There is evidence from both tax practitioners and from individuals that Americans abroad are suffering from a “Form 3520A” penalty epidemic. Some of the best discussion of both the scope and technicalities of this problem may be found at Tax Connections. See particularly the posts here, here and here. (Mr. Carter’s original post was also reproduced at American Expat Finance.) The posts have attracted commentary from a number of tax professionals. The IRS Taxpayer Advocate has been invited to intervene.
“Tax Compliant” Americans Abroad are just a penalty waiting to happen!
Americans abroad are potentially required a very large number of IRS forms. My point is simple. It’s the “possible” requirement to file International Information Returns that makes Americans abroad so vulnerable to the IRS penalty regime. As I commented at Tax Connections:
The only reason that the Form 3520A penalty was imposed was because a Form 3520 was filed!
Therefore, it’s important that Form 3520 (or any other International Information Return) be filed ONLY when it is required to be filed. Form 3520 is a form that is used for various requirements. This post is focused ONLY on the possible requirement of a Form 3520 because of a Foreign Trust.
In order to be a “foreign trust”, it must be a “trust”. Hence, the starting point is:
What are the requirements for an arrangement to qualify as a “trust” under the Internal Revenue Code?
1. Definitions are found in Internal Revenue Code 7701.
2. Treasury Reg. 301.7701-4(a) defines a trust as for Internal Revenue Code purposes as:
“an arrangement created either by will or inter vivos declaration whereby trustees take title to property for the purpose of protecting and conserving it for the beneficiaries under the ordinary rules applied in chancery or probate courts . . . . Generally speaking, an arrangement will be treated as a trust under the Internal Revenue Code if it can be shown that the purpose of the arrangement is to vest in trustees responsibility for the protection and conservation of property for beneficiaries who cannot share in the discharge of this responsibility and, therefore, are not associates in a joint enterprise for the conduct of business for profit”
There are at least two key components to this test:
1. The trustees have a responsibility for the protection and conservation of the property; and
2. The beneficiaries cannot share in the discharge of that responsibility.
It appears, that this means that a number of tax advantaged savings plans would NOT meet the definition of a “trust”. The suggestion that most Canadian TFSAs are “trusts” is laughable. How could a self-managed retirement fund be a “trust” under this definition? (See this 2013 post from Phil Hodgen where he applies this definition in order to to consider whether a UK ISA qualifies as a trust.)
The fact that the arrangement is labelled a trust is NOT determinative
Notice also that the definition focuses on the characteristics of the arrangement and NOT on the title of the arrangement. The fact that a TFSA is referred to as a “Trust” under the Income Tax Act of Canada is irrelevant. For example, much to the relief of Americans abroad, the IRS has ruled that “Mexican Land Trusts” are NOT trusts withing the meaning of the Internal Revenue Code.
Possible conclusion …
The first step is to consider whether the arrangement is a trust at all. An arrangement should be treated as a trust only if has the characteristics that are required to make it a trust.
When in doubt, it may be better to NOT treat the arrangement as a trust (possibly necessitating a Form 3520 and Form 3520A). Is it safer to file a 3520 anyway?
Have a question? Contact John Richardson.
Subscribe to TaxConnections Blog
Enter your email address to subscribe to this blog and receive notifications of new posts by email.
10 comments on “Be Form Warned And Form Armed: The Easiest Way To Receive A Form 3520A Penalty Would Be To File A Form 3520”
Great follow up John. For any foreign investment vehicle, whether or not it’s called a trust, or whether or not tax is deferred under local law, we are asking two questions: 1) Is there a trustee with a declared fiduciary responsibility? and 2) Does the owner have any control over investment choices? If the answer to 1) is no OR the answer to 2) is yes, we believe the Treasury definition does not classify it as a trust, and Form 3520 should not be filed.
This reign of terror by the Large Business and International Division of the IRS against taxpayers trying to do the right thing will damage voluntary compliance for years to come. Make the IRS issue a ruling to provide clarity instead of allowing it to issue penalty notices in response to protective filings. Stop filing Form 3520 unless the definition of a trust is definitely met. As John said, you will not get a penalty notice for not filing Form 3520-A unless you filed Form 3520 first!
Oh, and by the way, also contact your elected representatives and tell them they must take this crazy penalty power away from an agency that doesn’t understand how to use it.
Just one more thing. It’s really unfortunate that this is happening, and someone at the IRS should be held accountable. I believe that person is John Cardone, Director of Withholding and International Compliance in the Large Business and International Division.
So Now that I have been enlightened by your eminently clear analysis of the Form 3520/3520A error in filling a 3520 when the Foreign TRUST does not meet the IRS definition of trust, and the TAX COMPLIANCE INDUSTRY expert that I paid a King’s ransom and erroneously filed a 3520 and now I am on appeal with the IRS on Form 3520A Penalties. how do I proceed? Firstly in Handling the 3520A Penalty issue and secondly the Future Filing of Forms 3520/3520A that IRS computers are chomping at the bit to Impose Penalties?
I too would like to know how to proceed? I have been conned into filing and paying on my SMSF I share with my non US citizen partner. How do we just stop filling 3520/3520A forms without raising questions?
Without Raising questions? Have you read the posts on this subject? There is no easy way! you have to fight for it, starting with protest letters. Read all that Gary W. Carter has posted.
It would be interesting to hear the perspectives of some tax preparers on how to deal with the problem of the improperely filed Forms 3520 and 3520A. Normally if an error in filing is discovered it would be open to the taxpyaer to file an amended return. How would/could this play out in the context of Form 3520?
Well! I have contacted my elected representative Senator, and I have expounded on the problem! In addition, I have brought it to the attention of the Taxpayer advocate representative, thanks to the assistance of my representative senator. assigned to my case! I have also contacted the Tax Compliance industry Law Office, that made the error, in filling a FORM 3520 and to date they have been hiding under the carpet! You see, when you work via email and fax, being located in Europe, eye to eye physical presence contact is not a readily available option! as for myself, being the victim thrown under the bus, I resort to the established procedure filing appeals within the IRS system!
When Tax compliance industry LAWYERS , do not know what to do about it! Why run of the mill tax prepares have a solution about it?
Forms 3520 and 3520A are included with the Form 1040 and are not referenced anywhere within it. How can you file an amended return?
….fire any accountant who suggests that you do., AND SUE FOR MALFEASANCE & BREACH OF PROFESSIONAL RESPONSIBILITY FOR DAMAGES ANY US TAX COMPLIANCE INDUSTRY ACCOUNTANT OR TAX LAW OFFICE THAT FILED A 3520 ON YOUR BEHALF ,AND GOT YOU IN THIS MESS IN THE FIRST PLACE! And Ultimately the BEST SOLUTION is to DITCH the Citizenship, that does not Serve your life’s requirements!
Interestingly we are seeing a shift in attitude from “when in doubt file Form 3520” to “when in doubt (as long as the doubt is reasonable) do NOT file Form 3520”. The whole idea of what conservative filing means is evolving.
The 3520 problem is a specific instance of the reality that (1) it’s very difficult for Americans abroad to know what is expected of them and (2) the penalties for “so called” mistakes are outrageous.
People are not renouncing U.S. citizenship because they want to. They are renouncing U.S. citizenship because they have to.
Comments are closed.