Form 3520 and 3520-A: Big Penalties for Foreign Trust and Gift Transaction Reporting Failures
The IRS has been closely examining the accurate and timely reporting of foreign gifts and distributions to and from foreign trusts. As part of this effort, the Large Business and International division announced an enforcement campaign on this issue regarding the filing of Forms 3520 and 3520-A.
The IRS imposes six- and seven-figure penalties on individuals who fail to strictly comply or file late returns. Given the international component, parties to these trust-related and gift transactions often have less familiarity with the U.S. tax system. Further, many of these types of transactions are only required to be reported because they are international in nature; otherwise identical domestic transactions would not require reporting to the IRS. CPAs with clients who hold these types of assets must be vigilant about the strict filing requirements.
The IRS has specific reporting requirements for “foreign trusts.” A foreign trust is any trust over which a court in the United States can exercise primary jurisdiction for its administration or that has one or more U.S. persons with the authority to control all, or substantially all, of the decisions of the trust. The IRS has detailed guidance on these requirements.1
World map made of currenciesAs a general rule, U.S. persons who own foreign trusts must file Form 3520-A, Annual Information Return of Foreign Trust with a U.S. Owner. (The owner of the trust is usually the trust grantor). Form 3520-A collects information about income, expenses, distributions, trust assets, trust owners, and beneficiaries, and is due on the 15th day of the third month after the end of the trust’s tax year. IRS Form 3520, Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts, must be filed by the owner of the trust on the same date as Form 3520-A, when one of the following apply:
- A U.S. person is a grantor of a newly created foreign trust
- A U.S. person makes a gratuitous transfer (or a transfer in exchange for an obligation) to a foreign trust
- A U.S. person owns a foreign trust
- A foreign trust made distributions, constructive distributions, or a loan to a U.S. person
- A U.S. person receives foreign gifts in excess of $100,000 from individuals or in excess of $16,076 from a foreign corporation or foreign partnership (adjusted annually for inflation)
Several of these reporting obligations fall to executors when the U.S. person passes away.
There are several important points here. First, a number of these trust-related and gift transactions wouldn’t normally be reported to the IRS. For example, if a U.S. person creates a domestic revocable trust, he or she likely has no independent obligation to report the transaction to the IRS. Likewise, a recipient of a foreign gift is required to file Form 3520, but the recipient of a domestic gift has no such obligation. When a U.S. person makes a domestic gift, only the donor files a gift tax return. As a result, U.S. persons who receive large gifts are frequently not asked by their tax professional about these transactions. Thus, failing to report foreign gifts can be an easily made mistake.
Transfers and distributions to foreign business entities that have relationships with U.S. persons also can be subject to the Form 3520 reporting requirement. For example, if a foreign corporation receives a gift from another foreign corporation, but the donee corporate entity is owned by a U.S. person, then the donee corporation must file Form 3520.2 The requirement to file a Form 3520-A is independent of the Form 3520 filing requirement, so a U.S. owner often will need to file both.
The penalty for failing to file a Form 3520-A is the greater of $10,000 or 5% of the value of the corpus of the trust attributable to the U.S. owner. There is no statute of limitations for the IRS to impose penalties, and the agency can impose multiple 5% penalties. The IRS may also impose large penalties if a Form 3520 is not timely filed, is incomplete, or is incorrect. The penalty is the greater of $10,000 or:
- 35% of the gross value of any property transferred to a foreign trust if a U.S. person fails to report the creation of, or transfer to, a foreign trust
- 35% of the gross value of the distributions received from a foreign trust by a U.S. person who fails to report the receipt of the distribution
- 5% of the gross value of all a foreign trust’s assets treated as owned by the U.S. person if the U.S. owner fails to report required information (in addition to the 5% penalty imposed for failing to file a Form 3520-A)
If the U.S. person does not file a Form 3520 more than 90 days after the IRS notifies him or her of noncompliance, there is a further penalty of $10,000 for each additional 30 days of noncompliance. The penalty for failing to file a Form 3520 that should have reported a foreign gift or bequest, or for filing an incorrect or incomplete form with respect to a gift or bequest, is 5% of the gift or bequest for each month during which the failure continues, up to a maximum of 25% of the gift.
Unlike nearly every other tax penalty, when the IRS imposes 3520-A and 3520 penalties, these actions are not subject to normal deficiency rules. In short, there is no right to challenge its determination in court unless he or she pays the entire penalty first. Practitioners have shared anecdotes about returns that were mailed a few months late or had one blank line, and the IRS reportedly imposed the maximum penalty, which the taxpayer cannot challenge in court until the total amount is paid. The IRS has an amnesty program for other delinquent international tax forms, but taxpayers who need to submit Forms 3520 and 3520-A are not eligible for this program.
Tax return preparers whose clients may have Form 3520 and Form 3520-A reporting requirements must be aware of these unique reporting obligations.
"Form 3520 and 3520-A: Big Penalties for Foreign Trust and Gift Transaction Reporting Failures," by Jed M. Silversmith was published on April 1, 2020, in CPA Now, a blog of the Pennsylvania Institute of Certified Public Accountants. Reprinted with permission from CPA Now.
1 See 26 CFR Section 301.7701-7.
2 Certain closely held foreign corporations, in which U.S. persons have certain defined interests, must file Forms 3520.