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.
Prologue – The “Take Away” And Summary For Americans Abroad
The general message is contained in the above twitter thread. Americans abroad are likely to have financial involvements with a number of different kinds of “entities” that are “local” to them and “foreign to the United States. Examples may include: pension plans, tax advantaged savings plans, small business corporations and more. The descriptive title of these “entities” is irrelevant to their classification under US tax rules.
United States citizens and residents[i] are subject to federal income tax on their worldwide income. For example, even if a United States citizen permanently relocates to a foreign country, he or she will generally continue to have income tax reporting obligations in the United States. And, in many cases, because of this newfound nexus between the United States citizen and the foreign country, that person will also have newfound United States reporting obligations (such as FBARs).
Perhaps more commonly, United States reporting obligations arise in these situations when the United States person establishes a retirement account in a foreign jurisdiction. As discussed more fully below, many of the issues surrounding the proper reporting of foreign retirement accounts remain murky and unresolved. Because harmless mistakes can result in significant penalties for failing to file information returns, taxpayers with foreign retirement accounts should take actions to ensure that the accounts are properly disclosed for United States reporting purposes.
IRS Guidance and the 2018 GAO Report.
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.
Harrington v. Comm’r, T.C. Memo. 2021-95 | July 26, 2021 | Lauber, J. | Dkt. No. 13531-18
Short Summary: Mr. Harrington is a U.S. citizen; his wife is a dual citizen of the United States and Germany. Mr. Harrington sold his house after meeting Mr. John Glube, a Canadian attorney for Eastern Wood Harvesters (EHW). He then provided these proceeds—$350,000—to Mr. Glube, who deposited that amount in a Union Bank of Switzerland (UBS) account under the name of Reed International, Ltd. (the “Reed Account”). At trial, Mr. Harrington testified that he lent this $350,000 as part of his effort to stabilize EHW, a company in which he became an employee. Later, EHW went under due to the European Union banning the import of North American softwood products, products that EHW sold.
Introduction – A small step for forms, one giant leap for “formkind”
It’s true. Many Americans abroad will no longer have to file Form 3520 and Form 3520A to report their lives abroad! Early indications appear that many Americans will (assume their retirement vehicle does qualify as a trust) be required to report on Form 3520. This new initiative from Treasury a positive step in the right direction.
I have long thought that Treasury could solve many of the problems experienced by Americans abroad. Here is a wonderful example of Treasury taking the initiative to clarify the obvious:
Americans abroad do NOT use non-U.S. pension plans and non-U.S. tax-advantaged investing accounts to evade U.S. taxes. Hence, there is NO reason for the Form 3520 reporting requirement. This is an example of the tax compliance industry sitting down with Treasury, explaining a problem and getting a resolution. I suggest (and hope) that the same can be done for PFIC (Form 8621), Small Business Corporations (Form 5471) and other penalty-laden forms.
Yes, this announcement from Treasury in the form of RP 20-17 is a great achievement. Although it certainly doesn’t solve all the problems, it’s:
A small step for forms, one giant leap for “formkind”
The background to this problem – It starts in 1996 (same year as the beginning of the Exit Tax)…
Since 1996 Internal Revenue Code 6048 has required extensive reporting of almost any interaction with a foreign trust. Treasury has required that the reporting take place on Forms 3520 and 3520A. The forms are complex and subject to the draconian penalty regime described in Internal Revenue Code Section 6677. In order for an entity to be a foreign trust, it must be a trust. A “trust” for IRS purposes is defined by the Treasury Regulations as:
(NOTE: This important article is reposted in case anyone missed it over the July 4th weekend. Is this happening to your tax clients?)
It was early on a Monday morning, and I dragged myself in after a long weekend of reg. buzzing and Code section perusing. I was not looking forward to the day. I played a message on my answering machine that made me want to return home and crawl back into bed. It was left in the middle of the previous night by a crazed and panicked client living in Norway. She had just gotten a CP15 Notice from the IRS that said she had been charged a penalty in the amount of $10,000 under Section 6677 of the Internal Revenue Code (IRC) for failure to file Form 3520-A, under the requirements of IRC Section 6048(b).
The client was the owner of a foreign trust, and I knew we had properly filed Form 3520, “Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts.” Foreign trusts with U.S. owners have the responsibility to file Form 3520-A, “Annual Information Return of Foreign Trust With a U.S. Owner,” which few of them do. So since IRC Section 6048(b) requires the owner of a foreign trust to ensure that this happens, we attached “substitute” Form 3520-A to Form 3520, in accordance with the instructions to Form 3520. Form 3520 and the attached substitute Form 3520-A were filed in August, but we had filed an automatic extension for the client’s tax return, which, according to the instructions to Form 3520, also extended the filing date for Form 3520.
U.S. citizens (or even green cardholders) resident in Canada who are contributors (or a joint contributor) to their children’s RESP (Registered Educational Savings Plan) may have U.S. reporting issues.
The following is a response to comments made about an article written by Rachel Heller on medium.com titled, “Why I renounced my US citizenship (Hint: it’s not because I’m avoiding taxes!).” The article was well written, interesting and attracted responses from Homeland Americans. (It was reproduced here and attracted even more comments.) The comments from U.S. residents demonstrated again that they do NOT understand the problems experienced by Americans abroad.
The short-term highway funding extension was passed by the Senate and the House of Representatives and was signed into law by President Obama on July 31, 2015. It contains several important tax provisions (H.R. 3236 (https://www.congress.gov/114/bills/hr3236/BILLS-114hr3236ih.pdf)). The bill changes the due dates for several common tax returns, overrules the Supreme Court’s Home Concrete decision, mandates the reporting of additional information on mortgage information statements, and requires consistent basis reporting between estates and beneficiaries.
Broadly speaking, the act establishes new due dates for partnership and C corporation returns, as well as FinCEN Form 114, Report of Foreign Bank and Financial Accounts (FBAR), and several other IRS information returns: Read More
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
When looking for a picture for this post, I came across this one and remembered my college English Professor. She really loved the term, “Freudian Slip” for some reason! All I knew then was that Sigmund Freud was the father of psychoanalysis but I never quite understood how that related to a Business English class, unless that was the Professor’s way of telling us we were driving her nuts! Now I know that the term, “Freudian Slip” is a “mistake in speech that shows what the speaker is truly thinking” or “to do what one is truly thinking about”.
No, this post is not about defining psychoanalytic terms, dare I say more interesting than tax stuff? Not quite, but this post is about the latest buzz from the Internal Revenue Service, about some situations US taxpayers having foreign accounts might be in and their Read More