By Anthony Diosdi
The Internal Revenue Service (“IRS”) has been asked to do more with less by Congress. As a result far fewer American’s are having their tax returns audited by the IRS. For reasons that will be discussed in this article, that may not be a good thing. This is particularly true if you have an obligation to file IRS Form 3520 and/or IRS Form 3520-A.
The International Penalties Associated with Not Timely Filing an IRS Form 3520 and IRS Form 3520-A
Recently, U.S. persons with business interests outside of the United States have become subject to an expanding universe of reporting requirements. U.S. persons are required to disclose foreign assets and transactions not only on FinCen 114 (“FBAR”) but in many cases foreign assets and transactions must be disclosed on Form 5471, Form 3520, and Form 3520-A. Specific civil sanctions, sometimes referred to as “International Penalties,” may be assessed against individuals for any unexecuted failure to disclose foreign assets and transactions on any of the above discussed information returns. The monetary element of an International Penalty can be substantial.
Most tax penalties and other civil sanctions for noncompliance with internal revenue laws are located in Chapter 68 of the Internal Revenue Code. Chapter 68 authorizes the assessment of civil sanctions for fraud, negligence, and delinquency penalties. These civil sanctions are subject to the deficiency process. Meaning, that the IRS must issue a Statutory Notice of Deficiency before finalizing the assessment of these penalties. This means that a taxpayer is afforded the opportunity of judicial review by the United States Tax Court before these civil sanctions can be assessed and collected by the IRS. On the other hand, the authority to assess most International Penalties is embedded in Chapter 61 of the Internal Revenue Code. Notwithstanding these differences in geography, all International Penalties are “assessable penalties,” meaning that they may be assessed and collected without the IRS having to resort to issuing a Statutory Notice of Deficiency.
A prime example of an International Penalty assessable under Chapter 61 is provided in Internal Revenue Code Section 6677(a). Under Internal Revenue Code Section 6677(a), if any United States Person beneficiary receives (directly or indirectly) a distribution from a foreign trust, that person is required to make a return with respect to such a trust using Form 3520, and show thereon the name of the trust, the amount of the aggregate distribution received, and any other data the IRS may require. A foreign gift, bequest, or inheritance that exceeds $100,000 must also be disclosed on a Form 3520. The IRS may assess an annual penalty equal to 35 percent of the gross value of the trust or 35 percent of the gross value of the transferred property if the Form 3520 is not timely filed. In addition, if a U.S. Person is treated as an owner of any portion of a foreign trust under Internal Revenue Code Sections 671 through 679, he or she will be responsible for ensuring that the foreign trust files Form 3520-A and required annual statement. The form provides information about the foreign trust and its U.S. beneficiaries. The IRS may assess an annual penalty of $10,000 or 5 percent of the gross reportable amount of the trust per year if the Form 3520-A is not timely filed.
The only defense to an International Penalty associated with not timely filing an IRS Form 3520 and IRS Form 3520-A can be found in Internal Revenue Code Section 6677(a).The code section provides that no penalty will be imposed on the responsible party if the failure was due to reasonable cause and not due to willful neglect.
The IRS’ New Way of Assessing International Penalties for Delinquent Form 3520 and Form 3520-A
Up until fairly recently, the assessment of International Penalties associated with delinquent IRS Forms 3520 and 3520-A was confined to audits. During an audit, the taxpayer was typically informed of the possibility of being assessed an International Penalty and was usually provided an opportunity to respond with any Section 6677(a) defenses. Recently, the IRS changed their procedure regarding assessing International Penalties associated with filing delinquent Form 3520s and Form 3520-As. The assessment of International Penalties associated with IRS Form 3520 and IRS Form 3520-A is no longer confined to audits. The problem with this type of procedure is the individual being assessed cannot tell his or her side of the story. Instead, the individual being assessed a large International Penalty must attempt to convince the IRS in writing why the penalty should be removed. This is no simple task.
On January 16, 2020, Lauren E. Busterna, IRS Attorney-Advisor, Estate & Gift Tax Policy has stated in no uncertain terms at Florida Bar 38th Annual International Tax Conference in Miami, Florida that going forward the IRS will automatically assess International Penalties for delinquent Form 3520 and Form 3520-As. Lauren Busterna has acknowledged that there have been cases in which the IRS has assessed International Penalties even in cases where taxpayers have timely mailed Form 3520s and 3520-As.
Once an International Penalty is assessed by the IRS, the IRS will simply send a bill to the taxpayer. If the bill is not satisfied, the IRS will proceed with enforced collection actions which may include the seizure of wages, income, bank accounts, or property to satisfy the International Penalty. So, ignoring the IRS is not an option. Even when individuals choose not to ignore an International Penalty could find themselves sending letters to what seems like a black hole and endless wait time should they attempt to call the IRS.
What Can I Do If I Have Been Assessment an International Penalty Associated with a Form 3520 or Form 3520-A?
The most important thing you can do if you have been assessed an International Penalty is not to ignore the assessment. The problem is not going away and neither is the IRS. If you believe that the IRS incorrectly assessed International Penalties against you, it is extremely important to immediately begin written and verbal communication with the IRS. If the IRS is unresponsive or unreasonable, document your attempts to communicate with the IRS and your communications. In some cases, you can utilize a procedure known as a “Collection Due Process Hearing” to contest an International Penalty, stop enforced collection actions, and in some cases get much needed judicial review from the Tax Court. However, you will need to be prepared to prove your case as to why the IRS incorrectly assessed International Penalties against you and your attempts to resolve the penalties with them.
Keep in mind that the IRS has acknowledged assessing International Penalties against innocent taxpayers. Let this serve as a warning- save your proof of mailings for any international informational returns you file in the future. Proof of mailing could save you a lot of money and grief in the long run.
Anthony Diosdi is a partner and attorney at Diosdi Ching & Liu, LLP, located in San Francisco, California. Diosdi Ching & Liu, LLP also has offices in Pleasanton, California and Fort Lauderdale, Florida. Anthony Diosdi advises clients in tax matters domestically and internationally throughout the United States, Asia, Europe, Australia, Canada, and South America. Anthony Diosdi may be reached at (415) 318-3990 or by email: adiosdi@sftaxcounsel.com.
This article is not legal or tax advice. If you are in need of legal or tax advice, you should immediately consult a licensed attorney.