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INTRODUCTION
U.S. persons are required to file Form 3520 (Annual Return ToReport Transactions With Foreign Trusts and Receipt of CertainForeign Gifts) with the I.R.S. to report
- certain transactions with foreign trusts,
- ownership of foreign trusts under the grantor trust rules ofCode §§671 through 679, and
- the receipt of certain large gifts or bequests from foreignpersons.
The penalty for filing a delinquent Form 3520 is 5% of the valueof the unreported gift for each month that passes after its duedate. The maximum penalty is 25% of the amount of the gift. Form3520 is due at the time of a timely filing of the U.S. income taxreturn. If the due date for filing the tax return is extended, thedue date for filing the Form 3520 is automatically extended.
This article addresses the winding road that must be navigatedwhen a U.S. person discovers that the Form 3520 has not been filedon a timely basis.
REPORTABLE GIFTS AND BEQUESTS
Outright gifts and bequests received from a foreign donor or theestate of a foreign decedent in excess of $100,000 must be reportedby a U.S. recipient. Gifts received from related individuals areaggregated in determining whether the threshold has been exceeded.If none of the gifts exceed $5,000, a blanket statement is used totell the I.R.S. that no gifts or bequests exceed that level.
Example:
Husband and wife are nonresident, noncitizen individuals. Theirdaughter lives and works in the U.S. She holds an H 1B visa. Hgifts daughter. Husband gifts $78,000 to the daughter and wifeseparately gifts $25,000 to the daughter. The threshold of $100,000is exceeded. Daughter must file Form 3520.
Distributions from a revocable, grantor trust that has a foreignperson as grantor are treated as gifts from the foreign grantor forsubstantive U.S. tax purposes. If they exceed $100,000, they mustbe reported. For reporting purposes, and reporting purposes only,the receipt retains the character of a trust distribution and mustbe reported as such on the form.
I.R.S. WEBSITE
The I.R.S. website contains a page entitled "DelinquentInternational Information Return SubmissionProcedures."1 It provides as follows in pertinentpart.
What do I do if I have a delinquent internationalinformation return?
Taxpayers who have identified the need to file delinquentinternational information returns who are not under a civilexamination or a criminal investigation by the IRS and have notalready been contacted by the IRS about the delinquent informationreturns should file the delinquent information returns throughnormal filing procedures.
Penalties may be assessed in accordance with existingprocedures.
All delinquent Forms 3520 and 3520-Ashould be filed according to the applicable instructions for thoseforms.
Taxpayers may attach a reasonablecause statement to each delinquent information return filed forwhich reasonable cause is being asserted. During processing of thedelinquent information return, penalties may be assessed withoutconsidering the attached reasonable cause statement. It may benecessary for taxpayers to respond to specific correspondence andsubmit or resubmit reasonable cause information.
On its surface, the page suggests the existence of a benignprocedure designed to invite late compliance. In practice, latecompliance is penalized.2
PENALTY REGIME
If a penalty is imposed, it is not a tax deficiency.Consequently, the U.S. Tax Court has no jurisdiction to review theasserted penalty. The I.R.S. treats the penalty as due whenasserted unless appealed. The appeal is an administrative appeal tothe I.R.S. Independent Office of Appeals based on reasonable causefor failure to timely file.
The appeal does not stop the running of collection notices. Ifthe I.R.S. sends a notice to levy on bank accounts and otherproperty under standard collection procedure, a Due Process Appealto U.S. Tax Court may be filed.
Failure to file Form 3520 keeps the statute of limitations from.running as to the penalty until the date that is three years fromfiling.
I.R.S. APPEALS PROCEDURE
The first communication from I.R.S. after submitting areasonable cause statement is Form Letter CP 854C. It Informs thetaxpayer that the request for a penalty waiver or abatement hasbeen fully or partially denied. The taxpayer is invited to appeal.The deadline for responding is typically 60 days from the date ofthe letter. It is not uncommon for a taxpayer residing abroad tofirst receive the Form Letter CP 854C after the due date forresponding has passed. To date, our experience is that the appealwill be processed by the I.R.S. even if late in that set ofcirc*mstances. Of course, that may change.
The appeal is filed with the Independent Office of Appeals.Filing an appeal does not stop the collection process. Typically,the appeal includes the following information:
- The name, address, and taxpayer identification number of thetaxpayer
- A statement that the taxpayer appeals the findings
- A detailed statement of facts and law
- A copy of the original request for abatement of thepenalty
- A copy of CP 854C
The I.R.S. Appeals Office typically responds to a protest byissuing Form Letter 5157, in which it schedules a conference callwith the taxpayer. The letter typically grants one month's timeto prepare for the call. The taxpayer is typically offered theopportunity to provide additional information to assist the AppealsOfficer in reaching a decision. The Appeals Officer may becontacted in advance to reschedule the conference, at least onetime.
If the Appeals Officer has not responded within 60 to 90 days ofthe filing date of a in response to Form Letter CP 854C, the I.R.S.can be contacted at the following telephone number: (559) 233-1267.A recorded message will invite the caller to leave a message and toprovide a contact telephone number. The I.R.S. will research thestatus of the case and return the call within 48 hours. If the casehasn't been updated in the I.R.S. system, no callback will bereceived.
The I.R.S. sometimes responds by issuing Form Letter CP 15instead of Form Letter CP 854C. This invites the taxpayer to file asubmission to the I.R.S. prior to an appeal to the IndependentOffice of Appeals. Form letter CP 15 grants 30 days for theresponse to be submitted. Typically, the I.R.S. will issue a letterinforming the taxpayer that the I.R.S. is not equipped to handlethe matter and is forwarding the matter to the I.R.S. IndependentOffice of Appeals. This is simply one added step that increasesprocessing time
As mentioned above, the Appeals process does not stop thecollection process. Consequently, while an appeal is pending, thetaxpayer will continue to receive the following collectionnotices:
- CP 501 Reminder, We Show You Still Owe
- CP 503 Notice Important – Immediate Action Required
- CP 504 Notice Urgent Notice – We Intend to Levy onCertain Assets, Please Respond Now
- CP 90/ LT 11/ LT 1058 / Letter 3172 – Notice of Levy(prohibits the State Department from issuing or renewing a passportto a taxpayer with seriously delinquent tax debt in excess of$55,000.
COLLECTION DUE PROCESS HEARING
Before the I.R.S. can levy against the assets of a taxpayer, itwill issue Form Letter 3172. This letter grants a Taxpayer theright to request a hearing under the Collection Due Process("C.D.P.") program. The request is made by filing Form12153. The C.D.P hearing provides a taxpayer with an opportunity tobring the case before the IRS Office of Appeals, which isindependent and separate from the I.R.S. Collections office.
A hearing must be requested within 30 days from the date of FormLetter 3172. A negative determination by the Appeals Officer TheAppeals determination can be challenged in Tax Court. If the 30-dayperiod lapses, an equivalent hearing may be requested. However, theequivalent hearing does not allow a taxpayer the right to challengethe determination in Tax Court.
In a C.D.P. hearing, a taxpayer may raise issues relating tocollection. In particular, a taxpayer may raise the followinggrounds for relief from the threat of a levy:
- The taxpayer believes all taxes due were paid.
- The taxpayer cannot pay the taxes due to one or more of thefollowing reasons:
- A terminal illness or high medical bills
- Unemployment or no income
- Reasonable expenses exceed income
- The taxpayer's only source of income is social security,welfare, or unemployment benefits
- The taxpayer wants to pursue innocent spouse relief.
- The taxpayer thinks the statute of limitations on collectionhas expired.
- The taxpayer intends to propose a different way to pay thetaxes owed
- The I.R.S. made a procedural error in its tax assessment.
- The I.R.S. assessed taxes and initiated a levy when thetaxpayer was in bankruptcy
- The taxpayer wants a tax lien discharged to sell a piece ofproperty and use the proceeds to pay off their taxliabilities.
- The taxpayer desires a tax lien subordination orwithdrawal.
A taxpayer may also challenge the underlying tax liability forany tax period, but only if he or she did not receive a notice ofdeficiency or did not otherwise have an opportunity to dispute theliability.
A timely request for a C.D.P. hearing will prohibit levy actionin most cases. It will also suspend the running of the statutoryyear period to collect the taxes. Both prohibition on levy and thesuspension of the 10-year statutory period for collections willlast until a determination by the I.R.S. Independent Office ofAppeals. The suspended amount of time is, in effect, added to thetime remaining in the 10-year period.
The taxpayer has a right to challenge and adverse determinationin its C.D.P. hearing by filing a petition for review in the U.S.Tax Court.
THINGS TO REMEMBER WHEN DRAFTING AN APPEAL
When appealing the 25% penalty on a late-filed Form 3520, it isimportant to tell the whole story. A recitation of bare factsfollowed by a citation to a favorable decision in a court is arecipe for failure. The goal is to convince the Appeals Officerthat the taxpayer acted responsibly even though a failure incompliance occurred. The Appeals Officer must be convinced thatreasonable cause existed. This requires a full and completesubmission that is true, accurate, and complete. False statementswith the intent to mislead are punishable as felonies.
In fashioning the submission, emphasize the professionalcredentials of the tax adviser. Before arguing that the adviser ortax return preparer was at fault, explain in detail why it wasreasonable to choose this tax adviser in the first place. Remember,the capability of the tax adviser or return preparer is a keydecision point in determining that reasonable cause existed for thetaxpayer's failure to timely Form 3520. If the adviser orpreparer is painted as incompetent, the taxpayer's position isweakened, not strengthened.
Once it is established that the tax adviser or tax returnpreparer was highly competent to address this area of the law, thefocus shifts to whether the taxpayer made full disclosure. Thisrequires demonstrating that the person on whom the taxpayer relieswas given sufficient information to advise properly. Avoid givingconclusions without a detailed recitation of facts.
The final piece of the puzzle is to demonstrate that thetaxpayer actually relied in good faith on the advice. Here thestandard of care varies depending on the profile of the taxpayer.If the taxpayer's business is in the financial services sector,a higher standard of care must be demonstrated. If the taxpayer isnot a businessman, a lesser standard may be applied. Whicheverstandard applies, the taxpayer must demonstrate clearly that he orshe exercised ordinary business care and prudence in determiningapplicable obligations, but nevertheless failed to comply withthose obligations.
As a final point, a taxpayer should provide all facts in detail.Look for facts highlighted in cases that produced favorable resultsand see if they reasonably exist in the circ*mstances at hand. Moredetail is better than less detail.
Footnotes
1. See the I.R.S. website.
2. See Wooyoung Lee, "When it Comes to Penalty Abatement, is theI.R.S. Offside?"
The content of this article is intended to provide a generalguide to the subject matter. Specialist advice should be soughtabout your specific circ*mstances.
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