Form 3520 Penalties (2018) – Penalty Abatement & Reasonable Cause
Form 3520 Penalties (2018) – Penalty Abatement & Reasonable Cause
When it comes to receiving gifts or an inheritance from a foreign person — or a foreign trust distribution, you may have an IRS Form 3520 Reporting requirement.
In most situations, either a U.S. person receives a money gift or an inheritance from a foreign parent or relative (or a trust distribution) – and had no idea they were supposed to report the information to the IRS.
Foreign Gift Tax vs. Reporting
Presuming for the sake of example that the foreign person is not gifting U.S. Situs, in general there is no U.S. Tax on the receipt of a gift or inheritance from a foreign person (the rules for Foreign Trusts are complex and go far beyond this introductory article).
Why is There No U.S. Tax?
The reason there is no U.S. Tax is because if you receive a foreign property, asset, account, or investment gift/inheritance from a foreign person, the IRS does not have any authority over the foreign person. In other words, it is not as if the United States can just reach into Taiwan and try to levy a U.S. Tax against an individual who has no connection to the United States – the IRS has no jurisdiction.
Likewise, the IRS does not tax the U.S. recipient of the gift or inheritance from the foreign person when it involves foreign property.
Form 3520 Reporting
While there is no tax liability, there is a reporting requirement for the U.S. Person recipient of a gift from a foreign person. The main form is an IRS Form 3520 and there are various threshold requirements as to reporting depending on whether it is a gift/inheritance or a trust distribution, and whether the foreign person is a foreign individual, foreign business, or Foreign Trust (noting, there is no threshold requirements when it is received from a foreign trust).
When is the Form 3520 Due to be Filed?
The IRS Form 3520 is typically filed at the same time your file your tax returns. If you receive an extension for your tax return, then it will extend to form 3520 and they will be due at the same time.
What if You Did Not File Form 3520?
If a person does not file form 3520, there can be some significant penalties associated with the non-filing of the form in accordance with IRC 6677
IRC Section 6677
“A penalty applies if Form 3520 is not timely filed or if the information is incomplete or incorrect (see below for an exception if there is reasonable cause).
Generally, the initial penalty is equal to the greater of $10,000 or the following (as applicable): 35% of the gross value of any property transferred to a foreign trust for failure by a U.S. transferor to report the creation of or transfer to a foreign trust. 35% of the gross value of the distributions received from a foreign trust for failure by a U.S. person to report receipt of the distribution.
5% of the gross value of the portion of the foreign trust’s assets treated as owned by a U.S. person under the grantor trust rules (sections 671 through 679) for failure by the U.S. person to report the U.S. owner information.
Such U.S. person is subject to an additional separate 5% penalty (or $10,000 if greater), if the foreign trust (a) fails to file a timely Form 3520-A, or (b) does not furnish all of the information required by section 6048(b) or includes incorrect information. See section 6677(a) through (c) and the Instructions for Form 3520-A.
Additional penalties will be imposed if the noncompliance continues for more than 90 days after the IRS mails a notice of failure to comply with the required reporting. For more information, see section 6677.
Other Required IRS International Tax Forms
In addition to filing form 3520, depending on whether the gift receipt was a foreign account, specified foreign financial asset, and/or interest in a foreign business, there may be additional reporting requirements as well – and possibly other penalties you could be subject to.
IRS Offshore Penalty List
The following is a list of potential IRS penalties for unreported and undisclosed foreign accounts and assets:
A Penalty for failing to file FBARs
United States citizens, residents and certain other persons must annually report their direct or indirect financial interest in, or signature authority (or other authority that is comparable to signature authority) over, a financial account that is maintained with a financial institution located in a foreign country if, for any calendar year, the aggregate value of all foreign financial accounts exceeded $10,000 at any time during the year. The civil penalty for willfully failing to file an FBAR can be as high as the greater of $100,000 or 50 percent of the total balance of the foreign financial account per violation. See 31 U.S.C. § 5321(a)(5). Non-willful violations that the IRS determines were not due to reasonable cause are subject to a $10,000 penalty per violation.
FATCA Form 8938
Beginning with the 2011 tax year, a penalty for failing to file Form 8938 reporting the taxpayer’s interest in certain foreign financial assets, including financial accounts, certain foreign securities, and interests in foreign entities, as required by IRC § 6038D. The penalty for failing to file each one of these information returns is $10,000, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return.
A Penalty for failing to file Form 3520
Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts. Taxpayers must also 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 under IRC § 6048. 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 returns, or for filing an incomplete return, is the greater of $10,000 or 35 percent of the gross reportable amount, except for returns reporting gifts, where the penalty is five percent of the gift per month, up to a maximum penalty of 25 percent of the gift.
A Penalty for failing to file Form 3520-A
Information Return of Foreign Trust With a U.S. Owner. Taxpayers must also report ownership interests in foreign trusts, by United States persons with various interests in and powers over those trusts under IRC § 6048(b). The penalty for failing to file each one of these information returns or for filing an incomplete return, is the greater of $10,000 or 5 percent of the gross value of trust assets determined to be owned by the United States person.
A Penalty for failing to file Form 5471
Information Return of U.S. Persons with Respect to Certain Foreign Corporations. Certain United States persons who are officers, directors or shareholders in certain foreign corporations (including International Business Corporations) are required to report information under IRC §§ 6035, 6038 and 6046. The penalty for failing to file each one of these information returns is $10,000, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return.
A Penalty for failing to file Form 5472
Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business. Taxpayers may be required to report transactions between a 25 percent foreign-owned domestic corporation or a foreign corporation engaged in a trade or business in the United States and a related party as required by IRC §§ 6038A and 6038C. The penalty for failing to file each one of these information returns, or to keep certain records regarding reportable transactions, is $10,000, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency.
A Penalty for failing to file Form 926
Return by a U.S. Transferor of Property to a Foreign Corporation. Taxpayers are required to report transfers of property to foreign corporations and other information under IRC § 6038B. The penalty for failing to file each one of these information returns is ten percent of the value of the property transferred, up to a maximum of $100,000 per return, with no limit if the failure to report the transfer was intentional.
A Penalty for failing to file Form 8865
Return of U.S. Persons With Respect to Certain Foreign Partnerships. United States persons with certain interests in foreign partnerships use this form to report interests in and transactions of the foreign partnerships, transfers of property to the foreign partnerships, and acquisitions, dispositions and changes in foreign partnership interests under IRC §§ 6038, 6038B, and 6046A. Penalties include $10,000 for failure to file each return, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return, and ten percent of the value of any transferred property that is not reported, subject to a $100,000 limit.
Fraud penalties imposed under IRC §§ 6651(f) or 6663
Where an underpayment of tax, or a failure to file a tax return, is due to fraud, the taxpayer is liable for penalties that, although calculated differently, essentially amount to 75 percent of the unpaid tax.
A Penalty for failing to file a tax return imposed under IRC § 6651(a)(1)
Generally, taxpayers are required to file income tax returns. If a taxpayer fails to do so, a penalty of 5 percent of the balance due, plus an additional 5 percent for each month or fraction thereof during which the failure continues may be imposed. The penalty shall not exceed 25 percent.
A Penalty for failing to pay the amount of tax shown on the return under IRC § 6651(a)(2)
If a taxpayer fails to pay the amount of tax shown on the return, he or she may be liable for a penalty of .5 percent of the amount of tax shown on the return, plus an additional .5 percent for each additional month or fraction thereof that the amount remains unpaid, not exceeding 25 percent.
An Accuracy-Related Penalty on underpayments imposed under IRC § 6662
Depending upon which component of the accuracy-related penalty is applicable, a taxpayer may be liable for a 20 percent or 40 percent penalty
Possible Criminal Charges related to tax matters include tax evasion (IRC § 7201)
Filing a false return (IRC § 7206(1)) and failure to file an income tax return (IRC § 7203). Willfully failing to file an FBAR and willfully filing a false FBAR are both violations that are subject to criminal penalties under 31 U.S.C. § 5322. Additional possible criminal charges include conspiracy to defraud the government with respect to claims (18 U.S.C. § 286) and conspiracy to commit offense or to defraud the United States (18 U.S.C. § 371).
A person convicted of tax evasion
Filing a false return subjects a person to a prison term of up to three years and a fine of up to $250,000. A person who fails to file a tax return is subject to a prison term of up to one year and a fine of up to $100,000. Failing to file an FBAR subjects a person to a prison term of up to ten years and criminal penalties of up to $500,000. A person convicted of conspiracy to defraud the government with respect to claims is subject to a prison term of up to not more than 10 years or a fine of up to $250,000. A person convicted of conspiracy to commit offense or to defraud the United States is subject to a prison term of not more than five years and a fine of up to $250,000.
What Should You Do?
Everyone makes mistakes. If at some point that you should have been reporting your foreign income, accounts, assets or investments the prudent and least costly (but most effective) method for getting compliance is through one of the approved IRS offshore voluntary disclosure program.
Sean M. Golding, JD, LL.M., EA (Board Certified Tax Law Specialist)
Our Managing Partner, Sean M. Golding, JD, LLM, EA earned an LL.M. (Master’s in Tax Law) from the University of Denver and is also an Enrolled Agent (the highest credential awarded by the IRS, and authorizes him to represent clients nationwide.)
Mr. Golding and his team have successfully handled several hundred IRS Offshore/Voluntary Disclosure Procedure cases. Whether it is a simple or complex case, safely getting clients into compliance is our passion, and we take it very seriously.
He is frequently called upon to lecture and write on issues involving IRS Voluntary Disclosure.
Less than 1% of Tax Attorneys Nationwide are Board Certified Tax Law Specialists
Out of more than 200,000 practicing attorneys in California, less than 400 attorneys have achieved this Certified Tax Law Specialist designation.
The exam is widely regarded as one of (if not) the hardest tax exam given in the United States for practicing Attorneys.
Beware of Copycat Law Firms
Unlike other attorneys who call themselves specialists but are not “Board Certified,” handle 5-10 different areas of tax law, purchase multiple keyword specific domain names, and even practice outside of tax, we are absolutely dedicated to Offshore Voluntary Disclosure.
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4 Types of IRS Voluntary Disclosure Programs
There are typically four types of IRS Voluntary Disclosure programs, and they include:
- Traditional (IRM) IRS Voluntary Disclosure Program
- Streamlined Domestic Offshore Procedures (SDOP)
- Streamlined Foreign Offshore Procedures (SFOP)
- Reasonable Cause (RC)