Everything That You Need To Know About International Tax Penalties

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Everything That You Need To Know About International Tax Penalties

International information return penalties are civil penalties assessed by the IRS against a United States person for failing to timely file complete and accurate international information returns required by specific Internal Revenue Code (IRC) sections.  Those information returns cover a broad spectrum of reporting obligations, and include IRS Forms 5471, 5472, 3520, 3520-A, 8938, 926, 8865, 8621, 8858 and others.

U.S. taxpayers are required to report their worldwide income. International information returns require taxpayers to report information relating to foreign assets, interests in various entities, certain transactions, and information relating to foreign-sourced income.

As a general matter, international information returns are required for entities or events that the taxpayer has “control” over or that the taxpayer has the power or authority to administer or that the taxpayer is beneficiary of.  However, the reporting obligations under the Code or substantially more expansive and cover various other reporting matters.

Returns that are filed but that are not substantially complete and accurate are considered “un-filed” and may result in penalty assessments.

Certain international information returns are also considered un-filed if the taxpayer does not provide required information when requested by the IRS, and penalties may be assessed even if the required return has been submitted.

A U.S. person may have several reporting obligations for a particular tax year and thus may have exposure to multiple penalty assessments.  Penalties may apply to each information return that was required to be filed for each year.

Common Terms

U.S. Person—Generally, the term “U.S. person” includes citizens or residents of the United States, domestic corporations, domestic partnerships, U.S. estates, or trusts. Trusts are considered U.S. persons only if they satisfy a two-part test: (1) a court within the U.S. is able to exercise primary supervision over the administration of the trust, and (2) one or more U.S. persons have the authority to control all substantial decisions of the trust. See IRC 7701(a)(30)(E).

Assessable Penalties—Assessable penalties are not subject to the IRC’s deficiency procedures set forth in IRC 6211 through IRC 6215. Assessable penalties are required to be paid upon notice and demand. For assessable penalties, there is no notice requirement prior to assessment. As a general rule, penalties are assessable without deficiency procedures when they are not dependent upon the determination of a deficiency. If a penalty is not dependent upon the determination of a deficiency, then the penalty may not be subject to deficiency procedures. See Smith v. Commissioner, 133 T.C. 424, 429 (2009).

Statute of Limitations—The IRS maintains that penalties that are not considered taxes generally have no statute of limitation for assessment.  As a result, it maintains that the statute of limitations may remain open for such items—in many cases, for an unlimited number of years.   Penalties related to returns, however, are generally treated as taxes and governed by the statute of limitation for assessment.  Section 6501(c)(8) often governs the statute of limitations with respect to international information returns.

Reasonable Cause—Reasonable cause is a defense to most, but not all, of international information return penalties. However, the IRS maintains that taxpayers who conduct business or transactions offshore or in foreign countries have a responsibility to exercise ordinary business care and prudence in determining their filing obligations and other requirements.  The IRS’s position is that it is not reasonable or prudent for taxpayers to have no knowledge of, or to solely rely on others for, the tax treatment of international transactions.

The IRS takes the position that reasonable cause does not apply to penalties assessable after the taxpayer was notified of the requirement to file or was requested to provide specific required information.

The fact that reasonable cause relief was granted to the related income tax return does not automatically provide relief for the failure to timely file the information returns.

The IRS takes the position that reasonable cause should not be granted to a taxpayer merely because of the following:1) A foreign country would impose penalties on them for disclosing the required information,

  1. A foreign trustee refuses to provide them information for any other reason, including difficulty in producing the required information or provisions in the trust instrument that prevent the disclosure of required information, or
  2. The taxpayer relied on another person to file returns. The IRS believes that it is the taxpayer’s responsibility to ensure that all returns are filed timely and accurately.

Appeal Rights—Appeals currently provides a prepayment, post assessment appeal process for all international penalties.  Appeals also provides for an accelerated process for certain international penalties.

Information Returns—Information returns generally must be attached to the related income tax return. In addition, certain information returns must also be separately filed with the IRS campus site identified in the instructions for such form. Any information return required to be attached to the related income tax return is due on the due date of the income tax return, including extensions. Form 3520, Annual Return to Report Transactions With Foreign Trust and Receipt of Certain Foreign Gifts, and Form 3520-A, Annual Information Return of Foreign Trust With a U.S. Owner are not required to be attached to an income tax return.


Form 8278—International penalties are assessed on Form 8278, Assessment and Abatement of Miscellaneous Civil Penalties, with a Form 886-A, Explanation of Items, attached to identify what penalty is being assessed, how the penalty was calculated, and why reasonable cause was not applicable.

Penalty Tax Adjustments—Some of the IRC penalty sections include penalty adjustments to income tax or penalties that are based on the amount of income tax. Penalties based on the amount of income tax, income tax deficiency, adjustments to taxable income, tax credits, or income tax computations are return-related penalties and are covered by deficiency procedures. Return-related penalties must be included in an examination report.

Related Statute for Assessment—The IRS takes the position that IRC section 6501(c)(8) extends the statute for assessment on the related income tax return regarding items related to the information required to be reported until 3 years after the information required by IRC 6038, IRC 6038A, IRC 6038B, IRC 6038D, IRC 6046, IRC 6046A, and IRC 6048 is furnished to the IRS. Thus, failing to file information returns may affect the statute for assessment on the related income tax return.

While IRC 6501(c)(8) may apply to extend the limitations period for assessment on the related tax return, there is a reasonable cause exception.


Other Penalties

Criminal penalties may apply to U.S. and foreign taxpayers who willfully fail to file a return (IRC 7203) or file a false or fraudulent return (IRC 7206 and IRC 7207).

IRC 6662(e), Substantial Valuation Misstatement Under Chapter 1, and IRC 6662(h), Increase in Penalty in Case of Gross Valuation Misstatements, may be applicable in the international reporting context.

In addition, the following reporting and filing requirements are subject to failure to deposit penalties and are applicable to Form 1042, Annual Withholding Tax Return for U.S. Source Income of Foreign Persons.

Statute Subject
IRC 1441 Withholding of Tax on Nonresident Aliens
IRC 1442 Withholding of Tax on Foreign Corporations
IRC 1446 Withholding Tax on Foreign Partners’ Share of Effectively Connected Income

 

31 U.S.C. 5321—Report of Foreign Bank and Financial Accounts (FBAR), FinCEN Form 114 (as of September 30, 2013)

Generally, a U.S. person having one or more foreign accounts with aggregate amounts in the accounts of over $10,000 any time during the calendar year is required to maintain records and submit FinCEN Form 114 by the due date in the following year.

Penalties for a failure to file may apply in the following situations:

  • Under 31 U.S.C. 5321(a)(5)(B) for any non-willful violation of the recordkeeping and filing requirements under 31 U.S.C. 5314.
  • Under 31 U.S.C. 5321(a)(5)(C) for any willful violation of the recordkeeping and filing requirements under 31 U.S.C. 5314.
  • Under 31 5321(a)(6)(A) for negligently failing to meet the filing and recordkeeping requirements for financial institutions or non-financial trades or businesses.
  • Under 5321(a)(6)(B) for a pattern of negligent violations of any provision of 31 U.S.C. 5311-5332 by financial institutions or non-financial trades or businesses.

See 31 U.S.C. 5321(b) for the statute of limitations on assessment and collection.


Assessment Procedures for Penalties Not Subject to Deficiency Procedures

The IRS maintains that deficiency procedures under Subchapter B of Chapter 63 (relating to deficiency procedures for income, estate, gift, and certain excise taxes) generally do not apply to international information return penalties discussed herein.

Requirement to File—The IRS makes a determination whether an information return was required to be filed. The IRS believes that the following types of information support a presumptive requirement to file an international information return:

  • Testimony of the taxpayer or other reliable persons.
  • Late filed return.
  • A filed return indicating that information returns are due for prior or subsequent periods or for related entities.
  • A filed return that does not include all the required information or the required supporting information was not provided when requested.
  • Information that the taxpayer has control over, is receiving benefits from, or is receiving distributions or income from an account in the name of a foreign entity.
  • Statement in the name of the foreign entity addressed to the taxpayer.
  • Information received from promoter investigations that indicates the taxpayer owns or has control over a foreign entity, is controlled by a foreign entity, or meets another filing requirement.

Generally, the information returns or statements are required to be attached to the related income tax return and the due date is the same as the related income tax return (including extensions). Specific exceptions, however, may apply.

Some returns have dual filing requirements and the penalty can apply for failure to file either return.

Notice Letter Provisions—Penalties under IRC 6038, IRC 6038A, IRC 6038D, IRC 6677, and IRC 6679 have “notice letter” provisions and a continuation penalty may apply. The provisions state the following:

  • If the required returns are not filed or the required information is not received on or before the 90th day after the notice letter is issued, additional penalties of $10,000 per month (or fraction thereof) may be assessed.
  • The penalty continues to increase until the required information is received, or the information returns are filed, or the maximum penalty is assessed.
  • The maximum penalty amount for the continuation penalty is different for each IRC section and is referenced in each penalty section.

Reasonable Cause—The IRS takes the position that reasonable cause does not apply to the initial penalty in some relevant IRC sections.

Many of the penalty sections, however, have specific provisions for reasonable cause.

The IRS takes the position that a taxpayer’s repeated failure to file does not support testimony that the taxpayer demonstrated normal business care or prudence for the older, late-filed years.

 

Continuation Penalties—A continuation penalty is associated with several penalties and can either be assessed at the same time as the initial penalty or at a later date. There are maximum limits to some continuation penalties while others have no limitation on the amount that can be assessed.

Approval—IRC 6751 requires that managers approve penalties prior to assertion. IRS guidance requires that managers approve the case control, sign the notice letters, and approve the penalty by signing Form 8278 prior to closing the penalty case file.

 

Penalty Assessment–Form 8278, Assessment and Abatement of Miscellaneous Civil Penalties

If a continuation penalty is proposed in conjunction with an initial penalty, a separate Form 8278 is required for each type of penalty, for each tax year, and for each IRC section for which a penalty assessment is made.

 

IRC 6038—Information Reporting With Respect to Foreign Corporations and Partnerships

IRC 6038(b) provides a monetary penalty for failure to furnish information with respect to certain foreign corporations and partnerships.

The filing requirements apply to both entities which are treated as associations taxable as corporations or as partnerships under Treas. Reg. 301.7701-3.

Reporting and Filing Requirements

Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations, and Form 8865, Return of U.S. Persons With Respect to Certain Foreign Partnerships, are used for reporting purposes.

Foreign Corporations—IRC 6038(a) and Treas. Reg. 1.6038-2(a) require a U.S. person to furnish information with respect to certain foreign corporations. The required information includes foreign corporation entity data, stock ownership data, financial statements, and intercompany transactions with related persons. Other provisions that must be considered include the following:

  • A taxpayer meets the requirement by providing the required information on a timely filed Form 5471. A Schedule M attached to Form 5471 is used to report related party transactions. The information is for the annual accounting period of the foreign corporation ending with or within the U.S. person’s taxable year. Form 5471 is filed with the U.S. person’s income tax return on or before the date required by law for the filing of that person’s income tax return, including extensions. See Treas. Reg. 1.6038–2(i).
  • Regulations provide exceptions for attaching the Form 5471 to the related income tax return when the return is filed by another shareholder. The non-Form-5471-filer must attach a statement to his or her income tax return with the name and TIN of the person filing the Form 5471. If the required return was not filed timely by the other party, the penalty applies. No statement is required to be attached to tax returns for persons claiming the constructive ownership exception. See Treas. Reg. 1.6038-2(j)(2).
  • Dormant Corporations. Proc. 92-70 provides for summary reporting of dormant corporations. By using the summary filing procedure, the filer agrees that it will provide any information required within 90 days of being asked to do so on audit. The monetary penalty or the foreign tax credit reduction can be imposed if the information is not provided within the 90 days.

Foreign Partnerships—IRC 6038(a) and Treas. Reg. 1.6038-3(a) require a U.S. person to furnish information with respect to certain foreign partnerships. The required information includes foreign partnership entity data, ownership data, financial statements, and intercompany transactions with related persons. The information is furnished to the IRS as follows:

  • A taxpayer meets the requirement by providing the required information on a timely filed Form 8865, Return of U.S. Persons With Respect to Certain Foreign Partnerships.
  • Schedule N, attached to Form 8865, is used to report related party transactions. The information is for the annual accounting period of the foreign partnership ending with or within the U.S. person’s taxable year.
  • Form 8865 is filed with the U.S. person’s income tax return on or before the date required by law for the filing of that person’s income tax return, including extensions. See Treas. Reg. 1.6038-3(i).

Penalty Computation

Initial Penalty—The initial penalty is $10,000 per failure to timely file complete and accurate information on each Form 5471 or Form 8865. The penalty is assessed for each form (of each foreign corporation or partnership) for each year that was not timely filed with complete and accurate information.

Continuation Penalty—If any failure continues more than 90 days after the day on which the notice of such failure was mailed to the taxpayer (90-day period), additional “continuation” penalties are generally applicable.  The continuation penalty is $10,000 for each 30-day period (or fraction thereof) during which such failure continues after the expiration of the 90-day period. The maximum continuation penalty for IRC 6038(b) is $50,000 per required Form 5471 or Form 8865.

Thus, the maximum total penalty under IRC 6038(b) is $60,000 per Form 5471 or Form 8865 required to be filed per year (an initial penalty maximum of $10,000 plus the continuation penalty maximum of $50,000 per return).

Of course, criminal penalties may also be applicable to U.S. and foreign taxpayers who willfully fail to file a return (IRC 7203) or file a false or fraudulent return (IRC 7206 and IRC 7207).

Reasonable Cause

Initial Penalties—To demonstrate that reasonable cause exists, a taxpayer should make an affirmative showing of the facts that demonstrates reasonable cause.  Taxpayers are strongly encouraged to engage legal counsel both for attorney-client privilege reasons and for purposes of providing a penalty defense submission that complies with IRS procedures and substantive legal requirements.  For a failure to file Form 5471, the written statement must contain a declaration that it is made under the penalties of perjury. Additional information required by IRS regulations is available as set forth below:

  1. Form 5471 see Treas. Reg. 1.6038-2(k)(3).
  2. Form 8865 see Treas. Reg. 1.6038-3(k)(4).

Continuation Penalty—The IRS maintains that there is no reasonable cause exception for this penalty.  Freeman Law disagrees with this position.

The IRS maintains that first-time abatement (FTA) penalty relief generally does not apply to event-based filing requirements such as with Form 5471.


IRC 6038(c)—Reduction of Foreign Tax Credit

IRC 6038(c) provides for a reduction in foreign tax credits for a failure to furnish information with respect to a controlled foreign corporation (see IRC 957) or a controlled foreign partnership that is required to be filed under IRC 6038.

The foreign tax credit reduction is limited to the greater of $10,000 or the income of the foreign entity for the applicable accounting period.

Not every controlled foreign entity carries a foreign tax credit to the U.S. income tax return. 

Coordination With IRC 6038(b). The amount of the IRC 6038(c) penalty is reduced by the amount of the dollar penalty imposed by IRC 6038(b).

Penalty Computation

Initial Penalties:

  • Application of IRC 901—The amount of taxes paid or deemed paid by the U.S. person is reduced by 10 percent.
  • Application of IRC 902 and IRC 960—The amount of taxes paid or deemed paid by each of the U.S. person’s controlled foreign corporations is reduced by 10 percent. The 10 percent reduction is not limited to the taxes paid or deemed paid by the foreign corporation(s) with respect to which there is a failure to file information but applies to the taxes paid or deemed paid by all foreign corporations controlled by that United States person.

Continuation Penalties—If such failure continues for more than 90 days after the day on which the notice of such failure was mailed to the taxpayer (90-day period), an additional reduction of 5 percent of the taxpayer’s foreign tax credit is applied for each 3-month period, or fraction thereof, during which such failure continues after the expiration of the 90-day period.

Limitation—The amount of the foreign tax credit reduction for each failure to furnish information with respect to a foreign entity may not exceed the greater of the following:

  • $10,000, or
  • The income of the foreign entity for its annual accounting period with respect to which the failure occurs.

Reasonable Cause

Initial Penalties— To demonstrate that reasonable cause exists, a taxpayer should make an affirmative showing of the facts that demonstrates reasonable cause.  Taxpayers are strongly encouraged to engage legal counsel both for attorney-client privilege reasons and for purposes of providing a penalty defense submission that complies with IRS procedures and substantive legal requirements.  For failure to file Form 5471, the written statement must contain a declaration that it is made under the penalties of perjury. Additional information is available for the following:

  • Form 5471 see Treas. Reg. 1.6038-2(k)(3).
  • Form 8865 see Treas. Reg. 1.6038-3(k)(4).

Continuation Penalty—The IRS maintains that there is no reasonable cause exception for this penalty.


IRC 6038A(d)—Information Reporting for Certain Foreign-Owned Corporations

IRC 6038A provides a penalty for certain foreign-owned domestic corporations that fail to report required information or to maintain records.

Reporting and Filing Requirements

IRC 6038A(a) and Treas. Reg. 1.6038A-2 generally require that a reporting corporation report detailed information regarding each person who is a related party and who had any transaction with the reporting corporation during the taxable year, including, but not limited to the following:

  1. Name,
  2. Business address,
  3. Nature of business,
  4. Country in which organized or resident,
  5. Name and address of all direct and indirect 25-percent shareholders,
  6. Name and address of all related parties with which the reporting corporation had a reportable transaction,
  7. Nature of relationship of each related party to the reporting corporation, and
  8. Description and value of transactions between the reporting corporation and each foreign person who is a related party.

Form 5472, Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business (Under Sections 6038A and 6038C of the Internal Revenue Code), is required to be filed as an attachment to the taxpayer’s U.S. income tax return by the due date of that return, including extensions. If the reporting corporation’s income tax return is not timely filed, Form 5472 nonetheless must be timely filed at the IRS campus where the return is due.  In such case, when the income tax return is ultimately filed, a copy of Form 5472 is required to be attached.

Note that a separate Form 5472 must be filed with respect to each related party that has a reportable transaction with the reporting corporation.

A taxpayer is also required to maintain relevant records to verify the correct tax treatment of transactions with related parties. See IRC 6038A(a) and Treas. Reg. 1.6038A-3.

Exceptions.  The following exceptions apply:

  • A reporting corporation that, along with all related reporting corporations, has less than $10,000,000 in U.S. gross receipts for a taxable year is not subject to the specific record maintenance requirement of Treas. Reg. 1.6038A-3 or the authorization of agent requirement of Treas. Reg. 1.6038A-5 for such taxable year. See Treas. Reg. 1.6038A-1(h).
  • If the total value of all gross payments (both made to and received from) foreign related parties (including the value of transactions involving less than full consideration) with respect to related party transactions for a taxable year is not more than $5,000,000 and is less than 10 percent of its U.S. gross income, the reporting corporation is not subject to the record maintenance requirement and the authorization of agent requirement for those transactions. See Treas. Reg. 1.6038A-1(i).

These exceptions apply only to the IRC 6038A record maintenance requirements and the authorization of agent requirement. These exceptions do not apply to the reporting requirements for Form 5472 and the general record maintenance requirements of IRC 6001.

Reporting Corporation—For purposes of IRC 6038A, a reporting corporation is a domestic corporation that is 25 percent (or more) foreign-owned.  A corporation is 25-percent foreign-owned if it has at least one direct or indirect 25-percent foreign shareholder at any time during the taxable year.

In addition, a foreign corporation engaged in a trade or business within the U.S. at any time during a tax year is a reporting corporation.  Reg § 1.6038A-1(c)(1).

25 Percent Foreign-Owned—A corporation is 25 percent foreign-owned if it has, at any time during the taxable year, at least one direct or indirect 25 percent foreign shareholder (a foreign person owning at least 25 percent of the total voting power of all classes of stock of such corporation entitled to vote or the total value of all classes of stock of such corporation). The attribution rules of IRC 318 apply, with modifications. See IRC 6038A(c)(5).

Attribution under section 318. For purposes of determining whether a corporation is 25-percent foreign-owned and whether a person is a related party under section 6038A, the constructive ownership rules of section 318 apply, and the attribution rules of section 267(c) also apply to the extent they attribute ownership to persons to whom section 318 does not attribute ownership. However, “10 percent” is substituted for “50 percent” in section 318(a)(2)(C), and Section 318(a)(3)(A), (B), and (C) is not applied so as to consider a U.S. person as owning stock that is owned by a person who is not a U.S. person. Additionally, section 318(a)(3)(C) and §1.318-1(b) are not applied so as to consider a U.S. corporation as being a reporting corporation if, but for the application of such sections, the U.S. corporation would not be 25-percent foreign owned.

Related Party—The term “related party” means:

  • Any direct or indirect 25 percent foreign shareholder of the reporting corporation;
  • Any person who is related (within the meaning of IRC 267(b) or IRC 707(b)(1)) to the reporting corporation or to a 25 percent foreign shareholder of the reporting corporation; and
  • Any other person who is related within the meaning of IRC 482 to the reporting corporation.

Foreign Person—For purposes of IRC 6038A, the term “foreign person” generally means:

  • Any individual who is not a citizen or resident of the United States;
  • Any individual who is a citizen of any possession of the United States and who is not otherwise a citizen or resident of the United States;
  • Any partnership, association, company, or corporation that is not created or organized in the United States or under the law of the United States or any State thereof;
  • Any foreign trust or foreign estate, as defined in IRC 7701(a)(31); or
  • Any foreign government (or agency or instrumentality thereof).

Records

Generally, the records that must be maintained pursuant to IRC 6038A are required to be maintained within the U.S. However, a reporting corporation may maintain such records outside the U.S. if such records are not ordinarily maintained in the U.S. and if within 60 days of the request to produce them the reporting corporation makes the records available to the Service, or brings the records to the U.S. and complies with the notice requirements under Treas. Reg. 1.6038A-3(f)(2)(ii).

Satisfying the Records Requirements—Generally, a taxpayer meets the requirement by complying with the IRS’s request for books, records, or documents.

Penalty Computation

Initial Penalty—The initial penalty for a reporting failure is $10,000 for each failure during a taxable year of a reporting corporation to:

  • Timely file a separate Form 5472 with respect to each related party with which it had a reportable transaction during such taxable year,
  • Maintain the required records relating to a reportable transaction, or
  • In the case of records maintained outside the U.S., meet the non-U.S. record maintenance requirements.

 

Continuation Penalties—If any failure continues more than 90 days after the day on which the IRS mails notice of such failure to the taxpayer (the 90-day period), additional “continuation” penalties may apply. The continuation penalty is $10,000 for each 30-day period (or fraction thereof) during which such failure continues after the expiration of the 90-day period.

Unlike the initial penalty, if both a reporting failure and a maintenance failure continue with respect to the same related party, separate continuing penalties may be asserted by the IRS (i.e., for a total of $20,000 each month).

Under certain circumstances, the IRS may impose an additional penalty for a taxable year if, at a time subsequent to the assessment of the initial penalty, a second failure is determined and the second failure continues after notification. See Treas. Reg. 1.6038A-4(d)(2) and Treas. Reg. 1.6038A-4(f) Example (2).

 

Reasonable Cause

Initial Penalty— To demonstrate that reasonable cause exists, a taxpayer should make an affirmative showing of the facts that demonstrates reasonable cause.  Taxpayers are strongly encouraged to engage legal counsel both for attorney-client privilege reasons and for purposes of providing a penalty defense submission that complies with IRS procedures and substantive legal requirements.

Treas. Reg. 1.6038A-4(b)(2)(ii) states that reasonable cause should be applied liberally when a small corporation had no knowledge of the IRC 6038A requirements, has limited presence in (and contact with) the U.S., promptly and fully complies with all requests to file Form 5472, and promptly and fully complies with all requests to furnish books and records relevant to the reportable transaction.

A “small corporation” for purposes of this section is defined as a corporation whose gross receipts for a taxable year are $20,000,000 or less.

There is not a small corporation exception for filing Form 5472.  All corporations are subject to filing requirements of Form 5472 (if otherwise applicable).

Continuation Penalty—Generally, if there is reasonable cause for a failure to file or maintain records, the IRS maintains that the latest date that reasonable cause can exist is 90 days from the date of notification of the failure by the Service. See Treas. Reg. 1.6038A-4(b)(1).


IRC 6038A(e)—Noncompliance Penalty for Certain Foreign-owned Corporations

IRC 6038A provides that a foreign related party is required to authorize the reporting corporation to act as its limited agent for purposes of an IRS summons regarding transaction(s) with the related party. IRC 6038A further provides that a reporting corporation is required to substantially comply in a timely manner to an IRS summons for records or testimony relating to a transaction with a related party. The penalty for failure to authorize an agent or for failure to produce records is set forth in IRC 6038A(e)(3).

Reporting and Filing Requirements

A taxpayer meets the requirement by providing an executed “Authorization of Agent” form within 30 days of request by the Service or, in the case of production of records, by complying with the request for books, records, or documents. The penalty will  not be imposed if a taxpayer quashes a summons other than on grounds that the records were not maintained as required by IRC 6038A(a).

Statute of Limitations—The running of any period of limitations under IRC 6501 and IRC 6531 may be suspended as set forth in in IRC 6038A(e)(4)(D) relating to proceedings to quash and for a review of a determination of noncompliance.

Penalty Assertion

The IRS will generally assert a penalty when an examiner determines that:

  • A foreign related party, upon request, failed to authorize the reporting corporation to act as its agent for IRS summons purposes pursuant to the requirements set forth in Treas. Reg. 1.6038A-5, or
  • The reporting corporation has failed to respond substantially and timely to a proper summons for records.

The noncompliance penalty is subject to deficiency procedures and is reflected on a notice of deficiency.

Penalty Computation

The IRS takes the position that the noncompliance penalty adjustment permits the Service, in its discretion, to adjust the amount of deductions and to adjust the cost of property with respect to the related party transaction(s) based upon information available to the Service. See IRC 6038A(e)(3).

Reasonable Cause

In exceptional circumstances, the IRS may treat a reporting corporation as authorized to act as agent for a related party for IRS summons purposes in the absence of an actual agency appointment by the foreign related party in circumstances where the absence of an appointment is reasonable. See Treas. Reg. 1.6038A-5(f).


IRC 6038B(c)—Failure to Provide Notice of Transfers to Foreign Persons

IRC 6038B(c) provides a penalty for failure to furnish information with respect to certain transfers of property by a U.S. person to certain foreign persons.

Reporting and Filing Requirements

Form 8865 Schedule O, Transfer of Property to a Foreign Partnership (Under section 6038B), and Form 926, Return by a U.S. Transferor of Property to a Foreign Corporation, are utilized and required for reporting purposes.

Foreign Corporations—IRC 6038B(a) and the regulations issued thereunder require that any U.S. person that transfers property to a foreign corporation (including cash, stock, or securities) in an exchange described in IRC 332, IRC 351, IRC 354, IRC 355, IRC 356, IRC 361, IRC 367(d), or IRC 367(e) report certain information concerning the transfer:

  • Reg. 1.6038B-1(b) provides the general reporting requirements.
  • Reg. 1.6038B-1(b)(1) states that notwithstanding any statement to the contrary on Form 926, the form and attachments must be filed with the transferor’s tax return for the taxable year that includes the date of the transfer.

Form 926 must be complete, accurate, and filed with the taxpayer’s income tax return by the due date of the return (including extensions) at the IRS campus where the taxpayer is required to file in order to meet the requirements outlined in Treas. Reg. 1.6038B-1(b).

Exceptions Relating to Certain Transfers to Foreign Corporations—Under the section 6038B regulations, a Form 926 is not required to be filed, and therefore the penalty does not apply, in certain situations as follows:

  • For transfers of stock or securities to a foreign corporation in a transaction described in IRC 6038B(a)(1)(A) in which the requirements of Treas. Reg. 1.6038B-1(b)(2)(i) are satisfied and Form 926 need not be filed.

Under Treas. Reg. 1.6038B-1(b)(3), for transfers of cash in a transfer described in IRC 6038B(a)(1)(A), Form 926 is only required to be filed in the following situations:

1) When immediately after the transfer, such person holds directly, indirectly, or by attribution (determined under the rules of IRC 318(a), as modified by IRC 6038(e)(2)) at least 10 percent of the total voting power or the total value of the foreign corporation; or

2) When the amount of cash transferred by such person or any related person (determined under IRC 267(b)(1) through (3) and (10) through (12)) to such foreign corporation during the 12-month period ending on the date of the transfer exceeds $100,000.

Transfers to Foreign Partnerships—IRC 6038B(a) and (b) as well as Treas. Reg. 1.6038B-2 require, in certain circumstances, a U.S. person that transfers property to a foreign partnership in a contribution described in IRC 721 to report certain information concerning the transfer.  In addition, note the following:

  • Reporting is required under these rules if:
    • i) Immediately after the transfer, the U.S. person owns, directly, indirectly, or by attribution, at least a 10% interest in the partnership, as defined in section 6038(e)(3)(C) and the regulations thereunder; or
    • ii) The value of the property transferred by the U.S. person, when added to the value of any other property transferred in a section 721 contribution by the person (or any related person) to the partnership during the 12-month period ending on the date of the transfer, exceeds $100,000. See Treas. Reg. 1.6038B-2(a)(1).

Note: The value of any property transferred is the fair market value at the time of its transfer.

If a domestic partnership transfers property to a foreign partnership in a section 751 contribution, the domestic partnership’s partners are considered to have transferred a proportionate share of the contributed property to the foreign partnership. However, if the domestic partnership files Form 8865 and properly reports all the required information with respect to the contribution, its partners are not required to report the transfer. See Treas. Reg. 1.6038B-2(a)(2).

Taxpayers meet the reporting requirements by filing Form 8865 Schedule O with their federal income tax return by the due date of the return (including extensions) at the campus where they are required to file.

Description of Transfer to Foreign Corporations—A transfer described in IRC 367(a) occurs if a U.S. person transfers property to a foreign person in connection with an exchange described in IRC 332, IRC 351, IRC 354, IRC 355, IRC 356, or IRC 361, provided an exception in IRC 367(a) is not applicable.

Note: A transfer described in IRC 367(d) occurs if a U.S. person transfers intangible property to a foreign corporation in an exchange described in IRC 351 or IRC 361.

Description of Transfer to Foreign Partnerships—A transfer described in IRC 721 occurs if a U.S. person transfers property to a foreign partnership in exchange for an interest in the partnership.

Statute of Limitations—The IRS takes the position that the HIRE Act amendments to IRC 6501(c)(8), as well as the additional amendments in the Education Jobs and Medicaid Assistance Act, Public Law No. 111-226, provide that the IRC 6501(c)(8) period applies to the entire return, not just those items associated with the failure to file under IRC 6038B, unless the taxpayer can show reasonable cause. In the case of a taxpayer who demonstrates reasonable cause, only those items related to the failure under IRC 6038B are subject to the longer period under IRC 6501(c)(8).

Penalty Assertion

A penalty is asserted on Form 8278 when the IRS believes that the taxpayer:

  • Is a U.S. person and has made a transfer to a foreign corporation or a foreign partnership as described above;
  • Has failed to timely file Form 926 and attachments, or Form 8865 Schedule O, Transfer of Property to a Foreign Partnership (Under section 6038B), as specified in IRC 6038B and the regulations thereunder, and
  • Has not shown that such failure to comply was due to reasonable cause.

The penalty under IRC 6038B(c) is not subject to deficiency procedures. However, the income tax adjustment for gain recognition is subject to deficiency procedures.

Penalty Computation

If a U.S. person fails to furnish information in accordance with IRC 6038B regarding some or all of the property transferred and the reasonable cause exception does not apply, then:

  • With respect to transfers of property to a foreign corporation, the property is not considered to have been transferred for use in the active conduct of a trade or business outside the U.S. for purposes of IRC 367(a) and the regulations thereunder. See Treas. Reg. 1.6038B-1(f);
  • With respect to transfers of property to a foreign partnership, the U.S. person must recognize gain on the property. See Treas. Reg. 1.6038B-2(h); and
  • The U.S. person must pay a penalty equal to 10% of the fair market value of the property on the date of transfer, not to exceed $100,000, unless the failure was due to intentional disregard. See Treas. Reg. 1.6038B-1(f) and Treas. Reg. 1.6038B-2(h).

The period for limitations on assessment of tax on the transfer of such property does not begin to run until the date on which the U.S. person complies with the reporting requirements.

Note: IRC 6501(c)(8) applies to the income tax deficiency from items required to be reported under IRC 6038B.

Reasonable Cause

The IRS maintains that no reasonable cause should be considered until the taxpayer has filed applicable forms for all open years (not on extension).

IRC 6038B(c)(2) provides that no penalty shall apply to any failure if the U.S. person demonstrates that such failure is due to reasonable cause and not to willful neglect.


IRC 6038C—Information With Respect to Foreign Corporations Engaged in U.S. Business

Generally, a foreign corporation engaged in a trade or business within the United States at any time during the taxable year is a “reporting corporation.” See IRC 6038C and Treas. Reg. 1.6038A-1(c)(1).

Reporting and Filing Requirements

Generally, each reporting corporation as defined in Treas. Reg. 1.6038A-1(c) shall make a separate annual information return on Form 5472 with respect to each related party as described in Treas. Reg. 1.6038A-1(d) with which the reporting corporation has had any “reportable transaction.” See Treas. Reg. 1.6038A-2(a)(2) and Treas. Reg. 1.6038A-2(a)(1).

Generally, a reporting corporation must keep the permanent books of account or records as required by IRC 6001 that are sufficient to establish the correctness of the federal income tax return of the corporation, including information, documents, or records to the extent they may be relevant to determine the correct U.S. tax treatment of transactions with related parties. Such records must be permanent, accurate, and complete, and must clearly establish income, deductions, and credits. See Treas. Reg. 1.6038A-3(a)(1).

Penalty Assertion

An initial penalty is asserted on IRS Form 8278  when the IRS determines a penalty under Treas. Reg. 1.6038A-4(a).

Penalty Computation

Initial Penalty—Generally, if a reporting corporation fails to furnish the information described in Treas. Reg. 1.6038A-2 within the time and manner prescribed by Treas. Reg. 1.6038A-2(d) and (e), fails to maintain or cause another to maintain records as required by Treas. Reg. 1.6038A-3, or (in the case of records maintained outside the United States) fails to meet the non-U.S. record maintenance requirements, within the applicable time prescribed in Treas. Reg. 1.6038A-3(f), the IRS will assess a penalty of $10,000 for each taxable year with respect to which such failure occurs. See Treas. Reg. 1.6038A-4(a)(1).

Continuation Penalty—Generally, if any such failure continues for more than 90 days after the day on which the Service mails notice the failure to the reporting corporation, the IRS will assess against the reporting corporation an additional penalty of $10,000 with respect to each related party for which a failure occurs for each 30-day period during which the failure continues after the expiration of the 90-day period. Any uncompleted fraction of a 30-day period shall count as a 30-day period for this purpose. See Treas. Reg. 1.6038A-4(d)(1).

Reasonable Cause

Generally, certain failures may be excused for reasonable cause, including not timely filing Form 5472, not maintaining or causing another to maintain records as required by Treas. Reg. 1.6038A-3, and not complying with the non-U.S. maintenance requirements described in Treas. Reg. 1.6038A-3(f). See Treas. Reg. 1.6038A-4(b)(1).

Generally, if there is reasonable cause for a failure, the beginning of the 90-day period after mailing of a notice by the Service of a failure shall be treated as not earlier than the last day on which reasonable cause existed. See Treas. Reg. 1.6038A-4(b)(1).


IRC 6038C(d)—Noncompliance Penalty for Certain Foreign Corporations Engaged in U.S. Business

IRC 6038C(d) requires that a foreign related party authorize the reporting corporation to act as its limited agent for summons purposes and requires that the reporting corporation maintain and produce records regarding transactions with the foreign related party.

Reporting and Filing Requirements

The requirement is the same as that of IRC 6038A(e).

Penalty Assertion

Generally, a penalty is asserted when:

  • For purposes of determining the amount of the reporting corporation’s liability for tax, the IRS issues a summons to the reporting corporation to produce (either directly or as an agent for a related party who is a foreign person) any records or testimony,
  • Such summons is not quashed in a judicial proceeding described in IRC 6038(d)(4) and is not determined to be invalid in a proceeding begun under IRC 7604(b) to enforce such summons, and
  • The reporting corporation does not substantially comply in a timely manner with such summons and the IRS has sent by certified or registered mail a notice to such reporting corporation that such reporting corporation has not so substantially complied.

The noncompliance penalty follows deficiency procedures and is reflected in the notice of deficiency.

Penalty Computation

The noncompliance penalty adjustment permits the IRS to deny deductions and adjust cost of goods sold with respect to the related party transaction(s) based upon information available to the Service. See IRC 6038(d)(3).

Reasonable Cause

The IRS maintains that there is no reasonable cause exception for this penalty.


IRC 6039F(c)—Large Gifts From Foreign Persons

IRC 6039F provides reporting requirements for U.S. persons who receive large gifts from foreign persons.

Reporting and Filing Requirements

U.S. persons who receive gifts from a foreign individual or foreign estate during the taxable year that in the aggregate exceed $10,000 must file Form 3520, Annual Return to Report Transactions With Foreign Trust and Receipt of Certain Foreign Gifts, and fill out Part IV of Form 3520. These gifts are reportable under IRC 6039F(a). See Notice 97-34.[1]

The threshold for gifts (or bequests) received from nonresident alien individuals and foreign estates is statutorily $10,000, but the amount was raised to $100,000 under Notice 97-34. Once that threshold is reached, reporting is only required with respect to each such gift that is in excess of $5,000. The threshold for gifts (or bequests) received from a foreign corporation or a foreign partnership was statutorily $10,000, but the amount is adjusted each year for inflation. The instructions for Form 3520 for any year will have the applicable dollar threshold for the filing requirement for that year. Failure to report gifts (or bequests) above the applicable dollar threshold for the relevant year is subject to penalties under IRC 6039F. Gifts from foreign trusts are reportable as distributions from a foreign trust under IRC 6048(c) and failure to report such distributions on Part III of the Form 3520 is subject to penalties under IRC 6677.

Section 6048(a) generally provides that any U.S. person who directly or indirectly transfers money or other property to a foreign trust (including a transfer by reason of death) must report such transfer at the time and in the manner prescribed by the Secretary. Section 6048(a)(2). Transfers to foreign trusts described in sections 402(b), 404(a)(4), or 404A, or trusts determined by the Secretary to be described in section 501(c)(3) are not reportable under these requirements. Section 6048(a)(3)(B)(ii). Transfers involving fair market value sales are also not reportable. Section 6048(a)(3)(B)(i). The Secretary may exempt other types of transfers from being reported if the United States does not have a significant interest in obtaining the required information. Section 6048(d)(4). A person who fails to comply with the reporting requirements of section 6048(a) with respect to a transfer occurring after August 20, 1996, will be subject to a 35 percent penalty on the gross value of the property transferred. Section 6677(a).

One of the purposes of the reporting requirements in section 6048(a) is to ensure that U.S. transferors comply with section 679. Section 679 generally treats a U.S. person as the owner of a foreign trust if the U.S. person transfers property to the foreign trust and the trust could benefit a U.S. person. However, a U.S. person will not be treated as the owner of the trust under section 679 if, in exchange for the property transferred to the trust, the U.S. person receives property whose value is at least equal to the fair market value of the property transferred. Section 679(a)(2)(B).

Certain transfers of property by U.S. persons to foreign trusts may be described in section 1491 as well as section 6048(a). Section 1491 generally provides that a U.S. person who transfers property to a foreign trust is subject to a 35 percent excise tax on any unrecognized gain in the transferred property. Section 1494 generally provides that transfers described in section 1491 to certain foreign entities (including foreign trusts) must be reported. Notice 97-18, 1997-10 I.R.B. 35, provided that in the case of transfers to foreign trusts, reporting obligations under section 1494 may be satisfied if the U.S. transferor complies with its reporting obligations under section 6048(a) and the U.S. transferor does not owe excise tax under section 1491.

Note: Form 3520 has four different parts that relate to different filing requirements for filing a Form 3520. The obligation to file a Form 3520 to report the receipt of a large gift (or bequest) from a foreign person by a U.S. person is reportable on Part IV of the form.

Form 3520 is required to be filed separately from the U.S. person’s income tax return with the Ogden Campus. The due date for filing is the same as the due date for filing a U.S. person’s income tax return, including extensions. In the case of a Form 3520 filed with respect to a U.S. decedent, Form 3520 is due on the date that Form 706, United States Estate (and Generation-Skipping) Tax Return, is due, including extensions, or would be due if the estate were required to file a return. A Form 3520 is filed once a year for all reportable gifts (and bequests) within the year with respect to each U.S. person.

Penalty Assertion

The penalty is asserted on Form 8278  when the examiner determines the following:

  • A U.S. person received a reportable gift (or bequest) from a foreign person.
  • Has failed to timely file Form 3520.
  • Has not shown that failure to file was due to reasonable cause.

Penalty Tax Adjustment—IRC 6039F(c)(1)(A) states that the Secretary will determine the tax consequence of the receipt of such gift (or bequest) if the information is not filed timely. This adjustment is subject to deficiency procedures.

Penalty Computation

The penalty for failure to report a large gift (or bequest) from a foreign person on a timely, complete, and accurate Form 3520 is 5 percent of the amount of such foreign gift (or bequest) for each month for which the failure continues after the due date of the reporting U.S. person’s income tax return (not to exceed 25% of such amount in the aggregate).

Reasonable Cause

IRC 6039F(c)(2) provides that no penalty shall apply for failure to furnish the required information if the U.S. person shows that the failure is due to reasonable cause and not to willful neglect.


IRC 6039G—Expatriation Reporting Requirements

IRC 6039G (originally designated as IRC 6039F) was added by the Health Insurance Portability and Accountability Act in 1996, P.L. 104-191.

The American Jobs Creation Act of 2004 (AJCA), P.L. 108-357, made significant amendments to IRC 6039G for individuals who expatriated after June 3, 2004 and before June 17, 2008. Individuals who relinquished their United States citizenship or lost their U.S. long-term resident status were required to file Form 8854, Initial and Annual Expatriation Information Statement, in order to complete their tax expatriation. Otherwise these individuals are still taxed as U.S. persons until they file the Form 8854.

The Heroes Earnings Assistance and Relief Tax Act of 2008 (HEART Act) made additional amendments to IRC 6039G to reflect the enactment of IRC 877A (see below) which applies to individuals who relinquish their U.S. citizenship or lose their long-term resident status on or after June 17, 2008.

Reporting and Filing Requirements

Pre-AJCA—For individuals who expatriated prior to June 4, 2004, a Form 8854 was due on the date of expatriation (for U.S. citizens) or the due date of the individual’s U.S. income tax return (for long-term residents). There was no annual requirement to file a Form 8854 after the initial form was filed.

Post-AJCA—For individuals who expatriated after June 3, 2004, and before June 17, 2008, there was no due date for the initial Form 8854. But their expatriation will not be recognized for tax purposes until a complete initial Form 8854 is filed with the IRS. If the expatriate was subject to the alternate expatriation tax regime (under IRC 877(b)) on the date of expatriation, an annual Form 8854 is then required for each of 10 tax years after the date of expatriation.

IRC 877A—This section generally provides that all property of a “covered expatriate” (defined below) is treated as sold on the day before the individual’s expatriation date. Gain or loss from the deemed sale must be taken into account at that time (subject to an exclusion amount that is indexed for inflation annually).

Note:  Exclusion amount are provided in the Form 8854 instructions.

The following information is required on the Form 8854 by the individual who expatriates:

  1. Taxpayer’s TIN
  2. Mailing address of such individual’s principal foreign residence
  3. Foreign country in which the individual resides
  4. Foreign country of which the individual is a citizen
  5. Information detailing the income, assets, and liabilities of such individual
  6. Number of days the individual was physically present in the U.S. during the taxable year
  7. Such other information the Secretary shall prescribe

Post-HEART Act-U.S. citizens and long-term residents who expatriate on or after June 17, 2008 must file Form 8854 by the due date of the income tax return (including extensions) for the year that includes their expatriation date. Under certain circumstances, such expatriates must file Form 8854 for subsequent years.

Form W-8CE—”Covered expatriates” who had an interest in a deferred compensation plan, a specified tax-deferred account (which includes an IRA), or a non-grantor trust on the day before their date of expatriation must file a Form W-8CE with each payer of these interests. The purpose of the Form W-8CE is to notify each payer that the individual is a “covered expatriate” and is subject to special rules with regard to these interests. Form W-8CE is filed with each payer on the earlier of (a) the day before the first distribution on or after the expatriation date, or (b) 30 days after the expatriation date for each item of deferred compensation, specified tax deferred account or interest in a non-grantor trust.

“Covered Expatriate” —An individual is a “covered expatriate” if the individual is either a former citizen or former long-term resident and:

  • The individual’s average annual net income tax for the five years ending before the date of expatriation or termination of residency is more than a specified amount that is adjusted for inflation as provided in the Form 8854 instructions,
  • The individual’s net worth is $2 million or more on the date of expatriation, or
  • The individual fails to certify on Form 8854 that he or she has complied with all U.S. federal tax obligations for the five years preceding the date of the individual’s expatriation.

Former Long-Term Resident—A former long-term-resident is any individual who was a lawful permanent resident of the United States for all or any part of 8 of the last 15 years preceding the date of expatriation.

Treatment of Deferred Compensation Plans, Specified Tax-Deferred Accounts, and Non-Grantor Trusts—The “mark-to-market” rules (of IRC 877A(a)) do not apply to a covered expatriate’s interest in a deferred compensation plan, a specified tax-deferred account nor a non-grantor trust.

Deferral of “Mark-to-Market” Tax—Covered expatriates may elect to defer the payment of all or part of the amount of the “mark-to-market” tax to which they are subject. This election is not available for tax due with respect to a covered expatriate’s interest in a deferred compensation plan, a specified tax-deferred account, or a non-grantor trust in which the covered expatriate held an interest on the day before expatriation. See Notice 2009-85 and the Form 8854 instructions for more information.

Penalty Assertion

IRC 6039G(c) imposes a $10,000 penalty for a failure to timely file a complete and accurate Form 8854, unless it is shown such failure is due to reasonable cause and not to willful neglect.

The penalty is applied as follows:

  • Pre-AJCA—For individuals who expatriated prior to June 4, 2004, if the individual has failed to file a complete, accurate and timely initial Form 8854, the penalty for failure to file the initial Form 8854 is asserted.
  • Post-AJCA—For individuals who expatriate after June 3, 2004 but before June 17, 2008, the penalty applies for failure to file a required annual Form 8854.
  • Post-HEART Act—For individuals who expatriate after June 16, 2008, if the individual has failed to file a complete, accurate and timely initial Form 8854, the penalty for failure to file the initial Form 8854 is asserted.

Note:  Certain expatriates may only be required to file an initial Form 8854 and have no continued obligation to file Form 8854 annually.

Penalty Computation

The penalty computation under IRC 6039G depends on the date an individual expatriates as follows:

  • Pre-AJCA—For individuals who expatriated prior to June 4, 2004, if the individual failed to file a complete, accurate and timely initial Form 8854, the penalty is the greater of 5% of the tax required to be paid under IRC 877 or $1,000 for each taxable year that the 8854 was not filed.
  • Post-AJCA—For individuals who expatriated after June 3, 2004, and before June 17, 2008, the penalty for failure to file an annual 8854 is $10,000 per required annual form.
  • Post-HEART Act—For individuals who expatriate after June 16, 2008, the penalty for each failure to file a required Form 8854 is $10,000.

Reasonable Cause

The penalty is improper if the failure to provide the required statement and information was due to reasonable cause and not to willful neglect.

The IRS may, however, refuse to recognize the existence of reasonable cause until the taxpayer has filed the required information for all open years (not on extension).


IRC 6652(f)—Foreign Persons Holding U.S. Real Property Investments

IRC 6652(f) provides a penalty for a  failure to meet reporting requirements under IRC 6039C.

Reporting and Filing Requirements

IRC 6039C states that, to the extent provided in regulations, any foreign person holding a direct investment in U.S. real property interests for a calendar year must file a return. The requirement is met by providing information such as name and address, a description of all U.S. real property interests, etc.

However, until such time as the regulations under IRC 6039C are issued, these provisions are not operative. Note, however, that there are other reporting requirements under the Foreign Investment in Real Property Tax Act (FIRPTA) that must still be satisfied.  See, e.g., IRC secs. 897 and IRC 1445.

Penalty Computation

IRC 6652(f)(2) provides that the amount of penalty with respect to any failure shall be $25 for each day during which such failure continues.

IRC 6652(f)(3) limits the amount of the penalty determined to the lesser of the following:

  • $25,000, or
  • 5 percent of the aggregate of the fair market value of the United States real property interests owned by such person at any time during such year.

Reasonable Cause

IRC 6652(f)(1) provides for a defense to penalties if the failure to report is due to reasonable cause and not to willful neglect.


IRC 6677(a)—Failure to File Information with Respect to Certain Foreign Trusts—Form 3520

IRC 6677 provides that U.S. persons, who have an IRC 6048 filing obligation because they engaged in certain transactions with a foreign trust or are treated as owning a foreign trust, who fail to file a complete and accurate Form 3520, Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts, or fail to ensure that a foreign trust has filed a Form 3520-A, Annual Return of Foreign Trust With a U.S. Owner, may be assessed penalties for such failures unless it is shown that such failure was due to reasonable cause and not to willful neglect.

Notice 97-34 provides additional guidance on the filing requirements and penalties.

Reporting and Filing Requirements

Form 3520, Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts, is required to be filed by a U.S. person for the following:

  • Report the creation of a foreign trust by a U.S. person during the tax year,
  • Report certain transfers of money or other property to a foreign trust by a U.S. person,
  • Identify U.S. persons who are treated as owners of a foreign trust during all or part of the tax year,
  • Provide information about distributions received by a U.S. person from a foreign trust,
  • Report the receipt of a loan from a foreign trust during the tax year,
  • Report the receipt of uncompensated use of trust property from a foreign trust (applicable only after March 18, 2010), or
  • Provide information about certain gifts or bequests received from foreign persons (penalties related to the failure to report the receipt of such gifts or bequests from foreign persons are imposed under IRC 6039F).

Form 3520 must be timely, complete and accurate to be considered filed.

U.S. Owners: Creation or Transfer—IRC 6048(a) generally provides that any U.S. person who creates a foreign trust and directly or indirectly transfers money or other property to a foreign trust (including a transfer by reason of death) must report such transfer. This reporting is performed on Part I of Form 3520.

Generally, a U.S. person who transfers property to a foreign trust is considered the owner of that portion of the foreign trust unless there is no possibility now or in the future of the trust having a U.S. beneficiary. IRC 679 and the regulations thereunder more specifically describe individuals who are considered owners of foreign trusts and describe exceptions to the general rule.

Other things to consider are as follows:

  • S. persons who make transfers to Canadian Registered Retirement Savings Plans (RRSPs) or Registered Retirement Income Funds (RRIFs) are not required to report such transfers on Form 3520. See Notice 2003-75 and the instructions to Form 8891, U.S. Information Return for Beneficiaries of Certain Canadian Registered Retirement Plans.
  • Generally, foreign trusts described in IRC 402(b), IRC 404(a)(4), IRC 404A, or IRC 501(c)(3) are not reportable under these requirements. See IRC 6048(a)(3)(B)(ii) and Notice 97-34.
  • Transfers involving fair market value sales are also not reportable. See IRC 6048(a)(3)(B)(i), Notice 97-34, IRC 679, and the regulations thereunder for additional information.

IRC 6048(b) provides that if at any time during the taxable year a U.S. person is treated as the owner of any portion of a foreign trust under the grantor trust rules (IRC 671 through IRC 679), such person must submit certain information and must ensure that the trust files certain information. The U.S. person must report ownership of the trust for the current tax year on Part II of Form 3520 and, if available, must attach a copy of the owner’s statement (from Form 3520-A) to Form 3520.

Even if the U.S. owner is not required to complete and file the other parts of Form 3520 in a particular year, the U.S. owner must nevertheless complete and file Part II of Form 3520. In addition, the U.S. owner must ensure that the foreign trust files Form 3520-A annually. If the foreign trust fails to file Form 3520-A, the U.S. owner must complete and attach a substitute Form 3520-A to his or her Form 3520.

Distributions: U.S. Beneficiaries—IRC 6048(c) generally requires a U.S. person who receives a distribution or is treated as receiving a distribution, directly or indirectly, from a foreign trust, to report on Form 3520 the name of the trust, the aggregate amount of distributions received from the trust during the taxable year and such other information as the Secretary may prescribe.

Some examples of distributions to U.S. persons from a foreign trust that are reportable or nonreportable are as follows:

Description Reportable
Distributions to the grantor or owner of the foreign trust. Yes
Distributions from non-grantor foreign trusts. Yes
Non-arm’s length loans from a foreign trust or the uncompensated use of trust property. Yes
Indirect distributions. For example, distributions by use of a credit card, where the charges on that credit card are paid or otherwise satisfied by a foreign trust or guaranteed or secured by the assets of a foreign trust for the year in which the charge occurs. Yes
Distributions reported as taxable compensation on the income tax return of the recipient. No
Distributions from Canadian Registered Retirement Savings Plans (RRSPs) or Registered Retirement Income Funds (RRIFs). See Notice 2003-75 and the instructions to Form 8891. No

Form 3520 is required to be filed separately from the U.S. person’s income tax return and must not be attached to the related income tax return. In addition:

  • Form 3520 is filed once a year with respect to each U.S. person and each foreign trust. A separate Form 3520 is required for each foreign trust.
  • Form 3520, filed by a U.S. owner, is required to have a copy of the owner’s statement from Form 3520-A attached to the Form 3520.
  • Form 3520 is required to be filed by the due date of the income tax return of a U.S. person, including extensions.
  • A separate Form 3520 must be filed by each U.S. person. However, married individuals who file married filing joint may file one Form 3520.

Penalty Letters, Notice Letters, and Notices

Letter 3804—This is an opening notice letter issued under the provisions of IRC 6677(a).

Letter 3943—This is the closing acceptance letter utilized after the IRS determines that no penalties will be asserted.

Letter 3944—This is the closing no response letter is issued when a taxpayer either fails to respond to notice letter (Letter 3804) or when a taxpayer does not provide a statement of reasonable cause for failing to file such returns.

Letter 3946—This is the closing reasonable cause rejected letter that is issued after the IRS determines that penalties will be asserted.

Penalty Computation

Gross Reportable Amount—The gross reportable amount is defined in IRC 6677(c) as follows:

  • Contributions to the foreign trust: The gross value of the property involved in the event (determined as of the date of the event) in the case of a failure relating to IRC 6048(a),
  • The gross value of the portion of the trust’s assets at the close of the year treated as owned by the U.S. person in the case of a failure relating to IRC 6048(b)(1), and
  • Distributions from the foreign trust: The gross amount of the distributions in the case of a failure relating to IRC 6048(c).

Inaccurate reporting: The penalty applies only to the extent that the transaction is not reported or is reported inaccurately. Thus, if a U.S. person transfers property worth $1,000,000 to a foreign trust, but reports only $400,000 of that amount, penalties may be imposed only on the unreported $600,000.

Also, if the return is not filed and the Service assesses a penalty based on available information, additional assessments can be made if additional information is received.

Initial Penalty—Prior to 2010 under IRC 6677, the initial penalty for failure to timely file a complete and accurate Form 3520 was calculated based on the respective percentages below of the gross reportable amount. There was no minimum penalty. Beginning with 2010, a minimum threshold was added and the initial penalty is equal to the greater of $10,000 or the following:

  • 35 percent of the gross reportable amount of any property transferred to a foreign trust for failure by a U.S. transferor to report the creation of, or transfer to, a foreign trust;
  • 35 percent of the gross reportable amount of the distributions received from a foreign trust for failure by a U.S. person to report receipt of the distribution; or
  • 5 percent of the gross reportable amount of the portion of the trust’s assets treated as owned by a U.S. person for failure by the U.S. person to report the U.S. owner information (this penalty is imposed under IRC 6677(b).

In the case of a U.S. person treated as the owner of a foreign trust, penalties are assessed in the case of a failure to report such ownership pursuant to IRC 6048(b) on a Form 3520-A rather than on the Form 3520.

Continuation Penalty—If any failure continues more than 90 days after the day on which the notice of such failure was mailed to the taxpayer (90-day period), additional penalties will apply. The continuation penalty is $10,000 for each 30-day period (or fraction thereof) during which such failure continues after the expiration of the 90-day period.

The maximum penalty (both initial penalty and continuation penalty) for each failure to file Form 3520 is the gross reportable amount each year.

Non-Compliance Tax Adjustment—IRC 6048(c)(2) provides that any distribution from a foreign trust, whether from income or corpus, to a U.S. beneficiary will be treated as an accumulation distribution includible in the gross income of that U.S. beneficiary if adequate records are not provided to the Secretary to determine the proper treatment of the distribution. The interest charge under IRC 668 shall apply to the distribution treated as an accumulation distribution. In determining the interest amount under IRC 668, the applicable number of years will be equal to one half of the number of years that the trust has been in existence. This adjustment is subject to deficiency procedures.

Interest—The interest charge will be determined using the normal interest rate and method as described in IRC 6621, unless the period is prior to 1996, when a simple interest rate of 6% will be used. This interest is not deductible.

Reasonable Cause

No reasonable cause should be considered until the taxpayer has filed the complete and accurate information required for all open years (not on extension).

IRC 6677 provides specific exclusions with respect to the initial penalty for reasonable cause and Notice 97-34 provides additional information:

  • A taxpayer will not have reasonable cause merely because a foreign country would impose a civil or criminal penalty on the taxpayer (or other person) for disclosing the required information. See IRC 6677(d).
  • Refusal on the part of a foreign trustee to provide information for any other reason, including difficulty in producing the required information or provisions in the trust instrument that prevent the disclosure of required information, will not be considered reasonable cause.

The fact that the trustee did not provide the taxpayer with a copy of the owner’s statement of Form 3520-A is not reasonable cause. The taxpayer owner is also the person responsible for ensuring that the Form 3520-A is filed and that he or she receives a copy of the owner’s statement.


IRC 6677(a) and (b)—Foreign Trusts With U.S. Owners—Form 3520-A

The penalties for failure to file Form 3520-A are similar to the penalties for failure to file Form 3520 except that IRC 6677(b) changes the amount of the initial penalty to the greater of $10,000 or 5 percent of the gross reportable amount. The gross reportable amount is defined in IRC 6677(c)(2) as the gross value of the portion of the trust’s assets at the close of the year treated as owned by the U.S. person.

If a foreign trust fails to file Form 3520-A, the penalties are imposed on the U.S. person who is treated as the owner of the foreign trust. The grantor trust rules are in IRC 671 through 679. The U.S. owner may be able to avoid penalties by attaching a substitute Form 3520-A to a timely filed Form 3520.

Reporting and Filing Requirements

Form 3520-AAnnual Information Return of Foreign Trust With a U.S. Owner, is due by the 15th day of the third month after the end of the trust’s tax year. Each U.S. person treated as an owner of a foreign trust under IRC 671 through IRC 679 is responsible for ensuring that the foreign trust files an annual return setting forth a full and complete accounting of all trust activities, trust operations, and other relevant information as the Secretary prescribes. See IRC 6048(b)(1). In addition, the U.S. owner is responsible for ensuring that the trust annually furnishes such information as the Secretary prescribes to U.S. owners and U.S. beneficiaries of the trust. See IRC 6048(b)(1)(B), Treas. Reg. 404.6048-1, and Notice 97-34.

IRC 6048 authorizes the Secretary to prescribe the information required to be reported. The instructions to Form 3520-A include all information required to be provided.

U.S. persons who are treated as owners of Canadian RRSPs or RRIFs do not need to ensure that the RRSP or RRIF files a Form 3520-A and do not need to file a substitute Form 3520-A.

Form 3520-A includes an owner’s statement (Foreign Grantor Trust Owner Statement) for each U.S. person considered to be an owner of a portion of the foreign trust. The owner’s statement is required to be provided to each U.S. owner of the foreign trust.

Form 3520-A includes a beneficiary’s statement (Foreign Grantor Trust Beneficiary Statement) for any distributions made to U.S. persons. The beneficiary’s statement is required to be provided to each U.S. beneficiary.

U.S. Agent—A copy of the authorization of agent must be attached to the Form 3520-A and must be substantially identical to the format shown in the instructions. The U.S. agent has a binding contract with the foreign trust to act as the foreign trust’s limited agent for purposes of applying IRC 7602, IRC 7603, and IRC 7604 with respect to a request by the IRS to examine records, produce testimony, or respond to a summons by the IRS for such records or testimony.

Trusts without U.S. agents must have the following attached to the Form 3520-A to be considered complete:

  • A summary of the terms of the trust including a summary of any oral or written agreements or understandings that the U.S. owner(s) has with the trustee whether or not legally enforceable.
  • Copy of any of the following that have not been previously provided:
    • All trust documents and instruments,
    • Any amendments to the trust agreement,
    • All letters of wishes prepared by the settlor,
    • Memorandum of wishes by trustee summarizing the settlor’s wishes, and
    • Any other similar documents.

Penalty Letters, Notice Letters, and Notices

Letter 3804—This is an opening notice letter issued under the provisions of IRC 6677(a).

Letter 3943—This is the closing acceptance letter utilized after the IRS determines that no penalties will be asserted.

Letter 3944—This is the closing no response letter is issued when a taxpayer either fails to respond to notice letter (Letter 3804) or when a taxpayer does not provide a statement of reasonable cause for failing to file such returns.

Letter 3946—This is the closing reasonable cause rejected letter that is issued after the IRS determines that penalties will be asserted.

Penalty Assertion

Form 3520-A is considered incomplete in the following situations:

  • The U.S. owner or beneficiary is not timely provided with the required statements.
  • A foreign trust without a U.S. agent does not provide all the required attachments, e.g., summary of the terms of the trust, copies of trust documents or amendments to trust documents, and other required information (See IRM 20.1.9.14.1(7)).
  • The U.S. agent does not provide information with respect to the trust after a request in writing as required by the terms of the U.S. agent agreement. Reasonable cause does not apply to the penalty in situations relating to a failure to provide information when requested.
  • Form 3520-A does not contain substantially all of the required information on the return, e.g., amount of contributions and distributions, amount deemed as owned by each U.S. person, and balance sheet and income statement information.

Penalty Computation

Initial Penalty—Prior to 2010, the initial penalty for failure to timely file a complete and accurate Form 3520-A was 5 percent of the gross reportable amount. There was no minimum penalty. Beginning with 2010, a minimum threshold was added and the initial penalty is the greater of $10,000 or 5 percent of the gross reportable amount at the close of the year treated as owned by the U.S. person. See IRC 6677(b) for the penalty and IRC 6677(c) for the meaning of “gross reportable amount.” In addition:

  • The initial penalty is computed for failure to provide information or inaccurate reporting. The penalty applies only to the extent that the transaction is not reported or is reported inaccurately. Thus, if a U.S. person reports the value of the account as worth $400,000, but the correct value is $1,000,000, penalties may be imposed on the unreported $600,000. See Notice 97-34.
  • If the return is not filed and the Service assesses a penalty based on available information, adjustments or additional assessments can be made if additional information is received.

Continuation Penalty—If any failure continues more than 90 days after the day on which the notice of such failure was mailed to the taxpayer (90-day period), additional penalties will apply. The continuation penalty is $10,000 for each 30-day period (or fraction thereof) during which such failure continues after the expiration of the 90-day period.

Reasonable Cause

IRC 6677(d) provides specific exceptions with respect to the penalty for reasonable cause and Notice 97-34 provides additional information. In addition:

  • The U.S. owner is responsible for ensuring that Form 3520-A is filed timely and includes all required information. The failure of the trustee or agent to timely file complete and accurate returns or provide information when requested is not reasonable cause for this penalty.
  • A taxpayer will not have reasonable cause merely because a foreign country would impose a civil or criminal penalty on the taxpayer (or other person) for disclosing the required information. See IRC 6677(d).
  • Refusal on the part of a foreign trustee to provide information for any other reason, including difficulty in producing the required information or provisions in the trust instrument that prevent the disclosure of required information, will not be considered reasonable cause.

IRC 6679—Return of U.S. Persons With Respect to Certain Foreign Corporations and Partnerships

IRC 6679 provides a penalty for failure to furnish information and timely file a return required under IRC 6046 or IRC 6046A.

Reporting and Filing Requirement

For tax years that began before January 1, 2005, IRC 6679 provided a penalty for failure to furnish information and timely file a return required under IRC 6035. IRC 6035 required a U.S. citizen or resident who was an officer, director, or 10 percent shareholder of a foreign personal holding company to file Form 5471 Schedule N by the due date of the taxpayer’s income tax return, including extensions.

Note:  Foreign personal holding company provisions have been repealed effective for tax years of foreign corporations beginning after December 31, 2004, and to tax years of U.S. shareholders with or within which such tax year of the foreign corporation ends. Therefore, there is no Form 5471 Schedule N filing requirement for periods after the rules have been repealed.

IRC 6046 requires Form 5471 Schedule O to be filed by the due date of the taxpayer’s income tax return, including extensions and must be filed by the following:

  • A U.S. citizen or resident who is an officer or director of a foreign corporation in which a U.S. person has acquired:
    • Stock which meets the 10% stock ownership requirement with respect to the foreign corporation, or
    • An additional 10% or more of the outstanding stock of the foreign corporation.
  • A U.S. person who acquires stock in a foreign corporation which, when added to any stock owned on the date of acquisition, meets the 10% stock ownership requirement with respect to the foreign corporation.
  • A U.S. person who acquires stock in a foreign corporation which, without regard to stock already owned on the date of acquisition, meets the 10% stock ownership requirement with respect to the foreign corporation.
  • Each person who is treated as a U.S. shareholder under IRC 953(c) with respect to the foreign corporation.
  • Each person who becomes a U.S. person while meeting the 10% stock ownership requirement with respect to the foreign corporation.
  • A U.S. person who disposes of sufficient stock in the foreign corporation to reduce his or her interest to less than the stock ownership requirement.

IRC 6046A requires Form 8865 Schedule P, to be filed by the due date of the taxpayer’s income tax return, including extensions. The form must be filed by any U.S. person who:

  • Acquires an interest in a foreign partnership,
  • Disposes of an interest in a foreign partnership, or
  • Whose proportional interest in a foreign partnership changes substantially.

Penalty Computation

Initial Penalty—The penalty is $10,000 per failure.

Note: For tax years beginning prior to January 1, 2005, the penalty for failure to file Form 5471 Schedule N, Return of Officers, Directors, and 10% or More Shareholders of a Foreign Personal Holding Company, was $1,000 per failure and was assessed with PRN 614.

Continuation Penalty—If any failure continues more than 90 days after the day on which the notice of such failure was mailed to the taxpayer (90-day period), additional penalties of $10,000 for each 30-day period (or fraction thereof) during which such failure continues after the expiration of the 90-day period will apply. The maximum continuation penalty is limited to $50,000 per failure.

Reasonable Cause

IRC 6679(a)(1) provides a reasonable cause exception to the initial penalty.

The IRS maintaines that a reasonable cause defense does not apply to the continuation penalty.  Freeman Law disagrees with this position.


IRC 6686—Information Returns for IC-DISCs

IRC 6686 was added by P.L. 92-178 for Domestic International Sales Corporations (DISC) or former Foreign Sales Corporations (FSC).

The provisions for FSCs were repealed by P.L. 106-519 effective generally for transactions after September 30, 2000.

Although the FSC provisions were repealed, the Interest Charge Domestic International Sales Corporations (IC-DISC) provisions remain in effect.

Reporting and Filing Requirements

An IC-DISC is a domestic corporation that has elected to be an IC-DISC on Form 4876-A, Election To Be Treated as an Interest Charge DISC, and its election is still in effect.

An IC-DISC must file an annual U.S. tax return even though it pays no U.S. income taxes. See IRC 6011(c)(2) and Treas. Reg. 1.991-1.

Penalty Computation

The penalty under IRC 6686 is $100 for each failure to supply information (but the total amount imposed for all such failures during any calendar year shall not exceed $25,000) and $1,000 for each failure to file a Form 1120-IC-DISC.

Reasonable Cause

IRC 6686 provides for such penalties unless it is shown that such failure to file or supply information is due to reasonable cause.

To be considered for reasonable cause, the taxpayer must make an affirmative showing of reasonable cause in a written statement containing a declaration that it was made under the penalties of perjury.


IRC 6688—Reporting for Residents of U.S. Possessions (U.S. Territories)

IRC 6688 applies to any person described in IRC 7654(a) who is required to furnish information and who fails to comply with such requirement unless it is shown that such failure is due to reasonable cause and not to willful neglect.

Reporting and Filing Requirements

IRC 6688 provides a penalty for individuals with total worldwide gross income of more than $75,000 who take the position that, for U.S. income tax reporting purposes (see IRC 937(c)), they became or ceased to be bona fide residents of a U.S. possession (U.S. territory) and fail to meet the requirements under IRC 937 by filing Form 8898, Statement for Individuals Who Begin or End Bona Fide Residence in a U.S. Possession.

Note that:

  • The instructions to Form 8898 currently specify that the form only needs to be filed by such individuals if they have more than $75,000 in worldwide gross income in the taxable year that they take the position that they became or ceased to be a bona fide resident of a U.S. possession.
  • S. Possessions—Guam, American Samoa, the Commonwealth of the Northern Mariana Islands (CNMI), the Commonwealth of Puerto Rico, and the U.S. Virgin Islands are U.S. possessions, as that term is used in the IRC. These jurisdictions are more commonly referred to as U.S. territories..
  • Form 8898 is filed separately with the Philadelphia Campus (or campus identified in future instructions), not with the individual’s tax return.

The penalty also applies to individuals who have adjusted gross income of $50,000 and gross income of $5,000 from sources within Guam or CNMI and who fail to file Form 5074, Allocation of Individual Income Tax to Guam or the Commonwealth of the Northern Mariana Islands (CNMI), as required under Treas. Reg. 301.7654-1(d) for individuals who file U.S. income tax returns.

Subsequent to 2005, Form 8898 must be filed by the due date (including extensions) for filing Form 1040, U.S. Individual Income Tax Return, or Form 1040NR, U.S. Nonresident Alien Income Tax Return.

Penalty Computation

For tax years ending after October 22, 2004, the penalty is $1,000 for failure to file the respective Form 8898, Form 5074, Form 8689, or for filing incorrect or incomplete information.

For tax years ending before October 23, 2004, the penalty is $100.

Reasonable Cause

IRC 6688 provides for such penalties unless it is shown that such failure is due to reasonable cause and not to willful neglect.


IRC 6689—Failure to File Notice of Foreign Tax Redetermination 

IRC 6689 provides a penalty for failure to notify the Service of a foreign tax redetermination with respect to the following:

  • The amount of foreign taxes paid, accrued, or deemed paid by the taxpayer for which a notice is required under IRC 905(c), or
  • The amount of adjustment to the deduction for certain foreign deferred compensation plans under IRC 404A(g).

Reporting and Filing Requirements

A taxpayer is required to notify the Service of any foreign tax redetermination that may affect U.S. tax liability. If a taxpayer has a reduction in the amount of foreign tax liability, the taxpayer must provide notification by filing Form 1040X, Amended U.S. Individual Income Tax Return, or Form 1120X, Amended U.S. Corporation Income Tax Return, and Form 1116, Foreign Tax Credit, or Form 1118, Foreign Tax Credit—Corporations, by the due date (with extensions) of the original return for the taxpayer’s taxable year in which the foreign tax redetermination occurred. See former Treas. Reg. 1.905-4T(b)(1)(ii).

In addition:

  • If a foreign tax redetermination results in an additional assessment of foreign tax, the taxpayer has the 10-year period provided by IRC 6511(d)(3)(A) to file a claim for refund based on additional foreign tax credits. See former Treas. Reg. 1.905-4T(b)(1)(iii).
  • When a foreign tax redetermination affects the indirect or deemed paid credit under IRC 902, the taxpayer must provide notification by reflecting the adjustments to the foreign corporation’s pools of post-1986 undistributed earnings and post-1986 foreign income taxes on a Form 1118 for the taxpayer’s first taxable year with respect to which the redetermination affects the computation of foreign taxes deemed paid.

Redetermination of IRC 404A Deduction—A taxpayer is required to notify the Service, in the time and manner specified in the regulations under IRC 905, if the foreign tax deduction for deferred compensation expense is adjusted. See IRC 404A(g)(2)(B).

Foreign Tax Redetermination—Former Treas. Reg. 1.905-3T(c) defines a foreign tax redetermination as a change in the foreign tax liability that may affect a U.S. taxpayer’s foreign tax credit and includes the following:

  • Accrued taxes that when paid differ from the amounts added to post-1986 foreign income taxes or claimed as credits by the taxpayer,
  • Accrued taxes that are not paid before the date two years after the close of the taxable year to which such taxes relate, or
  • Any tax paid that is refunded in whole or in part, and
  • For taxes taken into account when accrued but translated into dollars on the date of payment, the difference between the dollar value of the accrued foreign tax and the dollar value of the foreign tax actually paid attributable to fluctuations in the value of the foreign currency relative to the dollar between the date of accrual and the date of payment.

Statute of Limitations—IRC 6501(c)(5) independently suspends the normal statute of limitations for additions to tax resulting from a redetermination of foreign tax. IRC 905(c) contains special rules for such changes.

Penalty Computation

The examiner determines the deficiency attributable to the foreign tax redetermination and to this deficiency is added a penalty computed as follows:

  • 5 percent of the deficiency if the failure to file a notice of foreign tax redetermination is for not for more than 1 month;
  • An additional 5 percent of the deficiency for each month (or fraction thereof) during which the failure continues, but not to exceed in the aggregate 25 percent of the deficiency; and
  • If this penalty applies, then the penalty under IRC 6662(a) and IRC 6662(b)(1), relating to the failure to pay by reason of negligent or intentional disregard of rules and regulations, shall not apply.

Reasonable Cause

The IRS maintains that reasonable cause should only be considered if the taxpayer has filed amended returns for all affected years for which the particular foreign tax redetermination results in a U.S. tax deficiency and for which amended returns are required under former temporary Treas. Reg. 1.905-4T.

IRC 6689(a) provides for such a penalty unless it is shown that such failure is due to reasonable cause and not due to willful neglect.


IRC 6712—Failure to Disclose Treaty-Based Return Position

IRC 6712 provides a penalty for failure to disclose a treaty-based return position as required by IRC 6114.

Reporting and Filing Requirements

IRC 6114 generally requires that if a taxpayer takes a position that any treaty of the U.S. overrules or modifies any provision of the Code, the taxpayer must disclose the position. A taxpayer meets the disclosure requirement by attaching Form 8833, Treaty-Based Return Position Disclosure Under Section 6114 or 7701(b), or appropriate successor form to his or her timely filed tax return (including extensions).

Note:  A taxpayer may be able to treat payments or income items of the same type (e.g., interest items) received from the same ultimate payor (e.g., the obligor of a note) as a single separate payment or income item. See Treas. Reg. 301.6114-1(d)(3)(ii) for guidance on rules for single separate payment or income item.

If an individual would not otherwise be required to file a tax return, the individual must file Form 8833 at the IRS campus where he or she would normally file a return to make the treaty-based return position disclosure under IRC 6114. See Treas. Reg. 301.6114-1(a)(1)(ii) or Treas. Reg. 301.7701(b)-7.

Penalty Computation

Individuals—For an individual, the penalty is $1,000 for each separate treaty-based return position taken and not properly disclosed.

Corporations—For a C corporation, the penalty is $10,000 for each separate failure to disclose a treaty-based return position.

Reasonable Cause

IRC 6712(b) provides that the Secretary may waive all or any part of the penalty on a showing by the taxpayer that there was reasonable cause for the failure and that the taxpayer acted in good faith.

Waiver Criteria—Treas. Reg. 301.6712-1(b) provides the authority to waive, in whole or in part, the penalty imposed under IRC 6712 if the taxpayer’s failure to disclose the required information is not due to willful neglect. An affirmative showing of lack of willful neglect must be made by the taxpayer in the form of a written statement setting forth all the facts alleged to show lack of willful neglect and must contain a declaration by the taxpayer that the statement is made under penalties of perjury.


IRC 6039E—Failure to Provide Information Concerning Resident Status (Passports and Immigration)

IRC 6039E provides a penalty for failure to provide information concerning resident status.

Reporting and Filing Requirements

Passports—IRC 6039E generally requires that any individual, who applies for a United States (U.S.) passport, must include with such application the taxpayer’s TIN (if the individual has one), any foreign country in which such individual is residing, and any other information as the Secretary may prescribe.

Immigration—IRC 6039E generally requires that any individual, who applies to be lawfully accorded the privilege of residing permanently in the U.S. as an immigrant in accordance with the immigration laws, must include with such application the taxpayer’s TIN (if the individual has one), information with respect to whether such individual is required to file a return of the tax imposed by Chapter 1 for such individual’s most recent 3 taxable years, and any other information as the Secretary may prescribe.

Penalty Letters, Notice Letters, and Notices

Letter 4318IRC 6039E Initial (Passport), and attachment Form 13997Validating Your TIN and Reasonable Cause, are used by the IRS to propose a penalty.

Letter 4319IRC 6039E No Penalty (Passport), is used by the IRS to notify the taxpayer that no penalty will be asserted.

Letter 4320IRC 6039E Penalty (Passport), is used by the IRS to notify the taxpayer that it found that he or she did not have reasonable cause and that the proposed penalty will be asserted.

Penalty Computation

The penalty is $500 for such failure.

Only one $500 penalty may be asserted per application.

Reasonable Cause

IRC 6039E provides for such penalties unless it is shown that such failure is due to reasonable cause and not to willful neglect.


IRC 6038D—Information With Respect to Specified Foreign Financial Assets

IRC 6038D was added by P.L. 111-147, the Hiring Incentives to Restore Employment (HIRE) Act, for any individual failing to disclose information with respect to specified foreign financial assets during any taxable year beginning after March 18, 2010.

Reporting and Filing Requirements

A complete and accurate Form 8938, Statement of Specified Foreign Financial Assets, attached to a timely filed tax return fulfills the reporting requirements.

The required information for such specified foreign financial assets include the following:

  • For all accounts and assets:
    • The maximum value of each account or asset during the year, and
    • The foreign currency in which the account or asset is designated, the exchange rate used to convert the account or asset value into U.S. dollars, and the source of the exchange rate if other than the U.S. Treasury Financial Management Service.
  • In the case of any foreign deposit or custodial account:
    • The account type, including account number, and account opening and closing dates, and
    • The name and address of the financial institution in which the account is maintained.
  • In the case of any stock of, or interest in, a foreign entity:
    • A description of the stock or interest in the entity, including any identifying number, and acquisition and disposition dates, and
    • The name, address, and type of foreign entity.
  • In the case of all other specified foreign financial assets:
    • A description of the asset, including any identifying number, and
    • The names and addresses of all issuers and counter-parties with respect to the asset.

Penalty Computation

Initial Penalty—The initial penalty is $10,000 for each taxable year with respect to which such failure occurs.

Continuation Penalty—If any failure continues more than 90 days after the day on which the notice of such failure was mailed to the taxpayer (90-day period), additional penalties will apply. The continuation penalty is $10,000 for each 30-day period (or fraction thereof) during which such failure continues after the expiration of the 90-day period. The maximum continuation penalty is limited to $50,000 per failure.

Reasonable Cause

IRC 6038D(g) provides that no penalty shall apply if the individual shows that the failure is due to reasonable cause and not to willful neglect.

An individual will not have reasonable cause merely because a foreign jurisdiction would impose a civil or criminal penalty on any person for disclosing the required information.


Quick Reference Guide to International Penalties

Taxpayer Filing Requirement Penalty Code Section
U.S. person with interest in: Foreign Corporation (FC) Form 5471 IRC 6038(b)
Foreign Partnership (FP) Form 8865
Foreign Disregarded Entity Form 8858
Penalty reducing Foreign Tax Credit: Foreign Corporation (FC) Form 5471 IRC 6038(c)
Foreign Partnership (FP) Form 8865
FC or FP with Foreign Disregarded Entity Form 8858
25 percent foreign-owned U.S. corporations Form 5472 IRC 6038A(d)
25 percent foreign-owned U.S. corporations that fail to: 1) authorize the reporting corporation to act as agent of a foreign related party, or 2) substantially comply with a summons for information Not applicable IRC 6038A(e)
Transferor of certain property to foreign persons: Foreign Corporation Form 926 IRC 6038B(c)
Foreign Partnership Form 8865 Schedule O
Foreign corporations engaged in U.S. business Form 5472 IRC 6038C(c)
Individuals receiving gifts from foreign persons exceeding $100,000 or $10,000 in the case of a gift from a foreign corporation or foreign partnership (adjusted annually for cost of living) Form 3520 IRC 6039F(c)
Individuals that relinquish their U.S. citizenship or abandon their long-term resident status Form 8854 IRC 6039G(c)
Foreign persons holding direct investments in U.S. real property interests Not applicable IRC 6652(f)
U.S. person who creates a foreign trust, transfers property to a foreign trust or receives a distribution from a foreign trust Form 3520 IRC 6677(a)
U.S. Owner of a foreign trust Form 3520-A IRC 6677(b)
Failure to file returns with respect to acquisitions of interests in: Foreign Corporation Form 5471 Schedule O IRC 6679,
Foreign Partnership Form 8865 Schedule P IRC 6679,
IC-DISC, or FSC failure to file returns or supply information: IC-DISC Form 1120-IC-DISC IRC 6686
FSC Form 1120-FSC
Allocation of Individual Income Tax to Guam or the CMNI Form 5074 IRC 6688
Statement for Individuals Who Begin or End Bona Fide Residence in a U.S. Possession Form 8898 IRC 6688
Taxpayer’s failure to file notice of foreign tax redetermination under IRC 905(c) or IRC 404A(g)(2) Form 1116 or Form 1118 (attached to Form 1040-X or Form 1120-X) IRC 6689
Taxpayer’s failure to file notice of foreign deferred compensation plan under IRC 404A(g)(2) Not applicable IRC 6689
Taxpayer’s failure to disclose treaty-based return position Form 8833 or statement IRC 6712
Failure to Provide Information Concerning Resident Status (Passports and Immigration) Not applicable IRC 6039E(c)
Taxpayer’s failure to furnish information with respect to specified foreign financial assets Form 8938 IRC 6038D(d)

Reference Guide to Forms

Form Description
Form 886-A Explanation of Items
Form 870 Waiver of Restrictions on Assessment and Collection of Deficiency in Tax and Acceptance of Overassessment
Form 926 Return by a U.S. Transferor of Property to a Foreign Corporation
Form 1040-X Amended U.S. Individual Income Tax Return
Form 1041 U.S. Income Tax Return (for Estates and Trusts)
Form 1042 Annual Withholding Tax Return for U.S. Source Income of Foreign Persons (Refer to IRM 4.10.21, Examination of Returns, U.S. Withholding Agent Examinations—Forms 1042 )
Form 1042-S Foreign Person’s U.S. Source Income Subject to Withholding (Refer to IRM 4.10.21)
Form 1116 Foreign Tax Credit (Individual, Estate or Trust)
Form 1118 Foreign Tax Credit—Corporations
Form 1120-FSC U.S. Income Tax Return of a Foreign Sales Corporation
Form 1120-IC-DISC Interest Charge Domestic International Sales Corporation Return
Form 1120-X Amended U.S. Corporation Income Tax Return
Form 3198 Special Handling Notice for Examination Case Processing
Form 3210 Document Transmittal
Form 3244 Payment Posting Voucher
Form 3520 Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts
Form 3520-A Annual Return of Foreign Trust With U.S. Owner
Form 3870 Request for Adjustment
Form 4549 Income Tax Examination Changes
Form 4549-A Income Tax Discrepancy Adjustments
Form 5074 Allocation of Individual Income Tax to Guam or the Commonwealth of the Northern Mariana Islands
Form 5344 Examination Closing Record
Form 5471 Information Return of U.S. Person With Respect to Certain Foreign Corporations
Form 5472 Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business
Form 8278 Assessment and Abatement of Miscellaneous Civil Penalties
Form 8288 U.S. Withholding Tax Return for Disposition by Foreign Persons of U.S. Real Property Interests
Form 8288-A Statement of Withholding on Disposition by Foreign Persons of U.S. Real Property Interests
Form 8689 Allocation of Individual Income Tax to the U.S. Virgin Islands
Form 8804 Annual Return for Partnership Withholding Tax (Section 1446)
Form 8805 Foreign Partner’s Information Statement of Section 1446 Withholding Tax
Form 8813 Partnership Withholding Tax Payment Voucher (Section 1446)
Form 8833 Treaty Based Return Position Disclosure Under Section 6114 or 7701(b)
Form 8854 Initial and Annual Expatriation Information Statement
Form 8858 Information Return of U.S. Persons With Respect to Foreign Disregarded Entities
Form 8865 Return of U.S. Persons With Respect to Certain Foreign Partnerships
Form 8898 Statement for Individuals Who Begin or End Bona Fide Residence in a U.S. Possession
Form 8938 Statement of Specified Foreign Financial Assets
Form W-8CE Notice of Expatriation and Waiver of Treaty Benefits

 

 

Quick Guide for Penalty Reference Numbers For International Penalty Assessments

Penalty Description Penalty Rate or Amount Reference
2009 Offshore Voluntary Disclosure Program, 2011 Offshore Voluntary Disclosure Initiative (OVDI), and the 2012 OVDI. Penalty is % of highest aggregate account and asset value in all foreign bank accounts and entities for the tax year, provided that required conditions were met. 5% In lieu of all other penalties that may apply
20%
12 1/2%
25%
27 1/2%
Initial Penalty—Failure of Foreign Corporation Engaged in a U. S. Business to Furnish Information or Maintain Records $10,000 per failure subject to continuation penalty IRC 6038C(c)
Failure of Foreign Person to File Return Regarding Direct Investment in U. S. Real Property Interests $25 each day of failure. Max at lesser of $25,000 or 5% of aggregate FMV of U.S. real property interest IRC 6652(f)
Failure to File (FTF) Returns or Supply Information by DISC or FSC $100 each failure (max $25,000) to supply info and $1,000 for each FTF Form 1120–DISC or Form 1120-FSC IRC 6686
Initial Penalty—FTF Form 5471 Schedule O (IRC 6046) or Form 8865 Schedule P (IRC 6046A) $10,000 per failure subject to continuation penalty IRC 6679
Continuation Penalty—Penalty for Continued Failure to Provide Information After 90-Day Period $10,000 per each 30-day period after the expiration of the 90-day initial notification period IRC 6038(b)(2) and (c)
Initial Penalty—FTF Form 5471 or Form 8865 $10,000 per failure plus FTC reduction within 90-day initial notification period IRC 6038(b)
Initial Penalty—Failure to Provide Information with Respect to Certain Foreign-Owned Corporations (Form 5472) $10,000 per taxable year subject to continuation penalty IRC 6038A
Initial Penalty—FTF Form 3520 transactions with foreign trusts (IRC 6048(a)) greater of $10,000 or 35% of the gross reportable amount IRC 6677(a),
Initial Penalty—FTF Form 3520-A Foreign Trust with U.S. Owner (IRC 6048(b) and/or IRC 6048(c)) greater of $10,000 or 5% of the gross reportable amount IRC 6677(b)
Failure to disclose treaty-based return position (IRC 6114) $1,000 per failure ($10,000 in the case of a C corporation) IRC 6712
FTF Form 3520 for reporting receipt of certain foreign gifts 5% of the amount of the gift per month not to exceed 25% IRC 6039F
FTF Form 8898 Regarding Residence in a U.S. Possession required by IRC 937(c) $1,000 per failure IRC 6688
FTF Form 5074 Allocation of Income Tax to Guam or CNMI required by IRC 7654 and Treas. Reg. 301.7654-1(d) $1,000 per failure IRC 6688
FTF Form 8689 Allocation of Income Tax to VI required by IRC 932(a) and Treas. Reg.1.932-1T(b)(1) $1,000 per failure IRC 6688
Failure to File an Information Statement Regarding Loss of U. S. Citizenship or Long-term Permanent Residency FTF Form 8854 regarding expatriation $10,000 per failure IRC 6039G
FTF Form 926 or Form 8865 Schedule O 10% of the fair market value of property at time of transfer or exchange, not to exceed $100,000 unless the failure was caused by intentional disregard IRC 6038B
Failure to provide information concerning resident status (passports and immigration) $500 for each failure. IRC 6039E
Initial Penalty—Failure to provide information with respect to specified foreign financial assets (Form 8938) $10,000 for each taxable year for failure IRC 6038D
Continuation Penalty—Penalty for Continued Failure to Provide Information After 90-Day Period $10,000 per each 30-day period after the expiration of the 90-day initial notification period IRC 6038A(d)(2)
Continuation Penalty—Penalty for Continued Failure to Provide Information After 90-Day Period—Form 3520 $10,000 per each 30-day period after the expiration of the 90-day initial notification period IRC 6677(a)
Continuation Penalty—Penalty for Continued Failure to Provide Information After 90-Day Period—Form 3520-A $10,000 per each 30-day period after the expiration of the 90-day initial notification period IRC 6677(a)
Continuation Penalty—Penalty for Continued Failure to Provide Information After 90-Day Period $10,000 per each 30-day period after the expiration of the 90-day initial notification period IRC 6679(a)(2)
Continuation Penalty—Penalty for Continued Failure to Provide Information After 90-Day Period $10,000 per each 30-day period after the expiration of the 90-day initial notification period IRC 6038C(c)
Continuation Penalty—Failure to provide information with respect to specified foreign financial assets (Form 8938) $10,000 per each 30-day period after the expiration of the 90-day initial notification period IRC 6038D

International Penalties Subject to or Not Subject to Deficiency Proceeding

Reference Description Form Deficiency Proceedings
IRC 6038(b) Information Reporting With Respect to Certain Foreign Corporations and Partnerships—Penalty for Failure to Furnish Information Form 5471, Form 8858, or Form 8865 No
IRC 6038(c) Penalty of Reducing Foreign Tax Credit Plus Continuation Penalty Form 5471, Form 8858, or Form 8865 Yes
IRC 6038A(d) Information Reporting for Foreign-Owned Corporations Form 5472 No
IRC 6038A(e) Noncompliance Penalty for Failure to Authorize an Agent or Failure to Produce Records Not applicable Yes
IRC 6038B(c) Failure to Provide Notice of Transfers to Foreign Persons Form 926 or Form 8865 Schedule O No for penalty. Yes for tax on gain
IRC 6038C(c) Information With Respect to Foreign Corporations Engaged in U.S. Business Form 5472 No
IRC 6038C(d) Noncompliance Penalty for Foreign Related Party Failing to Authorize the Reporting Corporation to Act as its Limited Agent Not applicable Yes
IRC 6038D Failure to Provide Information With Respect to Specified Foreign Financial Assets Form 8938 No
IRC 6039E Failure to Provide Information Concerning Resident Status (Passports and Immigration) Not applicable No
IRC 6039F(c) Gifts from Foreign Persons Form 3520 Yes if IRC 6039F(c)(1)(A). No if IRC 6039F(c)(1)(B).
IRC 6039G Expatriation Reporting Requirements Form 8854, Form W-8CE No
IRC 6652(f) Foreign Persons Holding U.S. Real Property Investments Not applicable No
IRC 6677(a) Failure to File a Foreign Trust Information Return Form 3520 No
IRC 6677(b) Failure to File an Information Return With Respect to U.S. Owners of a Foreign Trust Form 3520-A No
IRC 6679 Return of U.S. Persons With Respect to Certain Foreign Corporations and Partnerships Form 5471 Schedule O, Form 8865 Schedule P, or Form 5471 Schedule N No
IRC 6686 Information Returns for Former FSCs Form 1120-IC-DISC, or Form 1120-FSC Yes
IRC 6688 Reporting for Residents of U.S. Possessions Form 5074, Form 8689 or Form 8898 Yes
IRC 6689 Failure to File Notice of Foreign Tax Redetermination Form 1116 or Form 1118 (attach to Form 1040-X or Form 1120-X) No
IRC 6712 Failure to Disclose Treaty-Based Return Position Form 8833 No

 

Reasonable Cause Relief Summary (The IRS’s Position on Relief Availability)

 

Penalty Code Section Form Reasonable Cause Relief
IRC 6038(b) FCs—Form 5471
FPs—Form 8865
FCs and FPs with Foreign Disregarded Entities—Form 8858
Yes
IRC 6038(c) FCs—Form 5471
FPs—Form 8865
FCs and FPs with Foreign Disregarded Entities—Form 8858
Yes
IRC 6038A(d) Form 5472 Yes
IRC 6038A(e) Not applicable Not applicable
IRC 6038B(c) Form 926
Form 8865 Schedule O
Yes
IRC 6038C(c) Form 5472 Yes
IRC 6038C(d) Not applicable Not applicable
IRC 6038D Form 8938 Yes
IRC 6039E Not applicable Yes
IRC 6039F(c) Form 3520 Yes
IRC 6039G Form 8854, Form W-8CE Yes
IRC 6652(f) Not applicable Yes
IRC 6677(a) Form 3520 Yes
IRC 6677(b) Form 3520-A Yes
IRC 6679 Form 5471 Schedule O for IRC 6046
Form 8865 Schedule P for IRC 6046A
Yes
IRC 6686 Form 1120-IC-DISC, or
Form 1120-FSC
Yes
IRC 6688 Form 5074
Form 8689
Form 8898
Yes
IRC 6689 Form 1116 or Form 1118
(attach to Form 1040-X or Form 1120-X)
Yes

 

[1] Notice 97-34 provided guidance regarding the new foreign trust and foreign gift reporting provisions contained in the Small Business Job Protection Act of 1996 (the “Act”). The Act expands information reporting requirements under section 6048 of the Internal Revenue Code (the “Code”) for U.S. persons who make transfers to foreign trusts and for U.S. owners of foreign trusts. In addition, the Act adds new reporting requirements for U.S. beneficiaries of foreign trusts, extensively revises the civil penalties for failure to file information with respect to foreign trusts, and adds civil penalties for failure to report certain transfers to foreign entities. See sections 6048(c), 6677, and 1494(c). The Act also adds section 6039F 1 to the Code, creating reporting requirements for U.S. persons who receive large gifts from foreign persons.