Beware Form 3520-A

A U.S. personwho is a beneficiary of a foreign grantor trust must report the trust to the Internal Revenue Service on two different forms.  The forms have different deadlines, and the deadlines are extended by the filing of different extension forms.  There is confusion among tax preparers concerning these forms.  The IRS is aggressively assessing penalties for failure to timely report interests in foreign grantor trusts, and the penalties can be substantial.

Who Must File Forms 3520 and 3520-A

A U.S. person who, during a calendar year, is a deemed owner of a foreign grantor trust under the grantor trust rules of Internal Revenue Code Sections 671-679 must report the trust to the IRS on 3520-A, Annual Information Return of Foreign Trust With a U.S. Owner, for that calendar year.  A “U.S. person” is a citizen or resident of the United States. 

Under the grantor trust rules, where an individual creates and funds a trust, retaining the right to revoke the trust or control the enjoyment of the trust property or income, for Federal income tax purposes he or she is deemed to own the trust assets and to realize trust income.  Also, where a third party, such as a relative or an employer of a beneficiary, creates and funds a trust, and the beneficiary has the current right to withdraw property from the trust, the beneficiary is deemed to own the trust assets, and to realize trust income under the grantor trust rules.

A “foreign trust” is any trust which is not a U.S. trust.  A “U.S. trust” is any trust if (a) a court within the United States is able to exercise primary supervision over administration of the trust, and (b) one or more U.S. persons have the authority to control all substantial decisions of the trust.

A U.S. person who is a beneficiary of a foreign grantor trust during a calendar year must also report the trust to the IRS on Form 3520, Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts, for that calendar year.  Form 3520 must also be filed by a U.S. person who, during the current calendar year, received either (a) more than $100,000 from a nonresident alien individual or a foreign estate that the U.S. person recipient treats as gifts or bequests (as opposed to income subject to tax); or (b) more than $16,076 from foreign corporations or foreign partnerships that the U.S. person recipient treats as gifts.

Thus, a taxpayer who is a deemed owner of a foreign grantor trust at any time during a calendar year must report the trust on both Form 3520-A and Form 3520 filed for that calendar year.   

Filing Deadlines of Forms 3520 and 3520-A

Form 3520-A for a given calendar year is due to be filed by the ensuing March 15.  It may be extended by filing Form 7004, Application for Automatic Extension of Time To File Certain Business Income Tax, Information, and Other Returns, by the March 15 deadline. 

In contrast, Form 3520 for a given calendar year is due to be filed by the ensuing April 15.  It may be extended by filing Form 4868, Application for Automatic Extension of Time To File U.S. Individual Income Tax Return, by the April 15 deadline.  Form 4868 is the form by which a taxpayer generally extends the filing deadline of an individual U.S. income tax return.  Many tax preparers are under the mistaken impression that a timely-filed Form 4868 extends Form 3520-A.  As a result many Forms 3520-A are being filed late, with consequent late-filing penalties assessed against beneficiaries.

Heavy Penalties for Failure to Timely File Form 3520-A

The penalty for failure to timely file a Form 3520-A is five percent of the value of property held in the foreign trust on the last day of the tax year, or $10,000, whichever is greater.  A recent case involved a man who is a dual citizen of Canada and the United States from birth. He is the beneficiary of a trust established under the last will of his father, who died a Canadian resident.  The trust has about $800,000 in assets.

The man sensed that he needed to comply with U.S. laws concerning his Canadian trust.  He searched online, and found a U.S. attorney who held himself out as an expert in such matters. The attorney turned out to be a charlatan.  He took a $20,000 retainer from the man, and did absolutely nothing for him.  In March, 2018, the attorney told the man that he needed an additional $48,500 retainer to complete the case.  It was then the man began looking for another attorney to handle his voluntary disclosure case, and found our law firm.  We immediately filed his delinquent FinCEN Forms 114, Report of Foreign Bank and Financial Accounts, (“FBARs”).  We also referred the man to an accountant to prepare amended U.S. income tax returns for him.  We filed the amended tax returns in July, 2018, in a submission under the IRS’ Streamlined Compliance Procedures, making the man compliant through 2016. 

In October, 2018, the man filed his 2017 U.S. income tax return, including Forms 3520 and 3520-A reporting his Canadian trust.  The man had filed a Form 4868 by April 15, 2018 extending his 2017 U.S. income tax return, including Form 3520.  But a Form 7004 had not been filed extending the man’s 2018 Form 3520-A. 

In September, 2019, the man received a notice from the IRS charging him a penalty for failure to timely file a 2017 Form 3520-A.  The penalty approximated $40,000, five percent of the value the trust assets.  In the past the IRS had refrained from assessing a penalty for failure to timely file an information return, such as Form 3520-A, where the taxpayer voluntarily made the filing, albeit late, without the IRS bringing it to the taxpayer’s attention.  The policy behind this was to encourage taxpayers’ voluntary compliance with the law.  The policy obviously no longer obtains.

That prompted me to inquire of the man’s 2018 U.S. tax filings.  The man’s 2018 U.S. income tax return, filed in August, 2019, included Form 3520 and 3520-A.  Sure enough, a Form 7004 extending the man’s 2018 Form 3520-A had not been filed.  The man was thus facing another $40,000 penalty, this time for failure to timely file a 2018 Form 3520-A. 

The man is thus facing the spectre of penalties totaling $80,000 for filing the redundant Form 3520-A seven months late in two successive years.

IRC § 6677(d) provides for relief from the late-filing penalty where the failure to timely file Form 3520-A is due to reasonable cause and not willful neglect.  We filed a written protest appealing the penalty assessed against the man for failure to timely file a 2017 Form 3520-A.  Also, we wrote to the IRS asking that it not to assess a penalty against the man for failure to timely file a 2018 Form 3520-A.

Congress Must Act

The situation regarding Forms 3520 and 3520-A is terribly confusing and unfair.  Form 3520-A requires much the same information as Form 3520.  Yet the failure to file or extend Form 3520-A by the ensuing March 15 subjects the taxpayer to substantial a substantial penalty, even where the taxpayer timely files or extends Form 3520 by April 15.   

Failure to timely file Form 3520-A subjects taxpayers to heavy penalties, and to legal fees incurred in seeking relief from such penalties.  Accountants and attorneys face malpractice liability for failing to advise clients to file Form 3520-A or Form 7004 extending it by the March 15 due date.  Congress must act against IRS fervor in assessing penalties for failure to timely file Form 3520-A.  The fix is simple: provide that Form 3520-A has the same due date as Form 3520, i.e., the 15th day of the fourth month following close of the tax year; and that a timely-filed Form 4868 also extends the due date of Form 3520-A.  Moreover, no penalty should be assessed where the taxpayer late-files an information return, such as Form 3520 or Form 3520-A, voluntarily, without the IRS having brought it to the taxpayer’s attention.

Stephen J. Dunn

Tax and Estate Planning Attorney and Author

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