U.S. persons who create, own, or receive distributions from a foreign trust, or who receive large gifts or bequests from foreign persons, generally report those events on Form 3520. The penalties for a missing or late form are based on the amounts involved, not on any tax owed, so the filing rules are worth understanding.
Who Must File Form 3520?
Form 3520, Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts, is generally required for a U.S. person who, during the tax year:
Created or funded a foreign trust: transferred money or other property to a foreign trust, or is otherwise responsible for reporting a “reportable event” involving a foreign trust.
Owned a foreign trust: was treated as the owner of any part of a foreign trust under the grantor trust rules.
Received a distribution: received, directly or indirectly, a distribution from a foreign trust. Under §643(i), certain loans of cash or marketable securities from a foreign trust, and the uncompensated use of trust property, are treated as distributions.
Received a large foreign gift: received gifts or bequests totaling more than $100,000 from a nonresident alien individual or foreign estate, or gifts from foreign corporations or foreign partnerships above a separate, lower threshold that is adjusted annually for inflation.
A gift or bequest is generally not taxable income to the person who receives it, but it must still be reported once the threshold is crossed. Under Revenue Procedure 2020-17, certain tax-favored foreign retirement trusts and certain tax-favored foreign nonretirement savings trusts are exempt from Form 3520 and Form 3520-A reporting if the conditions of that revenue procedure are met.
When and Where to File
Form 3520 is due by the 15th day of the 4th month after the end of the person’s tax year, which is April 15 for calendar-year individuals. If the person receives an extension of time to file the income tax return, the Form 3520 due date is extended to the 15th day of the 10th month (October 15). Certain individuals living outside the United States who qualify for the automatic two-month extension have until June 15.
Form 3520 is not attached to the income tax return. It is filed separately with the IRS, at the address listed in the form instructions.
Form 3520-A for Foreign Grantor Trusts
A foreign trust with a U.S. owner files Form 3520-A, Annual Information Return of Foreign Trust With a U.S. Owner. It is due by the 15th day of the 3rd month after the end of the trust’s tax year (March 15 for a calendar-year trust), and an extension can be requested on Form 7004.
The U.S. owner is responsible for making sure the trust files Form 3520-A and furnishes the required owner and beneficiary statements. If the trust does not file, the instructions require the U.S. owner to complete a substitute Form 3520-A and attach it to the owner’s Form 3520 by the Form 3520 due date to avoid penalties for the trust’s failure.
Penalties
Under §6677, failing to report the creation of or a transfer to a foreign trust, or failing to report a distribution received, carries a penalty equal to the greater of $10,000 or 35 percent of the gross reportable amount, such as the value of the property transferred or the gross amount distributed. When a foreign trust with a U.S. owner fails to file a complete Form 3520-A, the U.S. owner faces a penalty equal to the greater of $10,000 or 5 percent of the gross value of the portion of the trust’s assets treated as owned by that person at year-end.
If a failure continues more than 90 days after the IRS mails a notice, an additional $10,000 penalty applies for each 30-day period, although total penalties cannot exceed the gross reportable amount.
For example, if a U.S. beneficiary receives a $200,000 distribution from a foreign trust and does not report it, the initial penalty is the greater of $10,000 or 35 percent of $200,000, which is $70,000. Any income tax on the distribution is determined separately.
For unreported foreign gifts, §6039F imposes a penalty of 5 percent of the gift’s amount for each month the failure continues, up to 25 percent.
No penalty applies under these sections if the failure was due to reasonable cause and not willful neglect. The statute provides that the possibility of civil or criminal penalties under foreign law for disclosing the information is not reasonable cause. In addition, when required information about a foreign trust is not reported, the period for assessing tax on the related return generally stays open until three years after the information is provided (§6501(c)(8)).
A foreign gift or trust distribution may not increase the tax owed, but the reporting requirement still applies, and the penalties are measured by the amounts involved rather than by any tax due.
Catching Up on Missed Filings
Taxpayers who missed Forms 3520 or 3520-A, have no unreported income, are not under civil examination or criminal investigation, and have not been contacted by the IRS about the missing returns may be able to use the IRS Delinquent International Information Return Submission Procedures. Penalties are not automatically waived under those procedures, but the IRS states that for Forms 3520 and 3520-A, reasonable cause statements will be considered before a penalty is assessed.
When the missed forms are accompanied by unreported income from foreign assets, the Streamlined Filing Compliance Procedures may be available to taxpayers who can certify that their conduct was not willful. Eligible taxpayers who follow the streamlined procedures are not subject to information return penalties, although the domestic version imposes a 5 percent miscellaneous offshore penalty and returns may still be selected for audit. Taxpayers concerned that their conduct could be viewed as willful should consider the IRS Criminal Investigation Voluntary Disclosure Practice.
The Bottom Line
Form 3520 reporting applies to transfers to foreign trusts, foreign trust ownership, distributions, and large foreign gifts, and Form 3520-A applies to foreign trusts with U.S. owners. Because the penalties are tied to the amounts involved, reviewing any foreign trust or gift activity before the filing deadline is the most effective way to avoid them.
Questions about a foreign trust or gift?
Tax attorney Cassra Minai, Esq. can review your Form 3520 obligations and options in a confidential consultation.