Foreign Trust Distributions Threshold and Form 3520

Foreign Trust Distributions Threshold and Form 3520

Foreign Trust Distributions Threshold and Form 3520

Foreign Trust Distributions Threshold and Form 3520: When it comes to US persons and IRS Form 3520, reporting issues involving distributions from foreign trusts make reporting the form more complicated than other issues involving receipt of a large gift from a foreign person. In fact, while there are specific threshold requirements when a person receives a gift from either a foreign individual or foreign corporation/entity — there is no threshold requirement when it comes to US persons reporting foreign trust distributions. In other words, if a US person receives a distribution from a foreign trust, they have to their report the distribution on Form 3520 — whether or not the distribution is high-dollar or de minimis.

Reporting Foreign Trust Distributions Threshold on Form 3520

In a common situation, a US person beneficiary may receive a distribution from a foreign trust. It can be a foreign trust owned by a foreign relative — even a parent — in which the US person  (not necessarily a US citizen but possibly a Lawful Permanent Resident or foreign national who meets the substantial presence test) receives the foreign trust distribution.

It doesn’t even have to be that complicated. It can literally be just as simple as a foreign parent who has a trust in New Zealand for New Zealand tax purposes and instead of giving a gift individually from the parent, the parent distributes the gift from the trust. While it may have no impact under New Zealand tax law — under US tax rules, the US person must report the trust distribution.

As provided by the Form 3520:

      • You are (a) a U.S. person (including a U.S. owner) or an executor of the estate of a U.S. person who, during the current tax year, received, directly or indirectly, a distribution from a foreign trust.

Penalties for Not Reporting Trust Distributions on Form 3520

In order to motivate you to be compliant, the Internal Revenue Service aggressively enforces penalties against US persons who do not properly report form 3520.

The penalties are broken down as follows:

      • 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.

Reasonable Cause to Avoid 3520 Penalties

When the filer is able to show that their failure to comply was reasonable, then they can show reasonable cause to avoid penalties:

      • “No penalties will be imposed if the taxpayer can demonstrate that the failure to comply was due to reasonable cause and not willful neglect.”

Form 3520 Trust Distribution Compliance is Important

In conclusion, IRS Form 3520 is an important international information reporting form that is used by US Persons to report certain transactions with foreign persons and foreign trusts. When a US person receives a trust distribution from a foreign trust, then they are required to report the distribution on Form 3520 — and there is no threshold reporting requirement as there is for the receipt of large gifts from foreign persons, which must be large enough to meet the threshold for filing Form 3520.

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