IRS Form 3520 Instructions (2018) – Key Steps to Reporting a Foreign Gift
IRS Form 3520 Instructions (2018) – Key Steps to Reporting a Foreign Gift
IRS Form 3520 Instructions can be difficult to digest, since it involves multiple jurisdiction and bodies of law.
Common questions we receive regarding Form 3520 are:
- When do I file Form 3520?
- Do I report Foreign Gifts?
- Do I report Foreign Inheritances?
- Is there a Foreign Inheritance Tax?
- What are the penalties for not filing form 3520?
When you receive a gift from a foreign person and if you meet certain threshold requirements, then you are required to report the gift. The following a summary of Form 3520 Instructions — the key steps necessary to reporting a Foreign Gift or Inheritance.
Form 3520 Instructions
It is important to note that the Form 3520 Instructions refer to both Gifts and Inheritances (an inheritance is also considered a gift). The form also includes instructions regarding the reporting of Foreign Trust Distributions.
Therefore, you may be required to file this form if you received either:
- A large gift
- A series of gifts from the same person
- A gift from a foreign business
- A foreign trust distribution
Sometimes, the IRS instructions can be a bit overwhelming. The form 3520 can be either relatively simple or more difficult depending on the nature of the gift or distribution you received. Some people choose to complete this form themselves (usually if they have a low, one-time gift and are not worried about getting audited). Other clients prefer to hire us despite the deceptively easy form, just for peace of mind. Whatever you choose, here are some key issues to consider:
1. What is the Type of Gift?
A gift is not limited to money. In other words, whether you received cash from overseas or other items that have cash value-you may be subject to reporting. Therefore, the first step is to evaluate the gifts you received from different foreign persons over the year and determine how much, in total, you received from individual.
*If you received a trust distribution, no matter what the value or amount of the distribution was, you will have to report it on form 3520.
2. What is the Value of the Gift?
The next step is to determine what the value of the gift is. Typically, individuals can use any reasonable exchange rate that was published during the year. Both the Internal Revenue Service and Department of Treasury sometimes publish different exchange rates. There is nothing wrong with picking one rate over the other if the rate is more beneficial to you during that year.
With that said, if you received different gifts from different countries, it may be in your best interest to use the same exchange rate source for each country location of the gift.
While this is not a hard and fast rule, maintaining consistency in reporting is one of the most important aspects of IRS reporting in order to try and avoid an unnecessary audit.
3. What is the Source of the Gift?
The source of the gift will determine the proper reporting requirements.
For example, when you receive a gift from a foreign person, the threshold is more than $100,000.
In other words, if you received a single gift from an individual who is a foreign person and the gift amount was $99,000 USD, then you would not have to report to the gift.
Alternatively, if you received two gifts from the same person each valued at $55,000 USD, then you would have to report the total amount of $110,000 in foreign gifts. Why? Because even though each gift was under $100,000 the total value of the gift from the individual during the year is over $100,000.
Foreign Corporation of Foreign Partnership
The threshold requirements for having to file a gift if you receive it from a foreign corporation or foreign partnership is significantly lower than it is for a foreign person. In fact, if you received foreign gifts from a foreign corporation or partnership that exceeds $15,671, then you are required to report.
*Unlike receiving a gift from a foreign person, in which you do not have to identify the name of the donor, if it is a foreign business then the IRS wants to know the name of the foreign business.
**Note: it may be beneficial for you if your foreign parents want to give you a gift but want to do it through the foreign corporation, to rather facilitate the gift to come from a foreign individual instead – a $50,000 gift from a foreign person does not need to be reported on form 3520 whereas a foreign gift of $50,000 from a foreign partnership needs to be reported.
As we’ve written about numerous times on different blog posts and for other publications – the IRS hates foreign trusts. The IRS believes any foreign trust is only being used for offshore tax and money laundering purposes. Obviously this is not true, but if you received any distribution of any amount from a foreign trust, then it needs to be reported.
While the reporting requirements for receiving a gift from a foreign person is not so bad at all, receiving a foreign trust distribution is brutal. Depending on various factors such as whether the recipient is a beneficiary or trustee of the trust, along with other issues such as related trusts and trust transfers, the reporting on form 3520 involving foreign trusts is complicated – you may want to speak with an experienced offshore disclosure lawyer first.
4. Don’t Forget to Complete Page 1 of Form 3520
No matter whether you are receiving distribution from an individual, corporation/partnership or trust, you will have to complete page 1 of form 3520. Page 1 is relatively straightforward and simply asks some background information regarding the taxpayer.
5. No Trust? Continue to Section IV
If you did not receive any distributions from a foreign trust, you can pass go and move all the way along to part IV. Part four asks very basic information regarding the foreign gift.
Namely, it just asks:
- The Date Of The Gift
- The Description Of The Property
- The Fair Market Value Of The Property
- The Donor (Foreign Businesses)
6. Don’t Forget to Sign the Form
On the bottom of page 6, you are required to sign this form. It is important that you sign the form, because if you do not sign a form the IRS may reject it.
7. Filing a Late Form 3520
This can be a problem. The reason why is because the IRS has authority to penalize you significant amounts of money based on the value of the gift if you do not report it.
The IRS takes this matter seriously mainly because of estate tax purposes. For a more comprehensive summary on this issue, please click here.
For a brief summary, consider the following: Michael receives a foreign gift of $10 million. When Michael receives the $10 million, it is not taxable to Michael. Five years later, Michael passes away. He is single, so there is no one to claim any portability. In addition, he does not have any charitable donations or other gifts to consider. At the time of his death, Michael’s estate would be taxed 40% of any amount over the value of the estate tax exclusion, which in 2017 is $5.49 million.
The tax liability is around $2 million. If Michael never filed Form 3520, then the IRS would not be aware that Michael had $10 million (since the gift was overseas and via multiple bank accounts as an inheritance he received from his aunt). Thereafter, the IRS learns Michael did not report this gift, they could severely penalize the estate upwards of 35% of the value of the gift — in addition to tax liability.
Get Into IRS Compliance
If you are seeking to get into compliance for a late filed 3520 there are few different alternatives.
The alternatives will depend on whether the form 3520 is a stand-alone issue, whether there are also other unreported foreign accounts, income, etc. in which the person may consider a streamlined application instead of a reasonable cause submission (presuming of course, that the individual was non-willful and/or had reasonable cause), the amount of unreported gift, inheritance or trust distribution, etc.
Typically, the best option may be for you to enter of the approved IRS Offshore Voluntary Disclosure Programs.
4 Types of IRS Offshore Voluntary Disclosure Programs
There are typically four types of IRS Offshore Voluntary Disclosure programs, and they include:
- Offshore Voluntary Disclosure Program (OVDP)
- Streamlined Domestic Offshore Procedures (SDOP)
- Streamlined Foreign Offshore Procedures (SFOP)
- Reasonable Cause (RC)
IRS Voluntary Disclosure of Offshore Accounts
Offshore Voluntary Disclosure Tax law is very complex. There are many aspects that go into any particular tax calculation, including the legal status, marital status, business status and residence status of the taxpayer.
When Do I Need to Use Voluntary Disclosure?
Voluntary Disclosure is for individuals, estates, and businesses who are out of compliance with the IRS and the Department of Treasury. What does that mean? It means that for one or more years, you were required to file a U.S. tax return, FBAR or other International Informational Return and you did not do so timely, then you are out of compliance.
Common Un-filed IRS International Tax Forms
Common un-filed international tax forms, include:
- 1040 (Tax Returns)
- Schedule B (Ownership or Signature Authority over Foreign Accounts)
- FBAR (FinCEN 114)
- FATCA (Form 8938)
- Form 3520 (Gift from Foreign Person)
- Form 5471 (Foreign Corporations)
- Form 8621 (Foreign Investments, aka PFIC)
- Form 8865 (Foreign Partnership)
If the IRS discovers that you are out of compliance, you may become subject to extensive fines and penalties – ranging from a warning letter all the way up to tax liens, tax levies, seizures, and criminal investigations. To combat this, you can take the proactive approach and submit to IRS Offshore Voluntary Disclosure.
Golding & Golding – Offshore Disclosure
At Golding & Golding, we limit our entire practice to offshore disclosure (IRS Voluntary Disclosure of Foreign and U.S. Assets). The term offshore disclosure is a bit of a misnomer, because the term “offshore” generally connotes visions of hiding money in secret places such as the Cayman Islands, Bahamas, Malta, or any other well-known tax haven jurisdiction – but that is not the case.
In fact, any money that is outside of the United States is considered to be offshore; the term offshore is not a bad word. In other words, merely because a person has money offshore (a.k.a. overseas or in a foreign country) does not mean that money is the result of ill-gotten gains or that the money is being “hidden.”
It just means it is not in the United States. Many of our clients have assets and bank accounts in their homeland countries and these are considered offshore assets and offshore bank accounts.
The Devil is in the Details…
If you do have money offshore, then it is very important to ensure that the money has been properly reported to the U.S. government. In addition, it is also very important to ensure that if you are earning any foreign income from that offshore money, that the earnings are being reported on your U.S. tax return.
It does not matter whether your money is in a country that does not tax a particular category of income (for example, many Asian countries do not tax passive income). It also does not matter if you are a dual citizen and/or if that money has already been taxed in the foreign country.
Rather, the default position is that if you are required to file a U.S. tax return and you meet the minimum threshold requirements for filing a U.S. tax return, then you have to include all of your foreign income. If you already paid foreign tax on the income, you may qualify for a Foreign Tax Credit. In addition, if the income is earned income – as opposed to passive income – and you meet either the Bona-Fide Resident Test or Physical-Presence Test, then you may qualify for an exclusion of that income; nevertheless, the money must be included on your tax return.
What if You Never Report the Money?
If you are in the unfortunate position of having foreign money or specified foreign assets that should have been reported to the U.S. government, but which you have not reported — then you are in a bit of a predicament, which you will need to resolve before it is too late.
As we have indicated numerous times on our website, there are very unscrupulous CPAs, Attorneys, Accountants, and Tax Representatives who would like nothing more than to get you to part with all of your money by scaring you into believing you are automatically going to be arrested, jailed, or deported because you have unreported money. While that is most likely not the case (depending on the facts and circumstances of your specific situation), you may be subject to extremely high fines and penalties.
Moreover, if you knowingly or willfully hid your foreign accounts, foreign money, and offshore assets overseas, then you may become subject to even higher fines and penalties…as well as a criminal investigation by the special agents of the IRS and/or DOJ (Department of Justice).
Getting into Compliance
There are five main methods people/businesses use to get into compliance. Four of these methods are perfectly legitimate as long as you meet the requirements for the particular mechanism of disclosure. The fifth alternative, which is called a Quiet Disclosure a.k.a. Silent Disclosure a.k.a. Soft Disclosure, is ill-advised as it is illegal and very well may result in criminal prosecution.
5 IRS Methods for Offshore Compliance
- Streamlined Domestic Offshore Procedures
- Streamlined Foreign Offshore Procedures
- Reasonable Cause
- Quiet Disclosure (Illegal)
We are going to provide a brief summary of each program below. We have also included links to the specific programs. If you are interested, we have also prepared very popular “FAQs from the Trenches” for FBAR, OVDP and Streamlined Disclosure reporting. Unlike the technical jargon of the IRS FAQs, our FAQs are based on the hundreds of different types of issues we have handled over the many years that we have been practicing international tax law and offshore disclosure in particular.
After reading this webpage, we hope you develop a basic understanding of each offshore disclosure alternative and how it may benefit you to get into compliance. We do not recommend attempting to disclose the information yourself as you may become subject to an IRS investigation insofar as you will have to answer questions directly to the IRS, which you can avoid with an attorney representative.
If you retain an attorney, then you will get the benefit of the attorney-client privilege which provides confidentiality between you and your representative. With a CPA, there is a relatively small privilege which does provide some comfort, but the privilege is nowhere near as strong as the confidentiality privilege you enjoy with an attorney.
Since you will be dealing with the Internal Revenue Service and they are not known to play nice or fair – it is in your best interest to obtain an experienced Offshore Disclosure Attorney.
OVDP is the Offshore Voluntary Disclosure Program — a program designed to facilitate taxpayer compliance with IRS, DOT, and DOJ International Tax Reporting and Compliance. It is generally reserved for individuals and businesses who were “Willful” (aka intentional) in their failure to comply with U.S. Government Laws and Regulations.
The Offshore Voluntary Disclosure Program is open to any US taxpayer who has offshore and foreign accounts and has not reported the financial information to the Internal Revenue Service (restrictions apply). There are some basic program requirements, with the main one being that the person/business who is applying under this amnesty program is not currently under IRS examination.
The reason is simple: OVDP is a voluntary program and if you are only entering because you are already under IRS examination, then technically, you are not voluntarily entering the program – rather, you are doing so under duress.
Any account that would have to be included on either the FBAR or 8938 form as well as additional income generating assets such as rental properties are accounts that qualify under OVDP. It should be noted that the requirements are different for the modified streamlined program, in which the taxpayer penalties are limited to only assets that are actually listed on either an FBAR or 8938 form; thus the value of a rental property would not be calculated into the penalty amount in a streamlined application, but it would be applicable in an OVDP submission.
An OVDP submission involves the failure of a taxpayer(s) to report foreign and overseas accounts such as: Foreign Bank Accounts, Foreign Financial Accounts, Foreign Retirement Accounts, Foreign Trading Accounts, Foreign Insurance, and Foreign Income, including 8938s, FBAR, Schedule B, 5741, 3520, and more.
What is Included in the Full OVDP Submission?
The full OVDP application includes:
- Eight (8) years of Amended Tax Return filings;
- Eight (8) Years of FBAR (Foreign Bank and Account Reporting Statements);
- Penalty Computation Worksheet; and
- Various OVDP specific documents in support of the application.
Under this program, the Internal Revenue Service wants to know all of the income that was generated under these accounts that were not properly reported previously. The way the taxpayer accomplishes this is by amending tax returns for eight years.
Generally, if the taxpayer has not previously reported his accounts, then there are common forms which were probably excluded from the prior year’s tax returns and include 8938 Forms, Schedule B forms, 3520 Forms, 5471 Forms, 8621 Forms, as well as proof of filing of FBARs (Foreign Bank and Financial Account Reports).
The taxpayer is required to pay the outstanding tax liability for the eight years within the disclosure period – as well as payment of interest along with another 20% penalty on that amount (for nonpayment of tax). To give you an example, let’s pick one tax year during the compliance period. If the taxpayer owed $20,000 in taxes for year 2014, then they would also have to include in the check the amount of $4,000 to cover the 20% penalty, as well as estimated interest (which is generally averaged at about 3% per year). This must be done for each year during the compliance period.
Then there is the “FBAR/8938” Penalty. The Penalty is 27.5% (or 50% if any of the foreign accounts are held at an IRS “Bad Bank”) on the highest year’s “annual aggregate total” of unreported accounts (accounts which were previously reported are not calculated into the penalty amount).
For OVDP, the annual aggregate total is determined by adding the “maximum value” of each unreported account for each year, in each of the last 8 years. To determine what the maximum value is, the taxpayer will add up the highest balances of all of their accounts for each year. In other words, for each tax year within the compliance period, the application will locate the highest balance for each account for each year, and total up the values to determine the maximum value for each year.
Thereafter, the OVDP applicant selects the highest year’s value, and multiplies it by either 27.5%, or possibly 50% if any of the money was being held in what the IRS considers to be one of the “bad banks.” When a person is completing the penalty portion of the application, the two most important things are to breathe and remember that by entering the program, the applicant is seeking to avoid criminal prosecution!
2. Streamlined Domestic Offshore Disclosure
The Streamlined Domestic Offshore Disclosure Program is a highly cost-effective method of quickly getting you into IRS (Internal Revenue Service) or DOT (Department of Treasury) compliance.
What am I supposed to Report?
There are three main reporting aspects: (1) foreign account(s), (2) certain specified assets, and (3) foreign money. While the IRS or DOJ will most likely not be kicking in your door and arresting you on the spot for failing to report, there are significantly high penalties associated with failing to comply.
In fact, the US government has the right to penalize you upwards of $10,000 per unreported account, per year for a six-year period if you are non-willful. If you are determined to be willful, the penalties can reach 100% value of the foreign accounts, including many other fines and penalties… not the least being a criminal investigation.
Reporting Specified Foreign Assets – FATCA Form 8938
Not all foreign assets must be reported. With that said, a majority of assets do have to be reported on a form 8938. For example, if you have ownership of a foreign business interest or investment such as a limited liability share of a foreign corporation, it may not need to be reported on the FBAR but may need to be disclosed on an 8938.
The reason why you may get caught in the middle of whether it must be filed or not is due largely to the reporting thresholds of the 8938. For example, while the threshold requirements for the FBAR is when the foreign accounts exceed $10,000 in annual aggregate total – and is not impacted by marital status and country of residence – the same is not true of the 8938.
The threshold requirements for filing the 8938 will depend on whether you are married filing jointly or married filing separate/single, or whether you are considered a US resident or foreign resident.
Other Forms – Foreign Business
While the FBAR and Form 8938 are the two most common forms, please keep in mind that there are many other forms that may need to be filed based on your specific facts and circumstances. For example:
- If you are the Beneficiary of a foreign trust or receive a foreign gift, you may have to file Form 3520.
- If you are the Owner of a foreign trust, you will also have to file Form 3520-A.
- If you have certain Ownerships of a foreign corporation, you have to file Form 5471.
- And (regrettably) if you fall into the unfortunate category of owning foreign mutual funds or any other Passive Foreign Investment Companies then you will have to file Form 8621 and possibly be subject to significant tax liabilities in accordance with excess distributions.
Reporting Foreign Income
If you are considered a US tax resident (which normally means you are a US citizen, Legal Permanent Resident/Green-Card Holder or Foreign National subject to US tax under the substantial presence test), then you will be taxed on your worldwide Income.
It does not matter if you earned the money in a foreign country or if it is the type of income that is not taxed in the country of origin such as interest income in Asian countries. The fact of the matter is you are required to report this information on your US tax return and pay any differential in tax that might be due.
In other words, if you earn $100,000 USD in Japan and paid 25% tax ($25,000) in Japan, you would receive a $25,000 tax credit against your foreign earnings. Thus, if your US tax liability is less than $25,000, then you will receive a carryover to use in future years against foreign income (you do not get a refund and it cannot be used against US income). If you have to pay the exact same in the United States as you did in Japan, it would equal itself out. If you would owe more money in the United States than you paid in Japan on the earnings (a.k.a. you are in a higher tax bracket), then you have to pay the difference to the U.S. Government.
3. Streamlined Foreign Offshore Disclosure
What do you do if you reside outside of the United States and recently learned that you’re out of US tax compliance, have no idea what FATCA or FBAR means, and are under the misimpression that you are going to be arrested and hauled off to jail due to irresponsible blogging by inexperienced attorneys and accountants?
If you live overseas and qualify as a foreign resident (reside outside of the United States for at least 330 days in any one of the last three tax years or do not meet the Substantial Presence Test), you may be in for a pleasant surprise.
Even though you may be completely out of US tax and reporting compliance, you may qualify for a penalty waiver and ALL of your disclosure penalties would be waived. Thus, all you will have to do besides reporting and disclosing the information is pay any outstanding tax liability and interest, if any is due. (Your foreign tax credit may offset any US taxes and you may end up with zero penalty and zero tax liability.)
*Under the Streamlined Foreign, you also have to amend or file 3 years of tax returns (and 8938s if applicable) as well as 6 years of FBAR statements just as in the Streamlined Domestic program.
4. Reasonable Cause
Reasonable Cause is different than the above referenced programs. Reasonable Cause is not a “program.” Rather, it is an alternative to traditional Offshore Voluntary Disclosure, which should be considered on a case by case basis, taking the specific facts and circumstances into consideration.
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