Non-US Trusts Remain IRS Target
IRS compliance campaign
In 2018, the IRS announced a compliance campaign with respect to information returns reporting ownership and transactions with foreign trusts - this campaign concerns Forms 3520/3520-A. The IRS started closely monitoring noncompliance and assessing penalties when these forms were filed late or incomplete.
Despite the official retirement of the campaign, non-US trusts (foreign) remain an easy target for levying penalties on virtually every incident of a late filed foreign trust return.
Potential risks and penalties
The initial penalty for late filing of form 3520-A is the greater of
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$10,000 or
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5% of the gross value of the trust's assets owned by the U.S. person at the close of that tax year
The initial penalty for late filed form 3520 is the greater of
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$10,000 or
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35% of the gross value of any property transferred to a foreign trust or
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35% of gross value of the distributions received from a foreign trust or
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35% of the value of foreign gift or bequest.
Who is affected
The taxpayers primarily affected by the campaign are US owners of foreign trusts with US beneficiaries. This requires filing of Form 3520-A.
Other affected individuals are US recipients of foreign gifts and inheritances. Those individuals need to file Form 3520. The deadline to file this form is the same as the deadline of the U.S. personal tax return Form 1040. Form 3520 is also required to those who file Form 3520-A but the timing for the two forms may be different.
Different filing deadlines than personal tax returns
Form 3520-A must be filed by the 15th day of the 3rd month after the end of the trust's tax year. As an example, if the trust tax year ends on June 30, Form 3520-A is due September 15 of that year while the personal return for the same year will be due April 15 of the following year.
Taxpayers are often caught unprepared and file form 3520-A along with the personal tax return, not realizing that the form is already past due.
What should taxpayers do preemptively?
If you are in the affected category (see above: who is affected) — contact your tax advisor as soon as possible, preferably before it’s time to file the personal tax return to inquire about the potential additional filing requirements and the upcoming deadlines.
A non-US trust is an entity in the eyes of the IRS. TFX has created a specific section of your portal to manage your entities (other entities are corporations, partnerships, etc). Once you provide us with the information, we will be able to send you individualized reminders to make sure you are aware of your filing deadlines.
We recommend you request an extension for your non-US trust in your portal (these are called non-personal extensions) which TFX will then process for you, giving you extra time to file.
If the inevitable has already happened, and you discovered that the form 3520 or 3520a or possibly multiple forms are past due - discuss the available options with your tax preparer. Perhaps you will qualify for amnesty under the Delinquent Information Returns Submission Procedure.
Whichever protective measures you take, be prepared for the worst. Most likely, if the due date passed, the IRS may assess penalties.. See below what you can do about it.
What taxpayers should do reactively (limited)
Penalties related to Forms 3520-A /3520 are different from other types of IRS penalties.
An individual does not receive notice that they may be subject to the penalty before it is issued — and are not provided the opportunity to dispute the penalty beforehand.
Tax court
For this reason, the Tax Court powers over International tax penalties are curtailed. There is no option to contest the penalties at the Tax Court at the prepayment stage of initial assessment.
Office of appeals
On a CP15 notice with the penalty assessment, the IRS informs the individual that they may file a protest with the IRS Independent Office of Appeals. This is a valid option yet the Office of Appeals review is extremely lengthy and with an unpredictable outcome.
Reasonable cause exception
Another option is to request a penalty waiver under the reasonable cause exception. Such exception applies if the taxpayer can prove that any failure to be due to reasonable cause and not due to willful neglect. While this is an option, it is important to temper expectations and reasonable cause exceptions with respect to forms 3520/3520-A are rarely granted.
United States district court
For those who can afford it, an option would be to pay the penalty in full, file administrative refund claims with the IRS and sue the government for a refund of the penalty in either a United States district court or the Court of Federal Claims. This solution is easier said than done.
Collection due process hearing (be mindful of IRS correspondence!)
For those who are unable to pay the penalties, there is another option called, “Collection Due Process Hearing”. If the penalty is not paid, the IRS will enforce collection actions by issuing three consecutive notices reminding the individual of the assessed penalty and accumulated interest. Eventually, the IRS will issue a “Final Notice of Intent to Levy and Notice of Your Right to a Hearing”.
Anyone who wishes to contest Form 3520 and/or Form 3520-A penalty in court without having to pay the penalty in full should not ignore or dismiss this correspondence.
The request for a Collection Due Process Hearing must be made within 30 days of the date of the final notice by filing IRS Form 12153. Form 12153 must state the reason for contesting the international penalty in detail.