Form 3520 Penalty Abatement
Abatement of a 3520 Penalty: When it comes to the IRS and international information reporting penalties, the Form 3520 is one of the worst penalties the IRS can issue. Primarily, it is because the taxpayer is oftentimes blindsided by the penalty since it does not stem from unreported income or undisclosed FATCA or FBAR assets. Rather, the U.S. person usually just received a gift from a foreign individual or entity — or otherwise conducted transactions (or has a beneficial interest in) a foreign trust. The form 3520 penalty can be staggering, and oftentimes clocks in at 25% value of the unreported gift from a foreign person. For example, if you received an $800,000 gift, you would be staring down the barrel of a $200,000 penalty. But, you may be able to abate the penalty by using form 3520 abatement procedures. Depending on whether the penalty resulted from a gift or trust may impact the ability to qualify for certain exemptions, such as Revenue Procedure 2020-17 – which is limited to tax deferred retirement and non-retirement trusts.
Example of 3520 Penalty
Let’s take a common example we see often: Maria is a US person Legal Permanent Resident who is originally from Portugal. Maria has relatives in Portugal, including her sweet grandma. While her grandma refuses to admit it, everyone in the family knows Maria is her favorite grandchild. Grandma is so proud of Maria that she gifted her $600,000 as a congratulation for finishing medical school and her final year of residency.
A quick Google search revealed to Maria that unless certain exceptions apply (which year they did not in Maria’s scenario), a gift received from a foreign person is not taxable in the US. Also, she does not have to file a form 709 gift tax return.
Gift Reporting & Form 3520 Penalty Abatement
Maria gets hired as a physician and her income goes up significantly. She used her grandma’s gift as a down payment on a home and has some deductions and expenses, but is unsure how the new tax rules work.
Therefore, Maria goes to a CPA. The CPA reviews the information and tax history and realizes that the foreign gift should have been reported on a form 3520.
Reasonable Cause Letter to Abate Penalties
Maria’s first defense is a Reasonable Cause letter to abate form 3520 penalties. These letters should be at least three-to-four pages and contain significant amount of facts and law sufficient to show Maria acted with reasonable cause and not willful neglect.
Unfortunately, the CPA put together a short 1/2 page statement that did not sufficiently show reasonable cause.
That is not to say that a well-written and artful letter will automatically negate penalties, but it will help to put Maria in a better position and help preserve her rights down the line to show that she had proved the reasonable cause from the outset.
A few months later, Maria receives a CP-15 notice from the IRS.
The notice tells Maria that she has been penalized 25% value of the gift. The 25% represents a 5% per month penalty up to a maximum 25% value of the gift. Even though Maria has been issued a penalty, she still has various tools at her disposal to try to qualify for a penalty abatement.
At this time, she should consider speaking with an experienced board-certified tax specialist who specializes in offshore tax matters to help walk her through the different options she may have available.
Here are some of the different tools that may be available to her depending on which avenue she takes:
- Protest/Appeal to the IRS (and Second follow-up if initial letter rejected)
- Form 843 Penalty Abatement/Refund
- CAP (Collection Appeal Program)
- CDP (Collection Due Process Hearing)
- Tax Court (Limited)
- Federal Court
3520 Penalty Abatement vs. Collection
There are two main aspects to the penalty: On the one hand, Maria wants to abate the penalty entirely. On the other hand, Maria also wants to slow down/limit enforcement. If the outcome of the initial response to the CP-15 notice is not successful (or it takes very long), she may receive a 504 notice, and then subsequent letters threatening liens, levies and worse.
It is important to note that by selecting certain options in replying to the collection enforcement, it will negate the ability to pursue other avenues and limit Tax Court — so it is important that Maria understands the different options she has available to her (pros and cons) before submitting to the IRS in response to the notices she receives re: Form 3520 Penalty.
In conclusion, the form 3520 is one of the most commonly issued penalties for matters involving foreign transactions. It is a completely unfair penalty, because oftentimes it merely involves a gift from a relative and there is no unreported income or undisclosed foreign accounts or assets. But the taxpayer may have an opportunity to abate the penalty using various methods available by the IRS or court.
Golding & Golding: About our International Tax Law Firm
Golding & Golding specializes exclusively in international tax, and specifically IRS offshore disclosure and Form 3520 penalty abatement.
Contact our firm today for assistance.