Form 3520 – IRS Penalties for Unreported Foreign Gifts or Trust Distributions
- 1 Form 3520
- 1.1 Why is Form 3520 Necessary?
- 1.2 Form 3520 – Earning Income From the Foreign Gift
- 1.3 Form 3520 –Estate Tax Purposes
- 1.4 Form 3520 – Gift vs. Inheritance
- 1.5 Form 3520 – Threshold requirements
- 1.6 3520 Penalties
- 1.7 FBAR (Report of Foreign Bank Accounts)
- 1.8 When Do I Need to Use Voluntary Disclosure?
- 1.9 Golding & Golding – Offshore Disclosure
- 1.10 The Devil is in the Details…
- 1.11 What if You Never Report the Money?
- 1.12 Getting into Compliance
The article, “Form 3520 – IRS Penalties for Not Reporting Foreign Gifts & Trust Distributions” was prepared by the International Tax Lawyers at Golding & Golding.
Form 3520 refers to individuals who received Foreign Gifts (including inheritances) from a Foreign Person or Foreign Business. It also includes receiving Foreign Trust Distributions.
Form 3520 – Annual Return To Report Transactions With. Foreign Trusts and Receipt of Certain Foreign Gifts is one of the most important international tax forms when it comes to Foreign Money (Foreign Gifts and/or Foreign Trust Distributions).
Why? Because even though Form 3520 is merely a reporting form for foreign gifts or trust distributions received from foreign persons, the IRS has the authority to issue extensive fines and penalties against any individual who fails to properly filed the form.
Why is Form 3520 Necessary?
There are many reasons why a Form 3520 may be necessary. While filing the form is used to report the receipt of a Foreign Gift from either a Foreign Individual or Foreign Business (or Foreign Trust Distribution) the form has a much more far reaching impact than just reporting the information. Moreover, in recent years (and with the enactment and enforcement of FATCA) the IRS has increased enforcement of this form.
The two main issues involving a form 3520 are usually the following:
Form 3520 – Earning Income From the Foreign Gift
At Golding & Golding, we like to use examples. Tax Law can de dense (read: Boring) and we don’t want you to be that bored this early in the article For example, let’s say Michelle received a million-dollar gift from a family member overseas. That gift is in the form of an investment fund that is spread throughout various different accounts and trading firms worldwide.
Thus, Michelle may have $500,000 in Hong Kong, a few hundred thousand dollars in Brazil, and some other investments scattered throughout China, Taiwan, and Portugal.
While the receipt of the gift is not taxable to Michelle (the recipient of the gift does not pay any income tax or gift tax) and the person who transferred the gift is not subject to any U.S. reporting (Michele’s grandma is a non-US person with no US reporting requirements) – what happens to the income generated from the gift?
In other words, while the gift itself is not taxable, the income being generated to Michelle from the Foreign Gift is absolutely taxable. Moreover, many foreign financial institutions (even with FATCA in play) do not issue 1099-INT or 1099-DIV equivalents to report distributions. Therefore, how would the Internal Revenue Service know that Michelle received a $1 million gift that is generating upwards of $70,000 – $100,000 a year in income?
By requiring individuals to file Form 3520, the IRS can track how much money and the type of gift Michelle received.
Form 3520 –Estate Tax Purposes
The Internal Revenue Service also likes to track whether a person who is subject to US tax (and may be subject to estate tax in the future) may have received foreign gifts (which in addition to other worldwide assets the individual owns) may lead to an estate tax issue.
Here’s another example: Scott is a US person who resides in Southern California. Scott has a net worth of $3.5 million. Therefore, if Scott passed away today, his estate would not be taxed. But, recently Scott received a $7 million gift from his grandma, which was an inheritance. Some of the money has been transferred to the United States while some of the funds remain abroad.
For U.S. Estate Tax purpose, it does not matter where Scott keeps the money or the assets. If Scott is the owner of the money/assets and he was to suddenly passed away, then his estate would have to pay estate tax on the value of the gift that exceeds (~$5.47 Million COLA).
But, since only half of the money was transferred to the United States, how would the IRS be aware of the additional $2-$3 million that Scott is the rightful owner of, but is located overseas? That is where Form 3520 comes in.
By requiring Scott to file a Form 3520, the IRS will be updated as to the value of Scott’s current assets.
Therefore, if Scott was to pass away and the estate tax laws have not changed, if the IRS did not know about Scott’s foreign assets, the IRS could be out upwards of $1 million.
Form 3520 – Gift vs. Inheritance
One technical nuance to keep in mind is that while all gifts are not inheritances, all inheritances are gifts. Therefore, if a person who is a U.S. person receives a foreign inheritance, it is considered a gift — and if it meets the threshold requirements required to file a Form 3520, then the person would have to file the Form 3520 to report the gift even though the gift is in the form of an inheritance.
Form 3520 – Threshold requirements
There are various threshold requirements for when a person is required to file a form 3520. The threshold requirements vary depending on whether the persons receiving a gift from a foreign individual, from a foreign business, or a trust distribution.
3520 – Foreign Gift From an Individual
When a person receives a foreign gift from an individual, they must report the receipt of the foreign gift on a form 3520 if the gift (in either one transaction or a series of transactions) exceeds $100,000 in any given tax year.
Therefore, whether or not you received a $150,000 gift from your mom, or received a series of $15,000 gifts from your mom in the same year – you would still have to file Form 3520.
3520 – Foreign Gift From a Business
The threshold requirements for having to file a Form 3520 upon the receipt of a gift from a business are much lower. If you received a foreign gift from a business that exceeds ~$15,000 COLA (Cost of Living Adjustment), then the person is required to file a form 3520 to report the gift.
3520 – Foreign Trust Distributions
With Foreign Trust Distributions, the IRS is very stringent. In fact, a person is required to file a form 3520 when he or she receives any trust distribution at all during the year from a foreign trust. There is no minimum threshold requirement for having to report the receipt of the trust. Therefore, if you are the beneficiary of a foreign trust in you received a trust distribution it is important that you file the form 3520 timely.
The penalties for failing to file form 3520 are located in Internal Revenue Code Section 6677, and are as follows:
– A penalty generally applies 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 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 or
– 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 or
– 5% of the gross value of the portion of the trust’s assets treated as owned by a U.S. person for failure by the U.S. person to report the U.S. owner information.
Additional penalties will be imposed if the noncompliance continues after the IRS mails a notice of failure to comply with the required reporting. For more information, see section 6677.
FBAR (Report of Foreign Bank Accounts)
If the gift is money or investment accounts which are being held in your name overseas, you may be subject to FBAR filing requirements.
An FBAR is a “Report of Foreign Bank and Financial Accounts” form. It is a form that is filed online directly with the Department of Treasury when a person, trust or business owner has more than an annual aggregate amount of $10,000 in foreign and overseas accounts.
The penalties for failing to file the FBAR can reach 100% value of the foreign accounts, so it is important that if you have not filed FBAR forms (or IRS Form 8938) that you get into compliance quickly.
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 if you are required to file a U.S. tax return and you don’t do so timely, then you are out of compliance.
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 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.
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.