- 1 Mitigating Form 3520 Penalties
- 2 Can Taxpayers Use Rev. Proc 2020-17 to Abate Foreign Gift Penalties?
- 3 Form 3520 & Mitigating Form 3520 Penalties
- 4 Reasonable Cause & Penalty Abatement
- 5 Reasonable Cause, Streamlined or Voluntary Disclosure?
- 6 CP 15 Notice & Mitigating Form 3520 Penalties
- 7 International Tax Law Specialist Team: Golding & Golding
Mitigating Form 3520 Penalties
Mitigating Form 3520 Penalties: When a U.S. person receives a gift from a foreign person or has certain transactions (ownership, loans contributions, or distributions) the U.S. person may have to report the foreign to the IRS on Form 3520. The most common 3520 penalties are for large gifts. Whether or not the person has to file a 3520 is determined by the type of foreign person (individual or entity) and the value of the gift. In recent years, the IRS has significantly increased the issuance of Form 3520 penalties. The avenues opened for the Taxpayer to respond to the Form 3520 penalty will depend on how the penalty was issued.
Let’s review the basics of the the Form 3520 Penalty Abatement:
- Was it issued during an audit or examination?
- Did the Taxpayer receive a CP15 Notice?
- Has the Taxpayer already filed an appeal/protest of the penalty?
- Has a Final Notice of Levy or Lien been issued?
- Was a CDP (12153) or CAP (9423) issued?
- Did the Taxpayers receive a NOD Letter (Notice of Deficiency)
Let’s review the basics of mitigating Form 3520 penalties.
Can Taxpayers Use Rev. Proc 2020-17 to Abate Foreign Gift Penalties?
The Form 3520 is used to report foreign trust transactions, gifts and inheritances.
The Form 3520-A is used to report foreign trusts. The recently released revenue procedure 2020-17 refers to certain retirement and non-retirement trust reporting that may be exempted on Form 3520/3520-A.
It also provides an avenue to for penalty relief on previously issued penalties for these specific types of foreign trusts (not gifts). When the form for receipt of a foreign gift is not filed timely, the IRS can (and does) issue penalties. These penalties can be relatively severe. When it comes to the foreign gift and inheritance reporting under form 3520, the average penalty hovers around 25% of the value of the gift/inheritance.
Simple Form 3520 Example
Nicole is a new University graduate who is originally Taiwan. Her Taiwanese foreign parents sent her a gift of $1 million to purchase a home for herself and for her parents staying when they visit her in the U.S.. Nicole does not have any foreign bank accounts, assets or investments, and therefore was unaware of any international reporting requirements.
To Nicole, the money is just a gift from her parents.
Nevertheless, Nicole can be penalized $250,000 for not reporting the gift money on form 3520.
Form 3520 & Mitigating Form 3520 Penalties
The IRS penalties for untimely reporting of gifts from foreign persons can be brutal. The penalty is 5% per period, up to a total of 25% of the value of the gift. Since most people do not learn of the form and file it for several months after the due date, the 25% penalty is the norm.
“Penalties 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) for failure by the U.S. person to report the U.S. owner information in Part II.
Such U.S. person is subject to an additional separate 5% penalty (or $10,000 if greater), if such person
(a) fails to ensure that the foreign trust files a timely Form 3520-A and furnishes 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 additional separate penalty for the foreign trust’s failure to 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 value (defined later) of the portion of the trust’s assets treated as owned by the U.S. person at the close of the tax year, then the additional penalties will be reduced as necessary to assure that the aggregate amount of such penalties do not exceed the gross value of the trust. For more information, see section 6677.”
Reasonable Cause & Penalty Abatement
The IRS provides an exception to penalties, if the filer can show Reasonable Cause. Draft an effective reasonable cause statement for 3520 is hard. Due to the nature and severity of the penalty, you may consider reaching out to a Board-Certified Tax Specialist for assistance for these types of matters.
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, Streamlined or Voluntary Disclosure?
When a person does not have any unreported income or other assets associated foreign reporting, the reasonable cause or “delinquency” option is generally preferred — noting that delinquency (DIIRSP) was discontinued in 2020 — although reasonable cause is still a viable option. Depending on whether the client has additional reporting, along with the specific facts and circumstances of their situation it may benefit them greatly to submit a streamlined or voluntary disclosure submission.
That is not to say that just by submitting a solid reasonable cause package to the IRS will guarantee a penalty waiver — but a well-written submission package greatly increases the client’s chances of a successful outcome.
CP 15 Notice & Mitigating Form 3520 Penalties
If you are in the unfortunate position of already having been penalized, either through audit or more commonly by having received a IRS CP15 notice, there is a different submission process required, and generally time is of the essence. The CP15 notice provides the Taxpayer with limited time to apply for a penalty abatement for foreign gifts.
International Tax Law Specialist Team: Golding & Golding
Our firm specializes exclusively in international tax, and specifically IRS offshore disclosure, including help clients with late reporting of Forms 3520 and 3520-A and Form 3520 Foreign Gift Penalty Abatement.
Contact our firm today for assistance.