Form 3520: In recent years, the Internal Revenue Service has significantly increased the enforcement for the reporting of foreign gifts and trusts. When a US person receives a large gift from a foreign person or has certain transactions with a foreign trust — they may become subject to reporting requirements on Forms 3520 and/or 3520-A. These forms are not necessarily used for tax purposes as much as they are used for reporting the existence of a gift, inheritance, or trust from a foreign person. Since the IRS has been routinely issuing penalties for noncompliance with this reporting requirement, we want to summarize some important facts about reporting Form 3520.
What is Form 3520?
Form 3520 is used by US persons who receive a gift or inheritance from a foreign person — or have certain transactions with a foreign trust. In a very common situation, a US person may have simply received a gift from their parents who are nonresident aliens. Even if the gift was used to assist the US person with purchasing a home or incidentals while they’re in school — it is reportable. When it comes to trusts, it is important to note that the US person may have a requirement to file Form 3520 even if they do not receive any distributions.
Tax Return Requirement
Even if a US person is not required to file a tax return because they are below the threshold, they may still be required to file a Form 3520 if they meet any of the requirements for filing. This is a common theme with international reporting forms such as Form 5471 or 8865 which also requires the US person to file the form even if they do not have to file a tax return during the year.
Who Has to File Form 3520?
The 3520 form is required by US persons. Therefore, when it comes to individuals, this primarily involves reporting by US citizens, Legal Permanent Residents, and foreign nationals who meet the Substantial Presence Test — and are therefore considered US persons for income tax purposes.
When Is Form 3520 Due?
Generally, the Form 3520 is filed by the April 15th due date. If a person resides outside of the United States and their tax return is due in June, then they have until June to file the Form 3520. If a person wants to go on extension to file their tax return, then the 3520 filing goes on extension as well. Unlike Form 3520-A, the Form 3520 does not require the filing of Form 7004 for extension.
Where Is Form 3520 Filed?
The Form 3520 is filed in Ogden, UT.
Internal Revenue Service Center
P.O. Box 409101
Ogden, UT 84409
What Is the Threshold for Gifts From Foreign Individuals?
When a US person receives a gift from one foreign person individual and the value of the gift (or total value of all the gifts from that same person in the same year) exceeds $100,000, the US person must file a Form 3520. (Keep in mind that if you have your mom in China give you 10 gifts of $99,000 from 10 different people, that is still considered coming from a single person and Form 3520 is required. See below regarding “Related Party Rules.”)
Threshold for Foreign Gifts From Foreign Entities
When a US person receives a gift from a foreign person entity and the value of the gift (or total value of all the gifts from that same person in the same year) exceeds $16,649, the US person must file a form 3520.
Threshold For Distributions from Foreign Trusts
There is no specific threshold when it comes to reporting trust distributions. Thus, if the US person receives any distribution from a foreign trust, then that distribution is reportable on Form 3520.
Related Party Rules
Related parties refers to receiving gifts from foreign persons who are “related.” With the related party rules and Form 3520, it means that if certain people who give the gift are related, then the value of the gift that each related person gives, is combined into an aggregate total. The purpose of this rule is to avoid related parties who had the intent to give the same person a large gift from splitting the gift to avoid the US person from having to report it.
Currency Restrictions and Multiple Parties Giving Gifts
Many countries have currency restrictions when it comes to transferring money outside of the country. Let’s use an example – Kenneth in the US receives a $500,000 gift from his dad in Taiwan. But, his dad had to ask 10 friends to each transfer $50,000 to Kenneth — in order to avoid the currency restrictions. Even though each person only transferred $50,000, and they may not be related — the gift came from Kenneth’s dad, and so the Form 3520 would still be required.
Does the US Tax the Gift?
This can get very complicated. From a baseline perspective, the mere gift from a non-resident foreign person to a US person in and of itself is not taxable. If the non-resident alien is transferring/gifting US real property interest, then the gift portion may become taxable depending on various factors.
Transferring Property To a Foreign Trust
The rules involving foreign trusts in Form 3520 are much more complicated than the foreign gift rules. If a person transfers property to a trust — which can include cash to a related foreign trust or a person related to the trust — the reporting rules kick-in. The rules involving what is considered a related trust/or person related to the trust are very broad.
Beneficiary Received a Trust Distribution
If a US person beneficiary receives a distribution from the foreign trust, then that distribution would require the US person to report the information on Form 3520.
Is the Trust Distribution Taxable?
Typically, with a foreign grantor trust, it is the grantor and not the beneficiary who is taxed on the income. Therefore, if a beneficiary receives a distribution from a grantor trust, it is generally not taxable to the US beneficiary. Conversely, if it is a non-grantor trust, then the distribution to the beneficiary is generally taxable.
Owner of a Foreign Trust
If a person has an ownership or beneficial interest in a foreign trust, they are required to report that information on Form 3520.
Is a Foreign Pension Considered a Trust?
Typically, a foreign pension is considered a trust, because there is a Grantor/Owner, an Administrator, and a Beneficiary.
Are All Foreign Pensions Reportable on Form 3520?
Yes, unless an exception or exclusion applies. While there is no specific rule that exempts all foreign pensions from being reported on Form 3520, there is a Revenue Procedure that excludes RRSP — which is one of the most common types of pension schemes (held in Canada). In addition, the IRS recently released Revenue Procedure 2020-17.
What Is Revenue Procedure 2020-17?
Instead of trying to carve out an exception for each and every type of foreign pension, the IRS promulgated Revenue Procedure 2020-17. The purpose of this Revenue Procedure is to exempt certain foreign tax-deferred trusts and certain tax-deferred retirement trusts from reporting. The problem with the Rev. Proc. is that the way the Revenue Procedure is written, it is unclear whether some of the more common foreign pensions meet the requirements for exemption.
Are There Penalties for Not Filing Form 3520?
Of course. The IRS does love itself some penalties, and especially in the world of international information reporting. Form 3520 penalties are unnecessarily high in relation to the violation — and oftentimes are “automatically assessed.”
What Is the Penalty for Foreign Gifts?
When it comes to foreign gifts, the penalty is absurd. It is typically 5% of the unreported gift but — the 5% accrues per month and most clients do not realize they were supposed to be reporting this form until several months have passed. The maximum threshold for the penalty is 25% of the value of the gift. It is not uncommon for taxpayers who received seven-figure gifts to also receive six- or seven-figure penalties.
What Is the Penalty for Foreign Trusts?
The penalties for foreign trusts vary based on whether there is a distribution or not and what the value of the trust is.
As provided by the IRS:
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.
Can the Penalty Be Appealed or Abated?
Yes, penalties can be abated but the process can be difficult. It is typically easier to try to avoid the penalty than to try to get the penalty removed. But, with the recent transition of the Delinquency Procedures back into a traditional Reasonable Cause submission — it is important to make sure taxpayers have their ducks in a row before moving forward and presenting their position to the IRS.
Foreign Gifts, Inheritances, and Trusts are Being Targeted
The IRS has made compliance issues involving US persons receiving large gifts or having certain transactions with foreign trusts, a key enforcement priority. It is important for taxpayers to remain in compliance with these reporting rules and if they are not in compliance already, to consider doing so.
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