Reasonable Cause Form 3520 Reporting: Post-DIIRSP Update

Reasonable Cause Form 3520 Reporting (New) 2020

Reasonable Cause Form 3520 Reporting Update

Form 3520 Reasonable Cause: When a US Person has ownership or interest in a foreign trust, receives a large gift from a foreign person, or engages in other transactions with a foreign trust — they may have a Form 3520 reporting requirement, Technically, Form 3520 refers to the Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts. With the Internal Revenue Service recently ending DIIRSP (Delinquency International Information Return Submission Procedures), Taxpayers have limited avenues available for avoiding a Form 3520 penalty from being issues — or seeking the abatement of an IRS Form 3520 penalty. Using reasonable cause for Form 3520 has several components to it that operate simultaneously.

Timing Reasonable Cause and Form 3520

How to approach a reasonable cause Form 3520 issue depends on which phase the Taxpayer is in with the process.

For example, is it:

• • • prior to penalty being issued;

    • in response to the initial CP15 Notice

    • a subsequent submission after the initial appeal is rejected

    • CDP Request (12153)

In recent years, the IRS has increased the enforcement of Form 3520 penalties — even going so far as issuing automatic penalties. In a very common foreign gift or trust situation, a foreign person who is in the U.S. on a Student or Work Visa (or is a Legal Permanent Resident) receives a gift from a foreign person. The gift may be money, bank accounts, assets or other investments. The U.S. Person learns months or years later that they were required to file Form 3520 to report the gift. In response, they file an inadequate reasonable cause letter and get dinged with penalties (While a well-written and thorough tax/legal reasonable cause statement will increase the chance of avoiding penalties, it does not guarantee the penalty waiver from the outset — and there are still several avenues the Taxpayer can pursue.) 

What are the Form 3520 Penalties?

The IRS penalties are found in multiple locations in the Internal Revenue Code.

IRC 6039F Foreign Gift

As provided by the IRS:

• • • (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).

    • (2) Reasonable Cause Exception

      • Paragraph (1) shall not apply to any failure to report a foreign gift if the United States person shows that the failure is due to reasonable cause and not due to willful neglect. (d)Cost-of-living adjustment In the case of any taxable year beginning after December 31, 1996, the $10,000 amount under subsection (a) shall be increased by an amount equal to the product of such amount and the cost-of-living adjustment for such taxable year under section 1(f)(3), except that subparagraph (A)(ii) thereof shall be applied by substituting “1995” for “2016”. (e)Regulations The Secretary shall prescribe such regulations as may be necessary or appropriate to carry out the purposes of this section.

    • (d) Cost-of-Living Adjustment

      • In the case of any taxable year beginning after December 31, 1996, the $10,000 amount under subsection (a) shall be increased by an amount equal to the product of such amount and the cost-of-living adjustment for such taxable year under section 1(f)(3), except that subparagraph (A)(ii) thereof shall be applied by substituting “1995” for “2016”.

    • (e) Regulations

      • The Secretary shall prescribe such regulations as may be necessary or appropriate to carry out the purposes of this section.

IRC 6048

As provided by the IRS (in pertinent part):

• • • “(a) Notice of Certain Events

      • (1) General rule On or before the 90th day (or such later day as the Secretary may prescribe) after any reportable event, the responsible party shall provide written notice of such event to the Secretary in accordance with paragraph (2).

    • (2) Contents of Notice

      • The notice required by paragraph (1) shall contain such information as the Secretary may prescribe, including— (A)the amount of money or other property (if any) transferred to the trust in connection with the reportable event, and (B)the identity of the trust and of each trustee and beneficiary (or class of beneficiaries) of the trust.

    • (3) Reportable Event

      • For purposes of this subsection—

    • (A) In general The term “reportable event” means—

      • (i) the creation of any foreign trust by a United States person,

      • (ii) the transfer of any money or property (directly or indirectly) to a foreign trust by a United States person, including a transfer by reason of death, and

      • (iii) the death of a citizen or resident of the United States if—

        • (I) the decedent was treated as the owner of any portion of a foreign trust under the rules of subpart E of part I of subchapter J of chapter 1, or

        • (II) any portion of a foreign trust was included in the gross estate of the decedent.

    • (B)Exceptions

      • (i)Fair market value sales Subparagraph (A)(ii) shall not apply to any transfer of property to a trust in exchange for consideration of at least the fair market value of the transferred property.”

Penalties 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).”

What is Form 3520 Reasonable Cause?

The IRS provides an exception to penalties, if the filer can show Reasonable Cause:

• • • “Reasonable cause.

      • No penalties will be imposed if the taxpayer can demonstrate that the failure to comply was due to reasonable cause and not willful neglect. Note. The fact that a foreign country would impose penalties for disclosing the required information is not reasonable cause.

      • Similarly, reluctance on the part of a foreign fiduciary or provisions in the trust instrument that prevent the disclosure of required information is not reasonable cause. See section 6677(d) for additional information. Section 6039F.

      • In the case of a failure to timely report foreign gifts described in section 6039F, the IRS will 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. Section 6662(j).

      • 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 Summarized

The concept of Reasonable Cause and Not Willful Neglect involves the idea that a U.S. Person who is in violation of Form 3520 filing requirements should not be required to pay penalties for their non-compliance.  Therefore, if the account holder can prove to the Internal Revenue Service that they have reasonable cause, then the IRS may avoid, mitigate or abate (eliminate) penalties. Taxpayers have an opportunity to show reasonable cause through a well-written and highly persuasive reasonable cause statement — usually through a Board-Certified Tax Law Specialist.  There are several factors to be aware of, including the type of accounts, number of accounts, total unreported income and account values, country of origin, and its relation to the account holder — along with many other considerations.

Missed Filing Form 3520 & Reasonable Cause?

Our firm specializes exclusively in international tax, and specifically IRS offshore disclosure, including helping clients with late reporting of Forms 3520 and 3520-A and Reasonable Cause Form 3520 submissions.

Contact our firm today for assistance.