Welcome news from IRS for late Form 3520 penalties

On its website, the IRS has announced that it has retired its Form 3520/3520A compliance campaign. In welcome relief for taxpayers, the IRS also indicates in updated IRM procedures that it will assert only one penalty — rather than the two that may be assessed under IRC Section 6677(b) — against US citizens and resident individuals who own foreign grantor trusts and fail to timely and accurately report their ownership, as required by IRC Section 6048(b), on both the Form 3520-A, Annual Information Return of Foreign Trust with U.S. Owner, and Form 3520, Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts, Part II.

The IRS’s approach in pursuing only one of two possible penalties for a US citizen or resident individual’s failure to timely report ownership of a foreign grantor trust is a welcome development and reduces double penalty exposure.

Background

US citizens and resident individuals who are settlors/grantors or beneficiaries of foreign trusts may be required to file Form 3520-A and/or Form 3520 to report (1) ownership of the trust, (2) transfers of property to the trust, or (3) distributions from the trust. Two separate penalties equal to 5% of the trust’s value (with a minimum penalty of $10,000) may apply for failure to report foreign trust ownership information on Form 3520-A and Form 3520, Part II. Separate penalties of up to 35% of a contribution to a foreign trust or 35% of a distribution from that trust (both with a minimum penalty of $10,000) may apply for failure to report the trust contribution or distribution on Form 3520.

LB&I compliance campaign

In May 2018, the IRS Large Business & International Division announced the rollout of an F3520/3520-A Non-Compliance and Campus Assessed Penalties campaign (see www.irs.gov) to “address noncompliance through a variety of treatment streams including . . . penalties assessed by the campus when the forms are received late or are incomplete” (see www.irs.gov, under the tab “Forms 3520/3520-A Non-Compliance and Campus Assessed Penalties”). Shortly thereafter, in November 2018, the IRS sent informational letters to taxpayers that it determined might have delinquent Form 3520 or 3520-A filing requirements (see www.irs.gov). At some point in 2019, taxpayers started to observe that late-filing Forms 3520 or 3520-A, even with a DIIRSP statement attached, was resulting in the automatic assessment of penalties, most often a flat $10,000 per form, or more if the assets reported rose above certain thresholds.

Following the receipt of a penalty assessment notice, the only administrative recourse for taxpayers with reasonable cause for their late filing is submitting a written abatement request to the service center that issued the notice. Some recent anecdotal evidence from tax practitioners indicates that these requests are routinely being denied. Following a denial from the service center, taxpayers may appeal the decision by submitting a written protest and engaging with an Appeals officer. Though many taxpayers have been able to successfully obtain penalty relief at this level, it can take well over a year from the submission of the initial abatement request until a resolution is reached with Appeals.

The IRS has in recent months begun sending increasingly collection notices to taxpayers, often starting just 30 days after the date of the initial penalty assessment. The notices inform the taxpayer that the IRS may file a notice of federal tax lien or levy assets to satisfy the penalty and, in some cases, result in a taxpayer’s account being referred to IRS Collections before the IRS even responds to the taxpayer’s abatement request.

Updated IRM procedures

The IRM instructs IRS employees on when to assess penalties related to the Form 3520-A and Form 3520, as well as when penalties should not be assessed, indirectly giving taxpayers some relief. Notably, IRM Section 20.1.9.13.4 provides that the IRS will pursue only one penalty, rather than two penalties as authorized under IRC Section 6677(b), for a US citizen or resident individual’s failure to timely and accurately report ownership of a foreign grantor trust on the Form 3520-A and Form 3520. Specifically, IRM Section 20.1.9.13.4 explains that the IRS will pursue penalties for failure to report ownership of a foreign grantor trust on the Form 3520-A but will not pursue penalties for failure to report such ownership on the Form 3520.

Bottom Line

The IRS’s retirement of its official Form 3520-A/3520 LB&I compliance campaign should not be interpreted as the end of the agency’s enforcement of these filings. While the official campaign has been retired, the IRS will continue asserting penalties for late, incomplete or inaccurate Forms 3520-A and Forms 3520 as provided in its penalty assessment procedures.

Taxpayers should therefore remain vigilant in ensuring that they timely comply with these filing requirements to avoid the imposition of significant penalties.

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