Who Must File Form 3520, Which Transactions & IRS Exceptions

Who Should File Form 3520 with IRS, Types of Transactions

Who Must File IRS Form 3520

Form 3520 has become one of the more controversial international information reporting forms that some U.S. persons must file. The reason why that form has become so mired in controversy is because oftentimes the form is filed simply for the Taxpayer to report the receipt of a large gift or inheritance from a foreign person — and there is no actual tax implication. Still, taxpayers who file the form more than five months late can become subject to a 25% penalty on the value of the unreported gift. In addition to foreign gift reporting, there are other situations in which the taxpayer may have to file Form 3520 as well, such as when they have ownership of or received a distribution from a foreign trust. Let’s first look at who must file IRS form 3520 and then look at some of the more common types of transactions involved.

Who Must File Form 3520 (Individuals)

To begin, not all taxpayers are required to file form 3520. Rather, only taxpayers who are considered U.S. persons for income tax purposes typically are required to file Form 3520 if any of the threshold requirements are met. For purposes of determining who must file form 3520, U.S. persons typically include:

• • • U.S. Citizens

    • Lawful Permanent Residents

    • Foreign Nationals who Meet the Substantial Presence Test

Thus, from a baseline perspective if a person falls into one of the above-referenced three types of categories of individuals, then they may be required to file Form 3520 in any year that the threshold requirements are met. This is also important to note that various domestic entities and trusts may also be required to file a 3520 form — but for purposes of the summary, we are focusing on individuals.

What types of transactions must be reported?

Many different types of transactions may require a taxpayer to file a Form 3520.

Receipt of Foreign Gifts and Inheritances

One of the most common scenarios that requires a taxpayer to file a Form 3520 is when the taxpayer is considered a U.S. person for tax purposes and receives a large gift or inheritance from a foreign person. This is the most common type of filing and includes when a Taxpayer receives a gift from a foreign person or related parties in the same year where the value exceeds $100,000 in that year. In other words, Taxpayer may have received $150,000 from a friend or $75,000 from a parent and $30,000 from another parent, and combined it would be $105,000 between related parties, and thus result in having to file Form 3520. In addition, if the taxpayer receives a gift from a foreign entity or related entities, they may also have to file Form 3520 if the threshold requirement is met — for entities the threshold requirement adjusts for inflation and currently hovers around $20,000.

Receipt of Foreign Trust Distributions

Unlike the receipt of a foreign gift or inheritance from a foreign person, there is no threshold requirement when it comes to foreign trust distributions. This means that if a U.S. person receives any foreign trust distribution even if it is diminished, technically they are still supposed to file Form 3520.

Ownership of a Foreign Trust

In addition to receiving distributions from a foreign trust, if the taxpayer has ownership of a foreign trust or an interest in a foreign trust, then they also have to file Form 3520 as well –and will usually have to file Form 3520-A as well.

Other Form 3520 Transactions

There are various other transactions involving a foreign trust that may require filing Form 3520 beyond just having direct ownership of the foreign trust.

As provided by the IRS:

File Form 3520 if any one or more of the following apply.

• • • You are the responsible party for reporting a reportable event that occurred during the current tax year, or you are a U.S. person who transferred property (including cash) to a related foreign trust (or a person related to the trust) in exchange for an obligation or you hold a qualified obligation from that trust that is currently outstanding. For definitions, see Responsible Party, Reportable Event, Qualified Obligation, and Person related to a foreign trust, later. Complete the identifying information on page 1 of the form and the relevant portions of Part I. See the instructions for Part I.

    • You are a U.S. person who, during the current tax year, is treated as the owner of any part of the assets of a foreign trust under the rules of sections 671 through 679. U.S. person and owner are defined later. Complete the identifying information on page 1 of the form and Part II. See the instructions for Part II. Note. You are required to complete Part II even if there have been no transactions involving the trust during the tax year. You may also be required to complete a substitute Form 3520-A, Annual Information Return of Foreign Trust With a U.S. Owner, and attach it to your Form 3520. See Penalties, later.

    • You are a U.S. person (including a U.S. owner) or an executor of the estate of a U.S. person who received, directly or indirectly, a distribution from a foreign trust during the current tax year; or you are a U.S. person who is a U.S. owner or beneficiary of a foreign trust and in the current tax year you or a U.S. person related to you received (1) a loan of cash or marketable securities (including an extension of credit) directly or indirectly from such foreign trust, or (2) the uncompensated use of trust property; or you are a U.S. person who is a U.S. owner or beneficiary of a foreign trust and in the current tax year such foreign trust holds an outstanding qualified obligation of yours or a U.S. person related to you. For definitions, see U.S. Person, Owner, Distribution, U.S. Beneficiary, and Related Person, later. Complete the identifying information on page 1 of the form and Part III. In the case of a U.S. person that is an estate, check “Executor” on line B on page 1. See the instructions for Part III.

Treaty Election or Exception to Substantial Presence

Some taxpayers who are considered U.S. persons for tax purposes still may be able to avoid having to file certain international information reporting forms if they are able to show that they meet one of the exceptions common exclusions, or limitations to filing. Two common scenarios the taxpayer may qualify for, are either the taxpayer is able to make a treaty election to be treated as a foreign person for tax purposes (although the IRS may disagree with the position) or the taxpayer qualifies for an exception to the substantial presence test such as the closer connection exception. If the Taxpayer qualifies under one of the exceptions to Substantial Presence, they would not be treated as a US person for tax purposes in that year and may be able to circumvent filing Form 3520.

Late Filing Penalties May be Reduced or Avoided

For Taxpayers who did not timely file their FBAR and other international information-related reporting forms, the IRS has developed many different offshore amnesty programs to assist taxpayers with safely getting into compliance. These programs may reduce or even eliminate international reporting penalties.

Current Year vs Prior Year Non-Compliance

Once a taxpayer missed the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, taxpayers should consider speaking with a Board-Certified Tax Law Specialist who specializes exclusively in these types of offshore disclosure matters.

Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)

In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful Taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties. 

Need Help Finding an Experienced Offshore Tax Attorney?

When it comes to hiring an experienced international tax attorney to represent you for unreported foreign and offshore account reporting, it can become overwhelming for taxpayers trying to trek through all the false information and nonsense they will find in their online research. There are only a handful of attorneys worldwide who are Board-Certified Tax Specialists and who specialize exclusively in offshore disclosure and international tax amnesty reporting. 

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure. 

Contact our firm today for assistance.