What Happens if You Fail to Report Foreign Trusts to the IRS?

Failure-to-File Penalty for Foreign Trust Penalties

Failure-to-File Penalty for Foreign Trust Penalties 

In recent years, the Internal Revenue Service has significantly increased enforcement of the  Form 3520-A Reporting Requirements. Under the Internal Revenue Code (Section 6677), US Person Taxpayers who have ownership of a foreign trust are required to report Form 3520-A to disclose their interest in the foreign trust. In addition, if certain transfers have been made into the trust or other transactions are taking place, additional reporting may be required as well. For some individuals who have a foreign trust by default such as a retirement trust (or another type of tax-deferred trust in their foreign country), they may be able to rely on a more recent Revenue Procedure to try to avoid or eliminate penalties. Even to the IRS, it became apparent that certain Form 3520-A reporting was unfair and over burdensome for tax-deferred retirement and non-retirement trusts that were already being disclosed on other international reporting forms such as the FBAR and Form 8938. There are various ways in which a Taxpayer may be able to remove or abate a Form 3520-A foreign trust penalty. Let’s review the basics of the failure-to-file penalty for foreign trusts.

Revenue 2020-17 or 2014-55 & Failure-to-File Penalty

In 2020, the Internal Revenue Service released Revenue Procedure 2020–17. The purpose of this revenue procedure is to assist Taxpayers in avoiding the duplicative nature of reporting a foreign trust on Forms 3520 and 3520-A after having already reported this information and other forms such as the FBAR and FATCA Form 8938. This Revenue Procedure refers specifically to tax-deferred retirement and non-retirement trusts in foreign countries. If a person qualifies under Revenue Procedure 2020–17, they may be able to avoid the duplicative reporting — and if a penalty has already been issued, they may be able to waive that penalty. One caveat with Revenue Procedure 2020–17 is that it does not identify which specific foreign tax-deferred trusts qualify for the exclusion.

Conversely, previous Revenue Procedure 2014–55 specifically exempts Canadian RRSPs from reporting on Form 3520/3520-A.

5 Key Facts About Form 3520-A Penalty

Unfortunately, the Internet is littered with self-proclaimed expert attorneys who unnecessarily fear-monger already scared taxpayers about the process and what can happen if they are non-compliance – without explaining to them that oftentimes, the penalty can be removed or abated – if not avoided.

Let’s go through five important facts about the failure-to-file penalty for foreign trusts in accordance with Form 3520-A:

Preemptive Reasonable Cause Not Willful Neglect

If a Taxpayer realizes that they are late in filing a Form 3520-A, the first and best line of defense is to preemptively avoid the penalty by submitting a reasonable cause statement to explain the delinquency. If the Taxpayer can show reasonable cause and non-willful neglect in the noncompliance, they may be able to avoid any penalty being issued.

Form 3520-A Abatement (Protest Letter)

If the Taxpayer gets assessed with a Form 3520-A penalty, they will generally receive notice by way of a CP-15 Notice. The notice provides the Taxpayer with 30 days to protest the penalty and to explain why the Taxpayer has a Reasonable Cause. Taxpayers should focus on presenting the “Totality of the Circumstance” in preparing a persuasive letter to the IRS as to why penalties should be removed. If they also qualify for the penalty removal procedures under Revenue Procedures 2020–17, that should be set forth in the reasonable cause letter.

Appealing Form 3520-A Failure-to-File Penalty

If the Taxpayer’s initial protest is rejected, they may have the opportunity to submit an appeal or submit a supplemental reasonable cause letter. The process of submitting a supplemental reasonable cause letter is different than submitting an appeal. With the appeal, the Taxpayer may lose the opportunity to pursue the matter in Tax Court, except under very limited circumstances –– but the result is binding on both parties (Taxpayer and IRS), so it is important that the Taxpayer assess the different options with an experienced Board-Certified Tax Law Specialist who specializes in international tax matters, before moving forward.

Collection Due Process Hearing

In some circumstances, it may benefit the Taxpayer to pursue a Collection Due Process Hearing before a “Settlement Officer” in order to try to resolve the Form 3520-A penalty issue. There are many potential issues to consider when deciding whether or not a Taxpayer should wait until a Collection Due Process hearing is ripe — not the least being the IRS may first issue a Notice of Federal Tax Lien against the Taxpayer.

Tax Court or Federal Court for the Failure-to-File Penalty for Foreign Trust

Depending on which path the Taxpayer chooses in order to try to remove the Form 3520-A penalty, they may have the opportunity to take the matter to Federal Court or Tax Court. With Federal Court, the Taxpayer generally has to pay the penalty first, then claim a refund from the IRS. When the refund claim is rejected, then file a claim in Federal Court.

Golding & Golding: About Our International Tax Law Firm

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

Contact our firm for assistance with getting compliant.