Overview
Over the past decade, the IRS has ramped up enforcement on foreign asset reporting. Failure to do so can lead United States taxpayers down a dark road of hefty civil penalties and even potential criminal exposure. Though we have already discussed at length the FBAR and Form 8938, this article will take a deeper dive into one of the most common international information reporting forms - Form 3520.
United States persons are required to report their worldwide income. Accordingly, it is important to define who may be considered a “United States person.” The term “United States Person” means:
A citizen or resident of the United States;
A domestic partnership;
A domestic corporation;
Any estate other than a foreign estate;
Any trust if:
- A court within the United States is able to exercise primary supervision over the administration of the trust, and
- One or more United States persons have authority to control all substantial decisions of the trust; or
Any other person that is not a foreign person.
A “foreign person” includes:
Nonresident alien individual;
Foreign corporation;
Foreign partnership;
Foreign trust;
A foreign estate; or
Any other person that is not a U.S. person.
Depending on the U.S. person’s portfolio, they may have several reporting obligations for any given tax year, which could expose them to significant monetary penalties if they are not careful.
Form 3520
Form 3520 is referred to as the “Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts.” To no surprise, U.S. persons and executors of estates of U.S. decedents must file Form 3520 to report:
Certain transactions with foreign trusts;
Ownership of foreign trusts if such ownership falls within the rules of IRC §§ 671 through 679; and
Receipt of certain large gifts or bequests from certain foreign persons.
Who Must File Form 3520
If any one of the following applies, a U.S. taxpayer must file Form 3520:
1. You are the responsible party for reporting a reportable event that occurred during the current tax year, or you are a U.S. person who transferred property (including cash) to a related foreign trust (or a person related to the trust) in exchange for an obligation or you hold a qualified obligation from that trust that is currently outstanding.
a. A “responsible party” means:
i. The grantor of an inter vivos trust;
ii. The transferor, in the case of a reportable event other than a transfer by reason of death; or
iii. The executor of the decedent’s estate (regardless of whether the executor is a U.S. person).
b. A “reportable event” includes:
i. The creation of a foreign trust by a U.S. person;
ii. The transfer of any money or property, directly or indirectly, to a foreign trust by a U.S. person, including a transfer by reason of death; and
iii. The death of a citizen or resident of the United States if:
1. Any portion of a foreign trust was included in the gross estate of the decedent, or
2. The decedent meets the requirements set forth below.
c. An “obligation” includes any bond, note, debenture, certificate, bill receivable, account receivable, note receivable, open account, or other evidence of indebtedness, and, to the extent not previously described, any annuity contract.
d. A person is related to a foreign trust if such person is the grantor, a beneficiary, or is related to any grantor or beneficiary of the trust.
2. You are a U.S. person who, during the current tax year, is treated as the owner of any part of the assets of a foreign trust under the rules of IRC §§ 671 through 679.
3. You are a U.S. person or an executor of the estate of a U.S. person who received (directly or indirectly) a distribution from a foreign trust during the current tax year; or you are a U.S. person who is a U.S. owner or beneficiary of a foreign trust and in the current tax year you or a U.S. person related to you received (1) a loan of cash or securities directly or indirectly from such foreign trust, or (2) the uncompensated use of trust property; or you are a U.S. person who is a U.S. owner or beneficiary of a foreign trust and in the current tax year such foreign trust holds an outstanding qualified obligation of yours or a U.S. person related to you.
4. You are a U.S. person who, during the current tax year, received either:
a. More than $100,000 from a nonresident or a foreign estate (including foreign persons related to the nonresident or foreign estate) that you treated as gifts or bequests; or
b. More than $16,649 from foreign corporations or foreign partnerships (including foreign persons related to such foreign corporations or foreign partnerships) that you treated as gifts.
When and Where to File
Generally, Form 3520 is due with the U.S. person’s tax return. As a result, the Form 3520 is typically due on April 15th, but will be due on October 15th if the taxpayer is granted an extension of time to file their income tax return.
Form 3520 must have all required attachments to be considered complete. If the Form 3520 that is filed is not substantially complete, the return will be considered “unfiled” and may result in penalty assessments. Moreover, the statute of limitations that the IRS has to audit the return (generally three years from the due date of the return or the date on which it was filed, whichever is later) will not begin to run on the return until a substantially complete Form 3520 is filed.
Penalties
Under IRC § 6677, a penalty shall apply if Form 3520 is not timely filed or if the information is incomplete or incorrect. Generally, the initial penalty is equal to the greater of $10,000 or 35% of the gross reportable amount. If the IRS sends the taxpayer a notice of failure to comply, additional penalties will be assessed after 90 days. Penalties in the amount of $10,000 will be assessed every 30 days until the gross reportable amount has been reached. However, no penalties will be imposed if the taxpayer can demonstrate that the failure to comply was due to reasonable cause and not willful neglect.
An example that does not constitute reasonable cause include a foreign country imposing penalties for disclosing the necessary information. Likewise, reluctance by a foreign fiduciary or provisions in the trust instrument that prevent the disclosure of required information is not reasonable cause.
If you have previously engaged in a transaction with a foreign trust or received a gift from a nonresident individual exceeding $100,000 or $16,649 from a foreign corporation or foreign partnership, give The Wilson Firm a call today. We have handled a number of cases involving offshore voluntary disclosures.
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