Crucial New Foreign Gift Penalty Relief with Reasonable Cause

Importance of the New Foreign Gift Penalty Relief with Reasonable Cause

Importance of the New Foreign Gift Penalty Relief with Reasonable Cause

When a U.S. Taxpayer receives a large foreign gift or inheritance, they may have to file an IRS Form 3520. The Form 3520 is used for many different purposes, but for most taxpayers, the reason they file the Form 3520 is to report a large foreign gift or inheritance they received from a foreign individual, entity, or trust. In prior years, the IRS was very aggressive in enforcing penalties against taxpayers who did not file Form 3520 in a timely. Taxpayers could become subject to a 5% penalty per month, up to 25% of the value of the unreported foreign gift or inheritance. This was extremely burdensome for many taxpayers, especially since oftentimes they only receive one gift or inheritance in a lifetime — so it is not a form that they would file annually. Moreover, oftentimes their CPA or other tax professional did not prompt them about having to file the form and there is typically no unreported income with respect to a missed Form 3520 for a large gift or inheritance.

As a result, many taxpayers and tax professionals were up in arms about these penalties. Recently, the IRS updated the Internal Revenue Manual (IRM) to reflect a change in penalty enforcement, making it less aggressive and more taxpayer-friendly. Let’s walk through a basic example of how penalties were assessed and how the new provisions make it better for taxpayers.

Importance of Form 3520 Reasonable Cause

The most important takeaway from these updated procedures is that the taxpayer needs to establish reasonable cause as early in the process as possible. Thus, Taxpayers should try to submit an effective reasonable cause statement at the outset with the late filing of the Form 3520 prepared. By doing this, the taxpayer will be in the best position to try to avoid/minimize penalties while establishing through the IRS that the taxpayer did seek to avoid penalties at the outset in case penalties are rejected and the taxpayer has to pursue an appeal or other penalty abatement process.

Large Foreign Gift Example

Adam is a U.S. taxpayer who has foreign national relatives living overseas. One of his relatives passed away, and since Adam was his favorite nephew, he gifted Adam $2,000,000. Adam received the $2,000,000 in cash; there is no income associated with the gift, and this is the only time Adam will ever receive a gift of this magnitude.

No Form 3520 is Filed

Adam had conducted some preliminary research and learned that since there is no income associated with the foreign gift, there is no income tax to report. Unfortunately, Adam’s CPA was not aware of the Form 3520 reporting requirement, and his research had only revealed that he is not subject to tax, but he did not find any mention of Form 3520, so the form was never filed.

Taxpayer Goes to a New CPA

A few years later, Adam had retained a new CPA who realized that Adam had never filed the Form 3520. The CPA did not have experience with Form 3520 and referred the taxpayer to an attorney to assist with the submission process.

Delinquent Form 3520 vs Streamlined Procedures

In this situation, Adam does not have any unreported foreign income, FBAR, or FATCA issue, so (generally) the streamlined procedures would not be the proper tool to get into compliance. In fact, if the taxpayer tries to submit through the streamlined procedures, it may be rejected because the IRS would take the position that since Adam is not required to amend his tax returns or file the FBAR, Form 8938, etc., he does not qualify for the streamlined procedures.

Instead, through his attorney, Adam submits a reasonable cause submission along with the Form 3520. An effective reasonable cause statement should be a detailed 3-to-4-page document (facts, legal, regulations, etc.) that works to establish reasonable cause so that Adam can avoid penalties.

Prior Form 3520 Enforcement vs Current Enforcement

Previously, no matter how wonderful the reasonable cause statement was, there was a 50/50 chance that the IRS would still automatically assess Form 3520 penalties, with the Taxpayer then having to work backwards to try to submit a protest, appeal, and/or collection due process procedure to challenge the fine. With the updated procedures, the IRS is no longer automatically assessing these penalties against taxpayers.

Instead, when the taxpayer submits a reasonable cause statement with the late Form 3520 filing, the IRS will review the reasonable cause statement first to determine whether the taxpayer sufficiently established reasonable costs or that no penalties are issued for failing to file the Form 3520 timely.

Late Filing Penalties May be Reduced or Avoided

For Taxpayers who did not timely file their FBAR and/or other international information-related reporting forms, the IRS has developed many different offshore amnesty programs to assist Taxpayers with safely getting into compliance. These programs may reduce or even eliminate international reporting penalties.

Current Year vs. Prior Year Non-Compliance

Once a taxpayer misses the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, Taxpayers should consider speaking with a Board-Certified Tax Law Specialist who specializes exclusively in these types of offshore disclosure matters.

Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)

In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful Taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties. 

Need Help Finding an Experienced Offshore Tax Attorney?

When it comes to hiring an experienced international tax attorney to represent you for unreported foreign and offshore account reporting, it can become overwhelming for Taxpayers trying to trek through all the false information and nonsense they will find in their online research. There are only a handful of attorneys worldwide who are Board-Certified Tax Specialists and who specialize exclusively in offshore disclosure and international tax amnesty reporting. 

*This resource may help Taxpayers seeking to hire offshore tax counsel: How to Hire an Offshore Disclosure Lawyer.

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure.

Contact our firm today for assistance.