the amount of such foreign gifts applies for each month for which the failure to report continues (not to exceed a total of 25%). No penalty will be imposed if the taxpayer can demonstrate that the failure to comply was due to reasonable cause and not willful neglect. See section 6039F for additional information.”

Accuracy-Related Penalties

The penalties relating to section 6662 are different and refer specifically to the imposition of accuracy-related penalties on underpayments. 

26 U.S.C. Section 6662(j)

• • • (j) Undisclosed foreign financial asset understatement 

      • (1) In general

        • For purposes of this section, the term “undisclosed foreign financial asset understatement” means, for any taxable year, the portion of the understatement for such taxable year which is attributable to any transaction involving an undisclosed foreign financial asset.

      • (2) Undisclosed foreign financial asset

        • For purposes of this subsection, the term “undisclosed foreign financial asset” means, with respect to any taxable year, any asset with respect to which information was required to be provided under section 6038, 6038B, 6038D, 6046A, or 6048 for such taxable year but was not provided by the taxpayer as required under the provisions of those sections.

      • (3) Increase in penalty for undisclosed foreign financial asset understatements

        • In the case of any portion of an underpayment which is attributable to any undisclosed foreign financial asset understatement, subsection (a) shall be applied with respect to such portion by substituting “40 percent” for “20 p

As further provided by the IRS:

• • • “If a U.S. owner of a foreign trust is subject to a penalty imposed under section 6662 for an underpayment of tax required to be shown on a return, then such penalty may be increased under section 6662(j) for any portion of an underpayment which is attributable to any transaction involving any asset with respect to which information was required to be provided on Form 3520-A. For more information about undisclosed foreign financial asset understatements, see section 6662(j). No penalty will be imposed with respect to any portion of an underpayment if the taxpayer can demonstrate that the failure to comply was due to reasonable cause with respect to such portion of the underpayment and the taxpayer acted in good faith with respect to such portion of the underpayment. See section 6662 and section 6664(c) for additional information.”

Reasonable Cause and Offshore Disclosure

It is important to note, that some taxpayers may be able to avoid or abate any foreign trust or foreign gift/inheritance penalties they received in accordance with IRS Form 3520, by proving to the Internal Revenue Service that the noncompliance was due to reasonable cause and not willful neglect. For taxpayers who do not qualify for the reasonable cause exception, they may still be able to minimize or even eliminate penalties if they qualify for one of the offshore disclosure programs such as the streamlined foreign offshore procedures.

Late Filing Penalties May be Reduced or Avoided

For Taxpayers who did not timely file their international information-related reporting forms, the IRS has developed many different offshore amnesty programs to assist taxpayers with safely getting into compliance. These programs may reduce or even eliminate international reporting penalties.

Current Year vs Prior Year Non-Compliance

Once a taxpayer missed the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, taxpayers should consider speaking with a Board-Certified Tax Law Specialist who specializes exclusively in these types of offshore disclosure matters.

Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)

In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful Taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties. 

Need Help Finding an Experienced Offshore Tax Attorney?

When it comes to hiring an experienced international tax attorney to represent you for unreported foreign and offshore account reporting, it can become overwhelming for taxpayers trying to trek through all the false information and nonsense they will find in their online research. There are only a handful of attorneys worldwide who are Board-Certified Tax Specialists and who specialize exclusively in offshore disclosure and international tax amnesty reporting. 

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure. 

Contact our firm today for assistance.