The Form 3520 Penalties and Abatement Procedure Explained

Form 3520 Penalties and Abatement Procedure

In recent years, the Internal Revenue Service has significantly increased enforcement of the Form 3520 filing requirements. Form 3520 is used for several different reasons, but one of the primary purposes of the form is for U.S. Persons to report large foreign gifts and inheritances that they receive from non-resident aliens (NRA). Even though there is generally no tax implication when receiving a foreign gift, the U.S. person is still required to report the receipt of the foreign gift on Form 3520. When a Taxpayer fails to report the receipt of the gift, they may become subject to fines and penalties — although the IRS has developed various offshore amnesty programs to assist Taxpayers with safely getting into compliance when filing late Form 3520. Since there has been an uptick in 3520 penalty assessments against Taxpayers who did not timely file the form, let’s review Form 3520 penalties along with examples and defenses.

*Golding & Golding previously published the How to Fight Form 3520 Penalties for Late-Filing Explained article back in 2022 and has since updated and expanded the list.

First, a Gift vs Loan

Before jumping into the Form 3520 filing requirements for Taxpayers who receive a gift from a non-resident alien, it is important to note that a Taxpayer is required to file a Form 3520 to report a gift, not a loan. If instead of a gift, the Taxpayer received a loan then this may not require reform 3520 — it will depend on the specific facts and circumstances of the transaction.

Individual Large Foreign Gift Example

Jake is a Lawful Permanent Resident who has family members overseas who are all non-U.S. persons. A few years ago, Jake received a $700,000 gift from his mom to help Jake purchase a home in the United States since Jake does not have any credit and cannot qualify for a mortgage. Jake is required to report this gift on form 3520.

Entity Large Foreign Gift Example

Roger is a U.S. Person with foreign national parents who own a company. The parents want to give Roger a gift, but they do not want him to pay any income tax on it. Also, the parents do not want to deal with the tax implications of issuing dividends from their corporation in the foreign country to Jake in the U.S. Therefore, Roger’s parents give Roger a $40,000 gift from the foreign entity. Since the gift is from a foreign entity and the threshold requirement is much less than it is from an individual, Roger is required to file Form 3520.

Multiple Gifts Example

Ricky is a U.S. citizen who naturalized about 10 years ago. His family members are all still non-resident aliens and they wanted to get together to give Ricky a gift for graduating medical school. They are hoping the gift will help Ricky purchase a new home. Four of Ricky’s family members each gave Ricky $75,000 in the same year. Even though not one individual gave Ricky more than $100,000, related parties together gave Ricky more than $100,000 in the same year, Ricky still must file Form 3520.

Large Foreign Inheritance

Rachel is a U.S. person who received a large foreign inheritance from her family abroad. From a technical standpoint, an inheritance is a type of gift. For estate tax purposes there are key distinctions — but from an IRS reporting perspective an inheritance is a gift (not income), and the recipient is required to file Form 3520.

Foreign Trust Distribution

Lou is a Lawful Permanent Resident who moved to the United States a few years ago. He is a discretionary beneficiary on a foreign family member’s trust. The trust had a windfall and distributed $25,000 to Lou. Since (currently) there is no threshold requirement for having to report for trust distributions, Lou is required to report this distribution on Form 3520.

*Some Taxpayers may try to make a distinction between a gift and their trust distribution when it is from the trust, but the IRS generally takes the position that if it came out of the trust it does not have to meet the $100,000 threshold.

Foreign Trust Ownership

Lynn initially came to the United States on an L-1 transfer visa and then became a Lawful Permanent Resident. Along the way, when Lynn realized, she was going to remain in the United States she decided to form a foreign trust to help provide distributions to family members living abroad. Since the land is the owner of a foreign trust she’s required to file form 3520 (along with form 3520-A).

Defenses to Late-Filed IRS Form 3520 Penalties

While Form 3520 penalties can be rough, taxpayers have many different options available to them to defend against (or avoid) Form 3520 penalties. Taxpayers have the opportunity to try to avoid the penalty through offshore disclosure if they have not yet been penalized — or if they have already been issued penalties (or as an alternative to offshore disclosure) they may have the opportunity to abate the penalties by proving reasonable cause and not willful neglect. While there are many different types of arguments a taxpayer can make to challenge the Form 3520 penalty, let’s look at five (5) of the common defenses taxpayers can use to defend against a late file Form 3520 penalty, by referencing the Internal Revenue Manual which effectively lays out the different options for taxpayers.

What is Reasonable Cause?

Reasonable cause is the concept that if the taxpayer can show they offer a sufficient explanation to convince the IRS agents that while they were non-compliant, they should not be penalized — then sometimes the IRS will avoid issuing a penalty, or abate a penalty that was already issued.

As provided by the IRM:

• • • “Reasonable cause is determined on a case by case basis considering all the facts and circumstances of your situation.

      • Reasons that qualify for relief due to reasonable cause depend on the type of penalty you owe and the laws in the Internal Revenue Code (IRC) for each penalty.

      • Reasonable cause doesn’t apply to certain penalties such as the estimated tax penalty.

      • For businesses, the reasons apply to the person with authority to submit the return, deposit, or tax.”

An important takeaway from the definition of Reasonable Cause is that it is based on each Taxpayer’s facts and circumstances – on a case-by-case basis. Thus, just because one Taxpayer qualifies for Reasonable Cause does not mean that a Taxpayer in a similar situation will also qualify for reasonable cause.

Information Return Penalty Relief

• • • “If you can show reasonable cause for failing to file accurate, timely information returns or payee statements, we may consider penalty relief if you prove:

      • • “You acted in a responsible manner both before and after the failure by having:

        • Requested extensions of time to file when possible

        • Tried to prevent a foreseeable failure to file on time

        • Fixed any issues causing the failure

        • Corrected the fail ure as quickly as possible

    • Along with acting in a responsible manner, you must also prove there were significant mitigating factors with respect to the failure or the failure happened due to events beyond your control such as:

      • • First time filer of the particular form or statement

        • Good compliance history

        • Actions by the IRS

        • Actions of an agent

        • Actions of another person

        • Access to relevant business records

        • Economic hardships that prevented electronic filing”

Since the failure to file international returns is a very common scenario that leads to IRS fines and penalties, the IRS provides several factors that can help bolster a Reasonable Cause submission. Factors such as a good compliance history and resolving the issue sooner than later may contribute to a successful reasonable cause submission package.

Other Factors to Consider for Reasonable Cause

• • “The following factors don’t generally qualify as valid reasons for failure to file or pay a tax on time:

    • “Reliance on a tax professional. You’re generally responsible for complying with tax law even if someone else handles your taxes. You should know what your tax preparer files and get proof that your return or payment is sent on time.

    • Lack of knowledge. You’re responsible for knowing or getting advice on how to file returns and pay or deposit taxes on time. This includes filing requirements, deadlines and amounts you owe.

    • Mistakes and oversights. You’re responsible for making sure your tax returns, payments and deposits are correct and on time. In certain cases, reasonable cause may apply to a mistake if additional facts and circumstances show that you tried to comply with tax law.

    • Lack of funds. By itself, lack of funds is not reasonable cause for failing to pay or deposit taxes due. However, you may qualify for relief based on other facts and circumstances that show you used reasonable care and tried to comply with tax law.”

It is important to note that the IRS is not stating these factors are not valid, but that generally they do not qualify.

This goes back to the concept of the ‘case-by-case basis,’ and that each Taxpayer must present their own story to the IRS based on all the factors to try to meet the reasonable cause exception to penalties. For example, while professional reliance will not always qualify for reasonable cause if the Taxpayer (in international tax matters) can meet certain requirements as set forth by the LB&I concept unit, then Reasonable Cause may still apply.

Mistake Was Made

While typically, making a mistake is not sufficient to avoid a Form 3520 penalty, sometimes if the taxpayer has specific facts and circumstances to support a penalty waiver of a late-filed Form 3520 Penalty for a mistake — especially when it was the first time the form was required to be filed.

As provided by the IRM:

• • • The taxpayer may try to establish reasonable cause by claiming a mistake was made. Generally, this is not in keeping with the ordinary business care and prudence standard and does not provide a basis for reasonable cause.

      • However, the reason for the mistake may be a supporting factor if additional facts and circumstances support the determination that the taxpayer exercised ordinary business care and prudence but nevertheless was unable to comply within the prescribed time.

      • Information to consider when evaluating a request for an abatement or non-assertion of a penalty based on a mistake or a claim of ignorance of the law includes, but is not limited to the following:

        • When and how the taxpayer became aware of the mistake.

        • The extent to which the taxpayer corrected the mistake.

        • The relationship between the taxpayer and the subordinate (if the taxpayer delegated the duty).

        • If the taxpayer took timely steps to correct the failure after it was discovered.

Erroneous Advice or Reliance

One very common way that taxpayers can try to avoid or abate a Form 3520 penalty for filing a late form is to show that they received erroneous advice from a tax professional who is experienced in these types of matters. Noting, it is not as simple as a taxpayer showing that they relied on a tax professional, but additional elements must be met.

As provided by the IRM:

• • • Each request for penalty relief should be reviewed thoroughly to determine the exact basis of the taxpayer’s request.

      • Is the taxpayer claiming they did not comply due to specific advice they received from someone, whether orally or in writing, or

      • Is the taxpayer claiming they relied on someone else to comply on their behalf?

    • Certain sections of the IRC and Treasury Regulations provide relief from certain penalties based on erroneous advice. See IRM 20.1.1.3.3.4, Advice, to first determine if a statutory exception or administrative waiver applies.

      • If the taxpayer states they relied on written or oral advice from the IRS but does not qualify for relief in accordance with the criteria in IRM 20.1.1.3.3.4.1, Written Advice From the IRS, or IRM 20.1.1.3.3.4.2, Oral Advice From the IRS, refer to IRM 20.1.1.3.2.2, Ordinary Business Care and Prudence, to determine if the taxpayer exercised ordinary business care and prudence in relying on the IRS’s advice.

      • The taxpayer may try to establish reasonable cause by claiming they relied on another party to comply on their behalf. Generally, this is not a basis for reasonable cause, particularly for filing or paying obligations, since the taxpayer is responsible for meeting their tax obligations and that responsibility cannot be delegated. However, other factors to consider include:

        • Was the taxpayer unable to comply because they did not have access to their own records? See IRM 20.1.1.3.2.2.3, Unable to Obtain Records.

        • Was the failure to comply due to a change in the tax law the taxpayer could not reasonably be expected to know? See IRM 20.1.1.3.2.2.6, Ignorance of the Law.

        • Consider all facts and circumstances presented by the taxpayer to determine if, despite the exercise of ordinary business care and prudence, the taxpayer nevertheless was unable to comply.

Ignorance of the Law

In some situations, if the taxpayer can show that there was an ignorance of the law, this too may qualify to avoid a late-filed Form 3520 penalty. In these types of situations, it is based primarily on the taxpayer’s education — along with other factors, such as whether or not the Taxpayer had been penalized for this type of violation in prior years.

• • • In some instances taxpayers may not be aware of specific obligations to file and/or pay taxes. The ordinary business care and prudence standard requires that taxpayers make reasonable efforts to determine their tax obligations. See IRM 20.1.1.3.2.2, Ordinary Business Care and Prudence.

    • Reasonable cause may be established if the taxpayer shows ignorance of the law in conjunction with other facts and circumstances. For example, consider the following:

      • The taxpayer’s education.

      • If the taxpayer has previously been subject to the tax.

      • If the taxpayer has been penalized before.

      • If there were recent changes in the tax forms or law which a taxpayer could not reasonably be expected to know.

      • The level of complexity of a tax or compliance issue.

    • Reasonable cause should never be presumed, even in cases where ignorance of the law is claimed.

    • The taxpayer may have reasonable cause for noncompliance due to ignorance of the law if the following are true:

      • A reasonable and good faith effort was made to comply with the law, or

      • The taxpayer was unaware of a requirement and could not reasonably be expected to know of the requirement.

Was the Gift directly made for Medical Purposes or Education?

Taxpayers need to be aware of what does NOT qualify as a gift as well —

As provided by the IRS:

• • • “A gift to a U.S. person does not include any amount paid for qualified tuition or medical payments made on behalf of the U.S. person.”

Offshore Disclosure Before a Penalty is Issued

Offshore Disclosure is not a defense, insomuch as it is an opportunity for a taxpayer to make a proactive submission to the Internal Revenue Service seeking to avoid penalties before they are issued. This way, the taxpayer can take the lead and make an offshore disclosure to the Internal Revenue Service using one of the international tax amnesty programs. Depending on which program the taxpayer qualifies for they may have a reduced penalty or their penalty may be avoided altogether.

Late Filing Form 3520-A Penalties May be Reduced or Avoided

For Taxpayers who did not timely file their Form 3520-A 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. 

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.