- 1 Penalized as Both Owner/Beneficiary of Foreign Trust
- 2 Form 3520 Beneficiary vs Owner Penalties
- 3 Court Holding
- 4 Penalty on Wilson
- 5 Case Background
- 6 Reporting Requirement
- 7 Filing Requirements
- 8 Missed Filing Requirement
- 9 Plaintiffs Argument
- 10 Court’s Reasoning
- 11 District Court
- 12 Holding Summarized by Court
- 13 International Tax Law Firm: Board-Certified Tax Law Specialist
Penalized as Both Owner/Beneficiary of Foreign Trust
When a US Person is the owner or beneficiary of a foreign trust, they have a filing requirement for reporting the foreign trust to the Internal Revenue Service. The two main code sections for foreign trusts is Internal Revenue Code Sections 6048 and 6677. In order to comply with these two code sections, Taxpayers are required to file either Form 3520 filing requirement — along with possibly a Form 3520-A filing requirement as well. The case of Wilson is a bit of a peculiar tax case, because Mr. Wilson was responsible as both the owner of the Trust and Beneficiary Trust — each with different and sometimes overlapping reporting requirements. Recently, the Appellate court in the second circuit remanded the District Court case limiting the — and Form 3520 penalties at the forefront of IRS enforcement — let’s dive into the basics of the case:
Form 3520 Beneficiary vs Owner Penalties
By way of background, Beneficiaries of a Foreign Trust can be subject to a 35% penalties, whereas the Owners of Foreign Trusts are usually subject to a 5% penalty.
Joseph Wilson was the sole owner and beneficiary of a foreign trust. Under the Internal Revenue Code (“IRC”), 26 U.S.C. § 6048(b), (c), U.S. owners and beneficiaries of foreign trusts are required to file annual returns. Because Wilson filed his returns for tax year 2007 late, the Internal Revenue Service (“IRS”) assessed a 35% penalty that applies to beneficiaries of foreign trusts; Wilson paid the penalty. Following Wilson’s death, Plaintiffs-Appellees sued on behalf ofWilson’s estate for a refund, arguing the IRS should have imposed only a 5% penalty that applies to owners of foreign trusts.
Penalty on Wilson
We disagree and hold that the 35% penalty applies including when the beneficiary is the owner of the trust. Accordingly, we VACATE the judgment of the district court and REMAND for further proceedings consistent with this opinion.
“Wilson established a foreign trust in 2003 with a value of approximately $9 million.1 In 2007, Wilson liquidated the trust and distributed all its assets, approximately $9.2 million,2 to himself.”
“Section 6048 of the IRC imposes disclosure requirements related to foreign trusts.
Subsection (c) instructs “any United States person [who] receives . . . during any taxable year . . . any distribution from a foreign trust” to “make a return with respect to such trust for such year” that includes, inter alia, “the aggregate amount of the distributions so received from such trust.” 26 U.S.C. § 6048(c). In other words, § 6048(c) requires beneficiariesof a foreign trust––such as Wilson––to disclose distributions they received from the trust in an annual filing.
(b) orders U.S. owners“of any portion of a foreign trust” to “ensure that . . . such trust makes a return for such [taxable] year which sets forth a full and complete accounting of all trust activities and operations for the year” and “other information as the Secretary [of the Treasury] may prescribe.” Id. § 6048(b).”
To satisfy these two separate reporting requirements, Wilson and the trust needed to file Forms 3520-A and 3520. Form 3520-A, the “Annual Information Return of Foreign Trust With a U.S. Owner,” provides that “[a] foreign trust with a U.S. owner must file Form 3520-A in order for the U.S. owner to satisfy its annual information reporting requirements under [§] 6048(b).” J.A. 128.
It contains a section to report distributions from the trust. Form 3520, the “Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts,” directs owners of “any part of the assets of a foreign trust” to provide the information in Part II and beneficiaries of a foreign trust to disclose distributions they received in Part III. Id.at 109.
If the owner of a foreign trust received a distribution and completes Part II of Form 3520, and the trust has filed Form 3520-A, the instructions for Form 3520 state “do not separately disclose distributions again in Part III.” Id. at 114.
Missed Filing Requirement
Wilson failed to file Form 3520 and failed to ensure that his trust file Form 3520-A by their respective deadlines for tax year 2007.3 As a result, he did not timely disclose the $9.2 million distribution he received or report other information about his trust.
The IRS assessed a late penalty of $3,221,183, 35% of the $9.2 million distribution. This penalty derives from § 6677(a) of the IRC, which provides “if any notice or return required to be filed by [§] 6048” is not filed on time or is incomplete, “the person required to file such notice or return shall pay a penalty equal to . . . 35 percent of the gross reportable amount.” 26 U.S.C. § 6677(a).
Wilson initially paid the penalty, but less than two months later submitted a claim to the IRS seeking a full refund. He argued that because he was both thesole beneficiary and the sole owner of the trust, only a 5% penalty applies for his failure to timely report the distribution to himself.
The 5% penalty stems from§ 6677(b) of the IRC, which states “[i]n the case of a return required under [§] 6048(b),” the reporting requirement for trust owners, a 5% penalty will substitute the 35% penalty. Id. § 6677(b)(2).
While Wilson’s claim for a refund was pending, he passed away. Plaintiffs brought this action against the government to recover the money for Wilson’s estate, pursuing Wilson’s 5% penalty argument and alleging in the alternative that there was “reasonable cause” that excused Wilson’s untimely filing.4
The government moved to dismiss only the 5% penalty claim, arguing that Plaintiffs did not exhaust their refund claim in the administrative process, which the district court denied.5 Plaintiffs moved for partial summary judgment on their 5% penalty argument, which the district court granted, concluding that “[t]he IRS can . . . assess only the 5% penalty under . . . § 6677 – not bothor either the 5% and/or 35% penalty – for Wilson’s untimely filing of his 2007 Form 3520.”Wilson v. United States, No. 19-CV-5037 (BMC), 2019 WL 6118013, at *8 (E.D.N.Y. Nov. 18, 2019).
The government appeals, arguing that the district court erred in its construction of the IRC. DISCUSSION“We review a grant of summary judgment de novo; specifically, where the disposition presents only a legal issue of statutory interpretation, as here, we review de novowhether the district court correctly interpreted the statute.” Power Auth. v. M/V Ellen S. Bouchard, 968 F.3d 165, 170 (2d Cir. 2020) (internal quotation 4 Section 6677 contains a “reasonable cause” exception, providing that “[n]o penalty shall be imposed . . . on any failure which is shown to be due to reasonable cause and not due to willful neglect.” 26 U.S.C. § 6677(d). 5 “The [g]overnment does not appeal the [d]istrict [c]ourt’s denial of [its] partial motion to dismiss.” Appellant’s Br. at 15 n.8.
The applicability of the 35% penalty to Wilson as a beneficiary of the trust.
However, the district court relied on § 6677(b) to conclude that the 35% penalty cannot apply. See Wilson, 2019 WL 6118013, at *6. Section 6677(b) “substitut[es] ‘5 percent’ for ‘35 percent’ [of the gross reportable amount]” as the applicable penalty for the failure to timely file “a return required under [§] 6048(b),” which is the reporting requirement for owners of foreign trusts.
According to the court, because Wilson violated § 6048(b) by failing to timely file as an owner, § 6677(b)’s “mandate that the 5% replace the 35%” applies. Wilson, 2019 WL 6118013, at *6 (emphasis omitted). The problem with the district court’s analysis is that § 6677(b) leaves untouched the 35% penalty that applies to all otherreporting requirements under § 6048, including to a return disclosing distributions required by § 6048(c).
The district court and Plaintiffs do not identify any text in the statute that elides therequirement to disclose distributions received as a beneficiary under § 6048(c) when the beneficiary is also the owner of a foreign trust. Nor is there any textual support for the court and Plaintiffs’ view that when the owner and beneficiary are one, a failure to timely report the distribution received violates only § 6048(b) andnot § 6048(c).
Even if the information the owner must report under § 6048(b) coversthe trust’s distributions, nothing in the statute indicates that as a result, § 6048(b) displaces or merges with the separate requirement to report distributions under § 6048(c). See id.at *6–7. Because Wilson’s failure to timely report the distribution he received violates § 6048(c) even if that same failure also violates his reporting requirements as an owner under § 6048(b), the 5% penalty under § 6677(b) does not supplant the 35% penalty.
The district court and Plaintiffs’ remaining textual arguments fail to defeatthis conclusion. The district court criticized the government’s justification of the 35% penalty as presenting “an irreconcilable textual conflict,” asserting that because § 6677(a) instructs the penalty should not “exceed the gross reportable amount,” “a taxpayer should not be liable for any two penalties if their combined assessment would add up to more than the gross reportable amount for any one violation.” Id.at *7 (quoting 26 U.S.C. § 6677(a)). “Because the gross reportable amount for an owner’s untimely filing . . . is ‘the gross value of the portion of the trust’s assets at the close of the year,’ Wilson’s $0 in trust assets at the end of 2007 yields a $0 gross reportable amount”––the government’s pursuit of “$3,221,183 above $0 [therefore] violates the statute.” Id.The court’s reasoning misses the fact that “gross reportable amount” has more than one meaning under § 6677(c).7 The definition of “gross reportable amount” varies depending on the subsection of § 6048 an individual violated.
Holding Summarized by Court
The plain language of §§ 6048 and 6677 requires that when an individualfails to timely report the distributions she received from a foreign trust, the 35% penalty applies; her concurrent status as owner of the trust does not alter this rule.Because the statute’s meaning is clear based from its text, we need not consider any extrinsic sources. See New York v. Nat’l Highway Traffic Safety Admin., 974 F.3d 87, 95 (2d Cir. 2020).
International Tax Law Firm: Board-Certified Tax Law Specialist
Golding & Golding specializes exclusively in international tax, and specifically IRS offshore disclosure.
Contact our firm for assistance.