What are Forms 3520 and 3520-A?
Form 3520, Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts, is used by U.S. persons to report certain transactions with foreign trusts, ownership of foreign trusts, or the receipt of large (greater than $100,000) gifts or bequests from certain foreign persons. The due date for filing Form 3520 is the same date as is for the U.S. person’s income tax return, including extensions. However, the form is filed separately from the U.S. income tax return.
Form 3520-A, Annual Information Return of Foreign Trust with a U.S. Owner, is filed by foreign trusts with at least one U.S. owner to provide the IRS with information about the trust, its U.S. beneficiaries, and any U.S. person treated as the trust’s owner (in the case of grantor trusts). Form 3520-A is due by the 15th day of the 3rd month after the trust’s tax year-end, March 15th, for calendar year trusts. However, an automatic 6-month extension can be filed using Form 7004.
The penalties for failure to timely file Forms 3520 and 3520-A under Internal Revenue Code (IRC) Section 6677 are the greater of $10,000 or the following as applicable:
- 35% of contributions to a foreign trust (Form 3520 Part I);
- 35% of distributions received from a foreign trust (Form 3520 Part III); and
- 5% of the gross value of the assets treated held by a foreign grantor trust at the end of the tax year and treated as owned by a U.S. person (Forms 3520 Part II and 3520-A)
In addition, under IRC section 6039F, a 5% to 25% penalty applies for failing to report the receipt of a gift or inheritance from a foreign person (Form 3520 Part IV). The aforementioned penalties should not apply if the filer has reasonable cause for the failure to file.
Historically, the IRS has automatically assessed penalties for late Forms 3520 and 3520-A filings without considering any reasonable cause statement included with the filing. These penalties could be significant, and taxpayers were forced to file a protest with the Independent Office of Appeals (Appeals) to have the penalties abated.
Update
On October 24, 2024, the National Taxpayer Advocate posted on its blog NTA Blog that the IRS announced it had ended its practice of automatically assessing penalties on late-filed Form 3520 submissions concerning foreign gifts and inheritances reported on Form 3520 Part IV and that by the end of the year, the IRS shall begin reviewing “reasonable cause” statements on late Forms 3520 and 3520-A before assessing penalties under IRC § 6677. The news was announced by IRS Commissioner Danny Werfel at the UCLA Extension Tax Controversy Conference, according to the post.
The post mentions that over the four years from 2018-2021, the abatement rate for Section 6677 penalties was 67% of the penalties assessed and 54% of the dollars assessed. Accordingly, the revised policy reduces undue hardship for taxpayers and the IRS by ending automatic penalties and implementing a pre-assessment review of reasonable cause statements for delinquent filings.
The change represents a victory for taxpayers, and we hope the IRS will soon apply the exact change to penalties resulting from other international information forms, such as Form 5472, which carries a similar “automatic” penalty of $25,000.
