/>iThe Internal Revenue Service will no longer automatically impose penalties on taxpayers who file late IRS Forms 3520 (Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts) reporting gifts or bequests from foreign persons, a change announced by IRS Commissioner Danny Werfel Oct. 24, 2024, during the UCLA Extension Tax Controversy Conference. Now, before assessing a penalty, the IRS will review reasonable cause statements submitted with late-filed forms reporting gifts or bequests from foreign persons to determine whether a penalty should be imposed.
On the same day, the IRS Taxpayer Advocate published on its website the further change to penalty assessments for late-filed Forms 3520 and 3520-A that report transactions involving foreign trusts. The Advocate’s guidance states that by the end of 2024, before assessing a penalty, the IRS will begin reviewing any reasonable cause statements that taxpayers attach to a late-filed Form 3520 or 3520-A.
The Advocate notes that from 2018 to 2021, the IRS abatement rate for automatic penalties imposed on failures to report Form 3520 for gifts and bequests was 67% (or 78% of the total dollars assessed) and the abatement rate for penalties imposed on failures to timely file Forms 3520-A was also 67% (or 54% of the total dollars assessed). According to the Advocate, imposing automatic penalties, many of which were abated, created a burden for the taxpayer and IRS.
Forms 3520 and 3520-A Filing Requirements
Form 3520 is an informational return that must be filed by any U.S. citizen or resident individual to report, among other things:
| (a) | gifts or bequests received by the U.S. individual from foreign individuals or foreign estates if such gifts or bequests during the year exceed $100,000; |
| (b) | distributions received by the U.S. individual from a foreign trust; |
| (c) | the income, gains, losses, deductions, and credits of a foreign grantor trust of which the U.S. individual is treated as a grantor (which “flow through” from the foreign grantor trust to the U.S. grantor); |
| (d) | the creation of a foreign trust by the U.S. individual; |
| (e) | transfers of cash or assets by the U.S. individual to a foreign trust, including a transfer by reason of death; and |
| (f) | the death of the U.S. individual if the decedent was treated as a grantor of a foreign trust or assets of a foreign trust are includible in the gross estate of the decedent for estate tax purposes. |
Form 3520 reporting requirements may also apply to executors of estates of a U.S. citizen or resident decedent, whether the executor is U.S. or foreign, as well as to other persons who may be treated as a “responsible party” subject to reporting.
Form 3520-A is also an informational return that generally must be submitted by any trustee (whether U.S. or foreign) of any foreign grantor trust the grantor of which is a U.S. citizen or resident to report the income, gains, losses, deductions, and credits of the foreign grantor trust that “flow through” to and must be reported by the U.S. grantor.
Form 3520 typically must be filed by April 15 of the following year and Form 3520-A is typically due March 15 of the following year (each subject to an automatic six-month extension if requested by the due date).
Key Takeaways
Under the IRS’s previous policy of imposing automatic payments, taxpayers filing late faced the burden of either paying or challenging such penalties even if they submitted reasonable cause explanations with the late forms. Taxpayers often had to submit reasonable cause statements to the IRS numerous times for such statements to be considered while receiving continuous penalty and collection notices before a determination had been made on the taxpayer’s reasonable cause explanation. Ending automatic penalties will provide individuals and trustees filing late with an opportunity to submit a reasonable cause defense that is reviewed by the IRS before any penalties are determined.
This new policy is particularly significant given the typical size of Forms 3520 and 3520-A penalties, which may reach 25% of unreported gifts or bequests from foreign persons and 35% of the amount of unreported transactions with foreign trusts. Late filers who meet the reasonable cause exception would be spared these penalties.
The IRS imposes automatic penalties for numerous other late-filed tax returns or information returns (e.g., Form 5471, Form 8938, etc.) before considering reasonable cause statements submitted by the taxpayers. The IRS has not stated whether it intends to end automatic penalties in any other situations.
Irrespective of this announcement, U.S. recipients of gifts or bequests from foreign persons, U.S. beneficiaries of foreign trusts, U.S. grantors of foreign grantor trusts, and trustees of foreign grantor trusts with a U.S. grantor should continue to be mindful of the reporting requirements and deadlines for Form 3520 and Form 3520-A to avoid being subject to potential penalties.
