Deficiency Procedures Do Not Apply to Form 3520 (or Do They?)

Deficiency Procedures Do Not Apply to Form 3520

For the past several years, the Internal Revenue Service has specifically targeted international information reporting noncompliance as a key enforcement priority. Oftentimes, U.S. taxpayers are penalized extensively for their failure to report foreign accounts, assets, investments, trusts, and gifts — even when there is no unreported income. In general, U.S. persons who receive gifts or inheritances from non-us persons are even more susceptible to penalties even though no income is missed on their tax return because the IRS does not follow deficiency procedures when they assess form 3520 penalties. Rather, these penalties are automatically assessed. However, there have been two recent Tax Court decisions in Farhy and Murkhi for a similar type of international information reporting form (Form 5471), which may in turn impact how the IRS will be able to automatically assess penalties under Form 3520.

Common Form 3520 Penalty Example

Here is a common example: Jennifer is a permanent resident who is originally from a foreign country. She recently graduated from University and then Graduate School and wants to purchase her first home. Unfortunately, Jennifer does not have any credit established yet in the United States and is not qualified for a mortgage. Therefore, Jennifer’s parents — who are non-U.S. persons (non-resident aliens) – gift Jennifer $1,000,000 gift so that she can purchase a home. Jennifer uses the money to purchase the home and she does not have any other foreign accounts, assets, or unreported income

A few years later, Jennifer realized that she should have filed IRS Form 3520. Since her failure to file the form is more than five months late she is assessed the maximum penalty of 25% (5% per month up to a total maximum of 25%) of $250,000.

Form 3520 Insanity and Absurdity Entwined

Taking a step back and looking at this penalty, the individual who is being penalized did not miss filing any income on her tax return. She did not fail to report Form 8938 for her foreign assets (FATCA) or fail to file FinCEN Form 114 (FBAR) for financial accounts. She literally only received a gift from her mom and dad — and now the IRS wants to take $250,000 of it away as a penalty.

The IRS Does Not Follow Deficiency Procedures

When it comes to issuing international information reporting form penalties on Form 3520, the Internal Revenue Service does not follow deficiency procedures. In other words, the Internal Revenue Service simply issues the CP15 notice and automatically assesses the Taxpayer a penalty without providing her any opportunity to pre-challenge the penalty through deficiency procedures. Technically, the taxpayer can file a reasonable cause submission, but oftentimes it takes a few go-arounds for the strategy to work. Likewise, taxpayers used to be able to submit a DIIRSP and avoid penalties, but in November of 2020, the IRS essentially did away with the penalty waiver under DIIRSP.

Farhy and Murkhi to The Rescue, Maybe

Recently, in the past year there have been two Tax Court cases involving automatically assessed penalties involving a similarly situated form, Internal Revenue Service Form 5471 which is used to report foreign corporations. Similarly to Form 3520, the Internal Revenue Service issues penalties for Form 5471 by automatically assessing them and not going through deficiency procedures. In both of these two tax court cases, the court disagreed with the IRS and said they did not have the authority to do so. Unfortunately, these decisions may be short-lived, because in Farhy, the government already filed its Notice of Intent to Appeal and Murkhi was only recently issued in the past 1-2 weeks. Hopefully, a Form 3520 penalty assessment case is just around the corner.

Late Filing Penalties May be Reduced or Avoided

For Taxpayers who did not timely file their FBAR and other international information-related reporting forms, the IRS has developed many different offshore amnesty programs to assist taxpayers with safely getting into compliance. These programs may reduce or even eliminate international reporting penalties.

Current Year vs Prior Year Non-Compliance

Once a taxpayer missed the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, taxpayers should consider speaking with a Board-Certified Tax Law Specialist who specializes exclusively in these types of offshore disclosure matters.

Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)

In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful Taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties. 

Need Help Finding an Experienced Offshore Tax Attorney?

When it comes to hiring an experienced international tax attorney to represent you for unreported foreign and offshore account reporting, it can become overwhelming for taxpayers trying to trek through all the false information and nonsense they will find in their online research. There are only a handful of attorneys worldwide who are Board-Certified Tax Specialists and who specialize exclusively in offshore disclosure and international tax amnesty reporting. 

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure. 

Contact our firm today for assistance.