Navigating the complexities of U.S. tax compliance and international taxation can be challenging, especially for U.S. expatriates. One form that often goes unnoticed but carries significant penalties for non-compliance is Form 3520-A. In this article, we’ll delve into what Form 3520-A is, who needs to file it, and the penalties for failing to do so.
WHAT IS FORM 3520-A?
Form 3520-A, also known as the “Annual Information Return of Foreign Trust With a U.S. Owner,” is a tax form required by the Internal Revenue Service (IRS) to report information about foreign trusts. If you are a U.S. person who is treated as the owner of any part of the assets of a foreign trust, you are obligated to ensure that this form is filed annually as part of your income tax return.
WHO MUST FILE FORM 3520-A?
The responsibility for filing Form 3520-A generally falls on the trustee of the foreign trust. However, if the foreign trust does not have a U.S. agent, the U.S. owner must ensure that the form is filed. A U.S. owner is defined as a U.S. person, including foreign persons who are treated as the owner of any part of the assets of a Foreign Grantor Trust under the grantor trust rules.
WHEN IS FORM 3520-A DUE?
Form 3520-A must be filed by the 15th day of the 3rd month following the end of the trust’s tax year, usually March 15th for calendar year taxpayers. This is a crucial 3520-A filing requirement that many expats are unaware of, leading to hefty penalties.
In the federal income tax world, there are effectively two functions within the Internal Revenue Service (“IRS”). First, the IRS examines tax years and tax returns to determine whether the taxpayer has reported the correct amount of tax liability. In this so-called “assessment phase,” the IRS may propose additional income tax owed beyond the amount reported on the taxpayer’s tax return.
Second, if the taxpayer and the IRS agree on the amount of taxes owed or the taxpayer can no longer challenge the amount of tax, the IRS may engage in actions to collect the federal income taxes that are due and not paid. In this so-called “collection phase,” the IRS may file notices of federal tax lien or propose levies to try to collect the unpaid tax debts.
Congress also recognizes the distinction between the assessment phase and the collection phase in the Internal Revenue Code (the “Code”). With respect to the assessment phase, Congress permits the IRS, as a very general matter, to make an assessment of additional income tax within three years of when the tax return is filed.[i] Barring some exceptions, the IRS may not make an assessment of tax outside this three-year window. With respect to the collection phase, Congress permits the IRS, again as a very general matter, to take collection actions within ten years after an assessment has been made.[ii]
But every general rule has its exceptions, and the assessment phase is no different. Under the governing provisions of section 6501 of the Code, for example, the IRS may make an assessment of additional tax at any time if the taxpayer files a fraudulent tax return.[iii] Similarly, section 6501 provides that the general three-year period to make an assessment does not run at all if the taxpayer has failed to file an income tax return.
The 35% penalty under I.R.C. section 6677 for failing to report a distribution from a foreign trust applies against a person who is both the beneficiary and grantor/owner of a foreign trust. At least, that is now the rule for taxpayers in the second circuit. This draconian penalty for failing to properly report a foreign trust is applicable even if the taxpayer and trust paid all required taxes, if any, with respect to the trust.
In the case before the court, the taxpayer (Wilson) was the sole owner and beneficiary of a foreign trust. He received a distribution from the foreign trust. He filed his tax return late. The IRS assessed a penalty equal to 35% of the amount of the distribution for failing to timely disclose the distribution.
The purpose of this post is to continue the discussion generated by the “Open Letter To Democrats Abroad” (discussing the notion that “revenue neutrality” should be part of the “citizenship taxation” debate) and the “13 Reasons Why” (describing why Americans abroad are being forced to renounce U.S. citizenship.
Neither of those posts really described that fact that as ridiculous and unfair as “citizenship-based taxation” is, Americans abroad are “in effect” subject to a separate tax system than are Homeland Americans. A more extensive version of this post appeared at Tax Connections on March 13, 2019.
There are many instances where a U.S. citizen living abroad who earns his salary abroad, owns his assets abroad, has his pension abroad and is married to a non-U.S. spouse will pay higher U.S. taxes on income that is local to him than a comparable Homeland American would pay on income that is local to him.
The IRS Office of Associate Chief Counsel (International) has agreed to investigate an erroneous penalty campaign by the IRS targeting foreign trust owners who have timely filed Substitute Form 3520-A. If you have clients who have received one of these Form 3520-A penalty notices, we need your input.
The IRS would like specific information from taxpayers who have been targeted, so I have created a password protected information form to distribute to practitioners. Your client (or you) should complete the form, save it, then open it to ensure the data is there before sending it back to me. Request Form from me at firstname.lastname@example.org
Out of frustration with the IRS, I published a blog article last summer describing my experience with one of my clients who had received a $10,000 penalty notice for Form 3520-A after properly filing the form. The comments and reactions to the article have indicated the problem is systemic and pervasive, potentially affecting thousands of taxpayers. The Taxpayer Advocate office has been unable to help.
I happened to sit next to Mark Koziel, Executive Vice President of the AICPA at a dinner in October. I described the problem to him. He sent my article to Eileen Sherr with the AICPA Tax Policy & Advocacy Team.
On November 15, the AICPA Trust, Estate and Gift Tax Technical Resource Panel met with IRS representatives from the Office of Associate Chief Counsel and described the issue. The IRS attorneys then had a call with the IRS processing and penalty groups responsible for these penalty notices and relayed our concerns. The processing and penalty groups agreed to a follow up call with the AICPA in January to address the issue, but first wanted to get details about individuals affected.
Taxpayers have been privately emailing TaxConnections asking if there is anything happening behind the scenes to address the problems they have encountered with IRS Form 3250 A. Many taxpayers were kind enough to share their stories which include the following:
It all started with the letter written by member Gary Carter who wrote an article titled Foreign Trusts: IRS Penalty Notices For Late Forms 3520-A Traumatize Many Innocent Taxpayers. The purpose of my post today is to share some of the stories that have followed from this original article when we were asked to call out all tax professionals and taxpayers to sharing their experiences with us.
It is important to note to that the tax professional community works very hard to solve many matters with the IRS. This article is enlightening as there are comments here you would rarely see regarding how the system works for those who represent you. Your tax advisors are often unsung heroes and taxpayers rarely know what the real battles are behind the scenes with the tax advisors representing them. Although we are keeping everyone’s name anonymous to protect them, you are about to receive a real world inside look at the unresolved issues on Form 3520-A.
Here Are Responses We Have Received From Taxpayers
Section 6048 of the Internal Revenue Code requires a United States person, as defined for FBAR reporting, (and the executor of the estate of a US decedent) to file Form 3520 to report:
- Certain transactions with foreign trusts,
- Ownership of foreign trusts, and
- Receipt of certain large gifts or bequests from certain foreign persons.
Additionally, an owner of a foreign trust might be required to file a Substitute Form 3520-A if the foreign trust fails to file Form 3520-A (See SUBSTITUTE Form 3520-A below). Here is Form 3520 and Instructions.
What Is a Foreign Trust For Which Form 3520 Must Be Filed?
Although the Internal Revenue Code (IRC) refers to trusts in numerous sections, nowhere in the IRC is the term “trust” actually defined. There is a definition of foreign trust. IRC Section 7701(a)(31)(B) says: “The term ‘foreign trust’ means any trust other than a trust described in subparagraph (E) of paragraph (30).” Subparagraph (E) describes “any trust if (i) a court within the United States is able to exercise primary supervision over the administration of the trust, and (ii) one or more United States persons have the authority to control all substantial decisions of the trust.”
So a foreign trust is one that is not under the jurisdiction of United States courts or controlled by a United States person. But what is a “trust”?
With all of the focus on FBARs and Form 8938s these days, it’s sometimes easy to forget about the other IRS international reporting forms. Below is a list of other important international reporting forms that relate to foreign asset reporting along with their penalties.
(1) Form 3520, Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts: Under IRC § 6048, taxpayers must report various transactions involving foreign trusts, including creation of a foreign trust by a United States person, transfers of property from a United States person to a foreign trust, and receipt of distributions from foreign trusts. This return also reports the receipt of gifts from foreign entities under IRC § 6039F. The penalty for failing to file each one of these information Read More