Form 3520 and Penalties: Who Must File and What if You File Late?

Form 3520

While there are many different international information reporting forms that a U.S. taxpayer must be aware of when it comes to tax filing season, IRS Form 3520 might be one of the most important foreign IRS tax forms to file timely. Form 3520 is the Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts under 26 U.S.C. 6039F and the Form is used for many different purposes — with a focus on foreign gift and trust reporting. Some of the most common reasons Taxpayers must file Form 3520 are because the Taxpayer:

• • • Received a Gift from a Foreign Individual,

    • Received an Inheritance from a Foreign Individual,

    • Received a Foreign Trust Distribution,

    • Ownership of a Foreign Trust, and

    • Certain Transactions with Foreign Trusts.

For taxpayers seeking a shortened summary, we have our ‘5 Facts to Know About Form 3520,’ (Published by Golding & Golding in 2020, Updated in 2024) and other articles on specific issues such as Form 3520 threshold filing requirements, Exceptions, Penalties, and examples.

Why is Form 3520 So Important?

The reason why it is so important to file a timely Form 3520 is because when a taxpayer fails to file Form 3520 timely, it can lead to significant fines and penalties — upwards of 25% value of the gift or a portion of the trust depending on whether it is the owner or the beneficiary of the trust who fails to report timely.  Making matters worse, Form 3520 penalties are ‘automatically assessable penalties‘ and do not go through the deficiency procedures — a point the IRS and Treasury Department drove home in the proposed regulations published in May of 2024. With all the recent changes in updates to form 3520 come and let’s walk through some of the basics involving:

• • • Who Must File IRS Form 3520 and Examples

    • When is the Form 3520 Due

    • Additional Complexities For Foreign Trust Owners (4790, UNI/DNI, Throwback Rule)

    • Form 3520 Late Filing

    • Form 3520 Penalties (Deficiency Vs Automatically Assessable)

    • Foreign Gift and Trust Amnesty

Who Must File IRS Form 3520?

Form 3520 is required by taxpayers who receive a large gift from a foreign individual, foreign entity, or foreign trust — as well as certain transactions with a foreign trust including trust ownership and transfers.   There are some important nuances to be aware of as well. For example, the values of gifts from related parties may be aggregated for purposes of the reporting thresholds — in addition, when certain gifts are made directly to institutions such as universities for tuition or hospitals for medical care, these gifts are not reported on Form 3520.

When is Form 3520 Due?

The Form 3520 is due at the same time that a person’s tax return is filed, which is typically April — unless on automatic extension or one of the expat return dates apply. If a taxpayer wants to extend the time to file Form 3520 then they would have to extend the time to file their tax return. It is important to note, that the extension requirements for form 3520-A are different and that requires the taxpayer to file Form 7004.

Foreign Trust Reporting (4790, UNI/DNI, Throwback Rule)

While reporting foreign gifts on Form 3520 is relatively straightforward, foreign trust reporting could be much more complicated. That is because foreign trusts come in all different shapes and sizes, and sometimes the foreign trust information does not fit neatly on Form 3520. In addition, there are several other factors to consider when a person is reporting form 3520 for a foreign trust. Here are some common issues to be aware of:

Foreign Non-Grantor Trust Beneficiary Statement

If the taxpayer does not receive a non-grantor trust beneficiary statement, then the tax implications may be worse than they should be because the taxpayers are required to calculate income without the benefit of taking into consideration the nature of the distribution. In other words, if the taxpayer receives a foreign non-grantor trust beneficiary statement that might indicate certain distributions were non-taxable corpus for example, then it may impact whether the distribution was income to the taxpayer or a gift from the trust — and this can impact how the distribution is taxed.

UNI/DNI and Throwback

With a foreign trust, there are more strict rules involving the throwback rule and distributable net income versus undistributed net income. When DNI becomes UNI, then oftentimes the income loses certain beneficial characteristics that it may have had if it was distributed in that year that it was DNI (noting there are already some restrictions on characterizations of income for foreign trust versus domestic trusts). This can result in a higher tax liability to the U.S. beneficiary who received the distribution. Likewise, depending on how long the income was remaining in the foreign trust before was distributed in conjunction with the total amount of distributions in the past years, may result in an accumulation distribution and additional taxes slash interest. It may necessitate the following of Form 4790.

Exceptions Trust

When it comes to a foreign trust, there are some exceptions to having to report on Form 3520. For example, an RRSP or RRIF is exempt from having to file form 3520 under Revenue Procedure 2014-55. In addition, certain tax-favored retirement and non-retirement trusts may avoid having to file form 3520 although those exceptions are limited and taxpayers should carefully review the recent proposed regulations and Revenue Procedure 2020-17 to determine whether their foreign retirement trust may be exempt from reporting on Form 3520.

Form 3520 Late Filing Penalties

The Form 3520 late filing penalties can be significant, when the late filing refers to a large foreign gift, the taxpayer can be penalized 5% a month up to a total value of 25%. Referring back to the example above, if the taxpayer received the gift of $900,000 but filed Form 3520 several months late, they could be looking at a $225,000 penalty, along with interest if the taxpayer does not pay the penalty immediately when it is assessed. When it comes to a foreign trust, various penalties are depending on whether it is the beneficiary or the owner of the trust along with the total value of the trust and the person’s ownership in that foreign trust.

Examples of Form 3520 Reporting

Many different circumstances may require the filing of Form 3520 and Form 3520-A. One of the most common situations is when a U.S. person receives a gift or inheritance from a Non-Resident Alien. Other common situations include reporting the ownership of a foreign trust or receipt of foreign trust distributions. Taxpayers who filed late Form 3520 or 3520-A and have been penalized by the IRS may qualify for a penalty abatement if they can show reasonable cause and/or submit to one of the offshore disclosure programs. Let’s walk through some common examples of who must file Form 3520 and 3520-A. *For all examples, please note that the Taxpayers are U.S. persons for tax purposes who have not made any treaty elections to be treated as a Non-Resident Alien (NRA). Also, these examples are for illustrative purposes only and Taxpayers should consult with a Board-Certified Tax Law Specialist if they have specific questions about their reporting requirements and not rely on this article for legal advice.

Form 3520 Foreign Gift

One of the most common scenarios involves when a U.S. person receives a gift from a non-resident alien (NRA) that exceeds the threshold for filing:

• • • Example: Dana is a U.S. Citizen but the rest of her family are non-resident aliens who live abroad. Her aunt is very proud that Dana graduated college and gifted her $400,000 to help her purchase a new home. Dana may have to file Form 3520.

    • Example: Devin is a Lawful Permanent Resident who currently attends school in the United States. Devin’s grandma is a non-resident alien who wants to help Devin with expenses — and gifted him $200,000 to help him supplement his expenses. Even if Devin does not use all the money for expenses, his grandma made it clear that the full amount is a gift to Devin. Devin may have to file Form 3520.

    • Example: Denise’s mom is a non-resident alien who wants to gift Denise and her sister each 15% in a foreign business. The value of the shares that Denise receives are $500,000. Even though Denise did not receive money, and the business is located outside of the United States, she may have to file Form 3520.

    • Example: Daniel is a visa holder who meets the substantial presence test. His dad gifted him a foreign rental property worth $600,000 so that Daniel can both own the property and collect any rents that are paid. Even though the rental property is located outside of the United States, Daniel still received a gift from a non-resident alien and may have to file Form 3520.

Form 3520 Foreign Inheritance

For purposes of Form 3520, the IRS takes the position that an inheritance is a type of gift and therefore if the Taxpayer receives an inheritance from a non-resident alien, it is reportable on Form 3520.

• • • Example: Brenda is a Lawful Permanent Resident who lives in the United States and recently received a $600,000 inheritance from her foreign mother who passed away. The inheritance is comprised of foreign property and assets and have not been transferred to the U.S. Even though no money or assets have been transferred to the United States, Brenda may still have to file Form 3520.

    • Example: Bill is a U.S. Citizen who received a $3,000,000 inheritance when his foreign father passed away. While it is a large sum of money and Bill is not required to pay any taxes on the inheritance, he may have to file Form 3520.

    • Example:  Belinda is a Lawful Permanent Resident who has several family members living overseas. Her mother also a Lawful Permanent Resident who lives in a foreign country. Belinda’s mom recently passed away and left Belinda $1,000,000. Even though Belinda’s mom lives outside of the United States, because she is a ‘U.S. person for tax purposes,’ Belinda is not required to file a Form 3520 when receiving this inheritance.

Form 3520 Trust Distribution

When a person receives a trust distribution from a foreign trust, the U.S. beneficiary is required to report the distribution on Form 3520 — but the tax implications of the distributions will vary depending on the type of foreign trust.

• • • Example: Steven is a U.S. Person who is a beneficiary of a foreign non-grantor trust. He received a $70,000 distribution in the current year from the foreign trust and is therefore required to file a Form 3520 — as well as include the trust distribution as income.

    • Example: Sam is a U.S. Person who is a beneficiary of a foreign grantor trust. Sam also received a $70,000 distribution in the current year from the foreign trust. Even though Sam is required to report the trust distribution on Form 3520, generally it is the grantor of a grantor trust who is required to pay tax on the income and not the beneficiary. (If the grantor of the foreign trust is a U.S. person and/or the trust contains both U.S. and foreign assets, it can further complicate the reporting).

Form 3520/3520-A Ownership of Foreign Trust

When a Taxpayer has ownership of a foreign trust, they may be required to file form 3520 and form 3520-A. The reporting requirements for ownership of a foreign trust are typically more complicated than when a taxpayer files a Form 3520 to report the receipt of a gift or distribution.

• • • Example: Denise is a U.S. Citizen who has non-resident alien family members living abroad. Her sisters — who are all non-resident aliens– decided to form a foreign trust and wanted to include Denise as one of the owners. Now that Denise is an owner of the foreign trust, she is required to report her ownership on form 3520 and 3520-A.

    • Example: Daniel is a Lawful Permanent Resident who recently became a U.S. person in the current year. Now that Daniel is a Lawful Permanent Resident and a U.S. person for tax purposes, his ownership in his foreign trust is now reportable on Form 3520 and 3520-A (U.S. owner of a foreign trust). In other words, even though the only action Daniel took was to become a U.S. person, his previous ownership in a foreign trust that he owned before becoming US person is now reportable.

Related Persons

An important rule to remember is that when Taxpayers receive a gift from foreign persons and those persons are related, then all of the gifts from related persons are aggregated together to determine whether the threshold requirements are met. This is to prevent taxpayers from ‘gift splitting’ to avoid reporting when the gifts are coming from the same related person. It is also important to note that related parties can include individuals or entities.

Trust Reporting Exceptions (2020-17 and Proposed Regulations)

For some Taxpayers who have a foreign trust that qualifies as a tax-deferred retirement or non-retirement savings plan, they may be able to avoid reporting if they qualify for the exception under Revenue Procedure 2020-17 (and the recently proposed foreign trust regulations). Not all foreign savings plans will qualify, so it is important that Taxpayers carefully evaluate the different requirements to see if the type of tax-deferred savings accounts they have is eligible for the exception.

The Tip of the Iceberg

The goal of this article is to help clarify some of the basics of Form 3520/3520-A. Reporting foreign assets to the U.S. tax authorities can be very complicated, especially when it involves additional items such as foreign life insurance policies, foreign corporations, foreign partnerships, and transactions between U.S. persons and foreign companies. Taxpayers should try to stay in compliance if they are already in compliance or should consider getting into compliance if they have not properly filed the necessary reporting forms if for no other reason than the fact that the IRS has made offshore compliance a key enforcement priority and has been issuing fines and penalties for non-compliance. 

Late Filing Penalties May be Reduced or Avoided

For Taxpayers who did not timely file their FBAR and/or 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.  *This resource may help Taxpayers seeking to hire offshore tax counsel: How to Hire an Offshore Disclosure Lawyer.

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.