Foreign Trust Penalties (Failure to Report Forms 3520/3520-A)

Foreign Trust Penalties for Late Filing 3520/3520-A

To facilitate compliance with offshore reporting initiatives, the IRS has developed many different international information reporting forms that require taxpayers to disclose offshore assets such as foreign businesses, accounts, investments, and foreign trusts to the US government. And, for the past few years, the Internal Revenue Service has been on the lookout for taxpayers who failed to complete international information forms in a timely manner – or filed them late. With specific regard to the reporting of foreign trusts, taxpayers who hold property or an interest in a foreign trust may be required to file Forms 3520 and 3520-A annually. Failure to complete these forms may result in significant fines and penalties. If you hold property or an interest in a foreign trust, here are six things you should know about foreign trust reporting and penalties.

Two main forms: 3520 and 3520-A

The two main tax forms a U.S. person may have to file when owning property or an interest in a foreign trust are Form 3520 and Form 3520–A. Depending on the facts and circumstances of the situation, taxpayers may have to file one or both forms. For example, where a US person is the owner of a foreign trust, they complete Forms 3520 and 3520-A – but where the person is only a beneficiary of the foreign trust, they are (usually) required to complete Form 3520 to report the foreign trust — and only when they receive a distribution.

Two different due dates and extension forms

Form 3520 is due when the filer’s individual tax return is due, including extensions. For example, if the person files an extension (such as Form 4868), Form 3520 is also extended, but Form 3520-A works differently. Form 3520-A is due March 15 (it may vary depending on the tax year of the trust) and to request an extension the taxpayer must file a separate Form 7004 (substitute filing rules may apply). ‘to apply).

Multiple penalties for the same trust (Wilson)

It is very common for a taxpayer to be both the owner of a foreign trust and a beneficiary of the same trust. In this type of situation, the taxpayer may have to file Forms 3520 and 3520-A. If the taxpayer fails to file these forms, the taxpayer may be penalized twice for failing to report for the same trust. This was the result in the case of Wilson.

Taxable penalties are different from other penalties

Forms 3520/3520-A are also different from other forms when it comes to penalties. As with most penalties related to international reporting forms, fines involving Forms 3520/3520-A are considered “taxable penalties”. This means that the first notice of non-compliance the taxpayer will receive regarding the penalty will be the actual penalty notice — usually through the receipt of a CP15 notice. This is different from other penalties where the taxpayer may be subject to audit or review – and was already advised that a potential penalty could be imposed (and could formulate a strategy upfront). There are various procedures available to taxpayers to attempt to reduce the penalty.

Foreign Trust Exceptions and Exclusions

The main exclusions for having to complete Forms 3520/3520-A relate to foreign pensions – which are technically considered foreign trusts (based on the relationship between the owner of the trust, the trustee/administrator and the beneficiaries of the trust). It is important to note that not all foreign trusts require the taxpayer to file Forms 3520 and 3520-A. For example, Tax Procedure 2014-55 provides a specific exception for Canadian retirement trusts (RRSPs and RRIFs) as well as Tax Procedure 2020-2017 — which eliminates the reporting of certain tax-deferred savings trusts for retirement and others, if they meet certain requirements – although FBAR and FATCA are still required.

Penalty Waivers and Reduction

When a person has been assessed penalties, there are various procedures a taxpayer can use to avoid, minimize, or reduce the penalties. The IRS recently issued Notice 2022-36 in late August 2022 which serves to eliminate or avoid penalties for late filed Forms 3520 and 3520-A. Alternatively, taxpayers should consider using one of the offshore disclosure programs to try to minimize or avoid penalties for foreign trusts.

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