IRS Announces Sweeping Changes To Form 3520 And 3520-A Penalty Rules

To combat late information return filings, the IRS has systemically assessed penalties for certain late-filed international information returns, including IRS Forms 3520, 3520-A, 5471, and 5472. Under these systemic assessment procedures, the IRS automatically imposes penalties against taxpayers who file one or more of these returns late. The penalty applies even if the taxpayer submits a bullet-proof reasonable cause statement explaining the reason for the tardiness.

Based on an October 24, 2024, announcement from the National Taxpayer Advocate, Erin Collins, the IRS appears ready to change course, at least with respect to IRS Form 3520 and 3520-A penalties. In her NTA Blog, Ms. Collins announced that the IRS will no longer make automatic penalty assessments for late-filed IRS Forms 3520 associated with foreign gift or inheritance reporting (i.e., Part IV). In addition, Ms. Collins indicated that the IRS intends, as of the end of this year, to start reviewing reasonable cause statements that are attached to a late-filed IRS Form 3520 or 3520-A for foreign trust reporting.

Foreign Gift Reporting

U.S. persons who receive gifts or inheritances from foreign persons or estates above a threshold reporting amount must report the transaction on IRS Form 3520. In general, the reporting requirement kicks in if the U.S. person receives a foreign gift or inheritance over $100,000 in the aggregate in the tax year (although proposed regulations have suggested that the IRS may index the reporting threshold in future tax years). If a taxpayer fails to file a timely IRS Form 3520 in these circumstances, the agency may assess penalties of up to 25% of the amount of the foreign gift or inheritance received.

Foreign Trust Reporting

U.S. persons who participate in certain transactions associated with foreign trusts also have IRS Form 3520 filing requirements. Unlike the reporting threshold applicable to foreign gifts and inheritances, there is no reporting threshold in these circumstances. Rather, any reportable event (e.g., creation or transfer of money or property to a foreign trust) or receipt of a distribution from a foreign trust triggers the IRS Form 3520 filing obligation. Moreover, there is a separate reporting requirement for U.S. persons who are treated as grantors or owners of foreign trusts under the grantor trust rules. These taxpayers must file an IRS Form 3520-A.

Taxpayers who fail to timely file IRS Forms 3520 and 3520-A are subject to steep penalties. Generally, the penalty for failure to file an IRS Form 3520 is 35% of the amount of the transaction at issue (i.e., the amount transferred to or distributed from the foreign trust). For late-filed Forms 3520-A, the penalty is 5% of the fair market value of the assets held in the foreign trust at the end of the year.

The IRS’ New Penalty Assessment Procedures

The IRS’ announcement is welcome news to many taxpayers and tax professionals who have long complained that the agency’s prior practice of automatically assessing penalties for late-filed IRS Forms 3520 and 3520-A was unfair, particularly given the large penalties involved. The hope by many, including the NTA as mentioned in her blog, is that the IRS will expand this type of relief to other systemically assessed penalties (e.g., IRS Forms 5472 and 5471).

The IRS will likely issue additional guidance on the penalty assessment rules in the future. However, taxpayers should take note now of the IRS’ new assessment procedures, including its intent to review reasonable cause statements for all late-filed IRS Forms 3520 and 3520-A by the end of this year. U.S. persons with late-filed information returns will want to submit a strong reasonable cause statement with the late information return to better their chances of avoiding a penalty assessment altogether. Indeed, unlike prior tax years, these taxpayers may be able to avoid completely the extra costs and time associated with appealing the penalty notice or paying the penalty assessment and seeking a refund through administrative procedures. Taxpayers can learn more about a few acceptable IRS Form 3520 and 3520-A reasonable cause defenses here.