IRS Issues Significant Guidance on Foreign Trusts: Forms 3520 and Form 3520-A

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Matthew L. Roberts

Matthew L. Roberts

Principal

469.998.8482
mroberts@freemanlaw.com

Mr. Roberts is a Principal of the firm. He devotes a substantial portion of his legal practice to helping his clients successfully navigate and resolve their federal tax disputes, either administratively, or, if necessary, through litigation. As a trusted advisor he has provided legal advice and counsel to hundreds of clients, including individuals and entrepreneurs, non-profits, trusts and estates, partnerships, and corporations.

Having served nearly three years as an attorney-advisor to the Chief Judge of the United States Tax Court in Washington, D.C., Mr. Roberts leverages his unique insight into government processes to offer his clients creative, innovative, and cost-effective solutions to their tax problems. In private practice, he has successfully represented clients in all phases of a federal tax dispute, including IRS audits, appeals, litigation, and collection matters. He also has significant experience representing clients in employment tax audits, voluntary disclosures, FBAR penalties and litigation, trust fund penalties, penalty abatement and waiver requests, and criminal tax matters.

Often times, Mr. Roberts has been engaged to utilize his extensive knowledge of tax controversy matters to assist clients in their transactional matters. For example, he has provided tax advice to businesses on complex tax matters related to domestic and international transactions, formations, acquisitions, dispositions, mergers, spin-offs, liquidations, and partnership divisions.

In addition to federal tax disputes, Mr. Roberts has represented clients in matters relating to white-collar crimes, estate and probate disputes, fiduciary disputes, complex contractual and settlement disputes, business disparagement and defamation claims, and other complex civil litigation matters.

IRS Form 3520 and Form 3520-A

In 1996, Congress enacted Section 6048.[1]   Under that provision, certain persons are responsible for reporting transactions or relationships with foreign trusts on IRS Form 3520 and/or IRS Form 3520-A.  The failure to timely file an IRS Form 3520 and/or IRS Form 3520-A can result in significant civil penalties and potential criminal referrals.

However, until recently, there has been significant debate among tax professionals regarding whether certain foreign trusts funded through employer and employee contributions were subject to the above reporting requirements.  On March 2, 2020, the IRS issued guidance on these types of compensation arrangements (and certain savings trusts) through the release of Revenue Procedure 2020-17.

In sum, Revenue Procedure 2020-17 concludes that the reporting requirements of IRS Form 3520 and IRS Form 3520-A are not required in these circumstances, provided the foreign trusts and taxpayers meet specified criteria under the Revenue Procedure.  Moreover, the Revenue Procedure provides helpful guidance to taxpayers who have been assessed civil penalties for failure to file IRS Forms 3520 and IRS Forms 3520-A in these circumstances and who wish to file a claim for abatement or refund of the civil penalty.

Summary of Foreign Trust Reporting Requirements

Section 6048 contains the reporting requirements applicable to foreign trusts. Under Section 6048(a), a “responsible party” must file an IRS Form 3520 if a “reportable event” occurs.  For these purposes, a reportable event includes: (1) the creation of a foreign trust by a U.S. person; (2) the transfer of money or property to a foreign trust by a U.S. person; and (3) the death of a U.S. person if the decedent was treated as the owner of any portion of the foreign trust under the grantor trust rules or any portion of the foreign trust was included in the gross estate of the decedent.   Generally, the responsible party is the grantor of the trust, the transferor of assets or property to the trust, or the executor of the decedent’s estate.

Section 6048(c) generally imposes reporting requirements on foreign trust beneficiaries.  Under that provision, U.S. persons are required to file IRS Form 3520 if they receive a distribution from the foreign trust during the tax year.

Section 6048(b) imposes reporting obligations on foreign trusts or certain U.S. persons.  This reporting obligation is the IRS Form 3520-A, which must be filed by any U.S. person treated as the owner of any portion of a trust under the grantor trust rules unless the foreign trust files the IRS Form 3520-A.

Failures to file IRS Forms 3520 and/or IRS Forms 3520-A can result in steep civil penalties.  For example, for violations under Section 6048(a) or Section 6048(c), the IRS can impose a civil penalty equal to the greater of $10,000 or 35% of the “gross reportable amount” under Section 6677.  Moreover, for violations under Section 6048(b), the IRS can assert a civil penalty equal to the greater of $10,000 or 5% of the gross reportable amount.  For these purposes, the gross reportable amount is:

Section 6048 has some statutory exceptions.  Specifically, Section 6048(a)(3)(B)(ii) provides an exception from the foreign trust reporting requirements under Section 6048(a) for transfers to foreign compensatory trusts described in Sections 402(b), 404(a), or 404A.[2]  Moreover, Section 6048(d)(4) permits the IRS to suspend or modify reporting requirements under Section 6048 if the United States has no significant tax interest in obtaining the required information.

Previously, the IRS has relied on either of these provisions to modify the reporting obligations under Section 6048. Specifically, in prior guidance, the IRS has held:

Revenue Procedure 2020-17

On March 2, 2020, the IRS issued Revenue Procedure 2020-17.  A summary of the Revenue Procedure follows:

Procedures for Requesting Abatement or Refund of Section 6677 Penalties

Because the IRS no longer believes that civil penalties are appropriate in the above circumstances, the Revenue Procedure also provides that eligible individuals who have been assessed civil penalties under Section 6677 for failing to file IRS Forms 3520 and IRS Forms 3520-A with respect to applicable tax-favored foreign trusts may request an abatement of the penalty or a refund of the penalty paid.

To do so, taxpayers should file an IRS Form 843, Claim for Refund and Request for Abatement.  However, to qualify for refund, the taxpayer must meet the requirements of Section 6402 and Section 6511.[4]  Significantly, Section 6511 limits the ability of the IRS to refund taxes and civil penalties unless the taxpayer files the claim for refund within 3 years from the date the return was filed or 2 years from the time the tax was paid, whichever expires later.

To request abatement and refund, the taxpayer should mail the Form 843 to the Internal Revenue Service office in Ogden, Utah.  In addition, the taxpayer should write on Line 7 of Form 843 “Relief Pursuant to Revenue Procedure 2020-17.” Moreover, the taxpayer should explain on Line 7 how the taxpayer and the foreign trust meet each relevant requirement under the Revenue Procedure.

Takeaway

The Revenue Procedure provides some welcome reporting relief for taxpayers who find themselves squarely within its parameters.  However, taxpayers should ensure the foreign trust at issue meets the applicable requirements of the Revenue Procedure if they intend not to file an IRS Form 3520 and/or IRS Form 3520-A.

Moreover, taxpayers should be cognizant of the Revenue Procedure’s specific warning regarding other reporting requirements which may apply and are not exempt from reporting under the Revenue Procedure, such as FinCEN Form 114, Report of Foreign Bank and Financial Accounts (“FBARs”) and Form 8938, Statement of Specified Foreign Financial Assets.

 

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[1] All “Section” references are to the Internal Revenue Code of 1986, as amended (the “Code”).

[2] These Sections of the Code generally refer to so-called employees’ trusts or deferred compensation plans.

[3] Generally, Section 6501 of the Code requires the IRS to assess tax within 3 years after the tax return was filed unless the return is false or fraudulent or no return is filed.  Section 6501(c)(8) provides an extension of the statute of limitations where the taxpayer fails to file certain foreign information reporting returns, such as IRS Form 3520, IRS Form 3520-A, IRS Form 5471, etc.

[4] Section 6402 permits the IRS to credit, within the applicable statute of limitations period, any overpayment against other liabilities, such as past-due support and certain debts to federal and state governments.

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