Tax Law Center Blog

IRS Form 3520, a critical international compliance document, requires meticulous attention, particularly Part IV, which involves the receipt of substantial foreign gifts and inheritances. For advisors, understanding the specific audit triggers associated with this section is critical to guiding clients toward compliance and mitigating potential IRS scrutiny. While audits specifically focused on Form 3520 Part IV are relatively rare compared to other areas, the potential consequences of non-compliance necessitate diligent preparation and adherence to reporting requirements. Failure to comply can result in significant penalties and potentially initiate a broader audit.

Form 3520 Part IV mandates reporting when a U.S. person receives gifts or inheritances exceeding a total $100,000 threshold from foreign individuals or estates.  The IRS scrutinizes in this area due to the potential for tax evasion, and while Form 3520 audits are not common, the triggers outlined below can still prompt examination. Understanding these triggers and ensuring preparedness is a critical part of responsible tax planning.

Possible Audit Triggers for Form 3520 Part IV:

• Non-Filing Above Thresholds: The most direct trigger, even if rare, is the failure to file Form 3520 when the value of foreign gifts or inheritances surpasses the statutory limit. The IRS utilizes international data and financial institution reporting to identify unreported transfers, making non-filing a significant red flag that can initiate an audit.
• Incomplete or Inaccurate Reporting: Even with filing, errors can invite audits, albeit potentially as part of a broader return review. Common mistakes include understating asset values, misidentifying the gift’s source, omitting crucial details, and inconsistencies with reported income. The IRS scrutinizes valuations, especially for non-cash assets, and discrepancies can prompt further investigation.
• Patterns of Gifts Approaching Thresholds: While individual gifts might fall below the reporting threshold, a recurring pattern of gifts from the same foreign source that collectively exceeds the limit, even if not a primary audit driver, can raise concerns.
• Gifts from Entities with Opaque Ownership: Receiving gifts from foreign entities with unclear ownership structures can raise concerns about the true source of funds and potential tax avoidance, potentially leading to inquiries during an audit. The IRS may investigate the entity’s background and the transaction’s legitimacy.
• Gifts from High-Risk Jurisdictions: Gifts originating from individuals or entities in jurisdictions known for tax secrecy may attract increased IRS attention, even if such audits are infrequent. These transfers can elevate the likelihood of review as part of a broader examination.
• Lack of Supporting Documentation: Taxpayers must retain documentation substantiating the reported information. While a specific Form 3520 audit might be rare, the inability to provide documentation during any audit can lead to penalties and further scrutiny.
• Connections to Other International Compliance Issues: Existing international reporting issues, like unreported foreign bank accounts (FBARs) or foreign trusts, can lead the IRS to examine foreign gift receipts as part of a broader compliance review, making Form 3520 a relevant area of inquiry.
• Amended or Late Filings: While necessary in some cases, amended or late Form 3520 filings can signal potential compliance issues and prompt closer examination by the IRS.

Mitigating Audit Risk (Even if Audits are Rare):

• Client Education: Proactively inform clients about Form 3520 Part IV requirements and thresholds.
• Thorough Fact-Finding: Diligently identify all foreign gifts and inheritances.
• Accurate Valuation and Documentation: Ensure precise valuation and maintain comprehensive supporting documentation.
• Clear Donor Identification: Accurately identify the donor and the nature of the transfer.
• Timely Filing: Emphasize the importance of meeting filing deadlines.
• Professional Guidance: Advise clients to seek expert tax counsel for complex situations.

While dedicated audits focusing solely on Form 3520 Part IV might be infrequent, the potential for these issues to arise during a broader audit underscores the importance of meticulous compliance. By prioritizing accurate reporting and maintaining thorough records, tax advisors play a crucial role in protecting their clients and navigating the complexities of international reporting obligations.