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U.S. taxpayers who have participated in transactions involving foreign trusts or received large sums of money from abroad may be required to inform the IRS of these activities via Form 3520. This article explores who needs to file this form, what must get reported, and the consequences for failing to do so.
What is IRS Form 3520 and Who Needs to File It?
IRS Form 3520, Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts, is an informational return which does not involve the calculation of a tax liability or a refund but rather provides information. This form serves to notify the IRS with respect to:
- Certain transactions with foreign trusts.
- Ownership of foreign trusts.
- Receipt of certain large gifts or bequests from certain foreign persons.
Internal Revenue Code section 7701(a)(30)(E) defines a “foreign trust” as one where 1) the United States is unable to exercise primary jurisdiction over the administration of the trust (the “court test”) or 2) all substantial decisions of the trust are made by foreign persons who are not U.S citizens (the “control test”).
Most trusts that are settled or created outside of the U.S. are considered foreign as they are outside of our courts’ jurisdiction. Similarly, a foreign person who holds the power to appoint a trustee under the trust is enough to signal the existence of a foreign trust under the control test.
There are three circumstances under which a U.S. taxpayer will need to file Form 3520:
- You are a U.S. owner of a foreign trust (Part II on Form 3520).
- You make certain transactions with a foreign trust (Parts I and III on Form 3520).
- You receive a large gift or inheritance from someone abroad (Part IV on Form 3520).
The Code clarifies that U.S. taxpayers who are deemed a “responsible party” (grantor, transferor, or executor) for reporting a “reportable event” (creation of foreign trust, transfer to foreign trust, death of U.S. citizen with ties to a foreign trust) will be required to file the form.
We note that reporting obligations will turn on the nature of the transaction and/or the nature of the foreign asset, hence the Internal Revenue Code’s reference to “certain” trusts, transactions and gifts. These are explored in more detail in the following section. “What Gets Reported.”
What Gets Reported?
There are four general categories of transactions that must be reported on Form 3520, each of which corresponds to a different part of the form where specific information about the foreign trust, transaction, and/or foreign gift must be disclosed.
Part I: Transfers to Foreign Trusts
The following circumstances will trigger reporting requirements under Part 1 of Form 3520 if you are:
- A U.S. person who transfers money or other property directly or indirectly to a foreign trust, whether by creating the trust or transferring to an existing trust.
- A U.S. person who 1) transfers property to a related foreign trust (or a person related to the trust during the tax year in exchange for an obligation or 2) holds a qualified obligation from a foreign trust that is outstanding at the time of filing the Form.
- The executor of the estate of a U.S. decedent where 1) the decedent made a transfer to a foreign trust by reason of death 2) the decedent was treated as the owner of any portion of a foreign trust immediately prior to death or 3) the decedent’s estate included any portion of the assets of a foreign trust.
The information that must be reported under Part I of Form 3520 includes the name of the trust’s creator, the date of the trust’s creation, the country in which the trust was created, and the country’s laws that govern the trust.
For transfers to a foreign trust, the date of the transfer, description of property transferred, and value of the property including adjusted basis must be disclosed as well as information about the beneficiaries and trustees.
Part II: Ownership of Foreign Trusts
If you own all or any part of a foreign trust you will need to report the existence of the trust and the value of the trust assets that you own on Part II of Form 3520. Additional identifying information such the country in which, and date on which, the trust was formed must also be provided. The reporting requirement remains in effect regardless of whether any distribution from the trust was made during the tax year.
The grantor trust provisions will determine whether a U.S. person is treated as “owning” a trust. Generally, if the creator or donor of the trust maintains certain controls or powers over the trust or a portion of the trust, then that person will be deemed owner of the trust for U.S. income tax purposes.
As an owner of a foreign trust, you may also be required to file IRS Form 3520-A, Annual Information Return of Foreign Trust with a U.S. Owner, and attach it to Form 3520.
Part III: Distributions from Foreign Trusts
The following circumstances will trigger reporting requirements under Part III of Form 3520 if you are:
- A U.S. person including an owner or an executor of the estate of U.S. person who receives any distribution from a foreign trust, either directly or indirectly
- A U.S. person who is a U.S owner or beneficiary of a foreign trust who receives 1) a loan of cash or marketable securities directly or indirectly form the foreign trust or 2) uncompensated use of trust property.
- A U.S. person who is the owner or beneficiary of a foreign trust that holds an outstanding qualified obligation of the U.S. person or a U.S. person related to the filer.
The information that must be reported under Part III of Form 3520 includes the distribution date, a description of the property, and the property’s fair market value. For loans or uncompensated use of trust property, the fair market value of the loan or property at issue, the date of the transaction, the term of the loan, and the interest rate must be reported.
Part IV: Receipt of Gifts or Bequests from Foreign Persons
The following circumstances will trigger reporting requirements under Part IV of Form 3520 if you are a U.S. person who receives a gift during the tax year as follows:
- More than $100,000 from a nonresident alien individual or foreign estate, or
- More than a threshold amount from a foreign corporation or partnership ($17,339 for gifts made during the 2022 tax year).
Once the aggregate value of all gifts from a single transferor exceeds the threshold, the reporting requirement is triggered. Also, if you know or have reason to know that the different foreign persons from whom you received gifts are related, you must aggregate all such gifts.
The information that must be reported under Part IV of Form 3520 includes the date the gifts were received, a description of the property, and the fair market value of the property. If the gifts are received from a foreign corporation or partnership, the name, address and U.S. taxpayer ID must also be provided.
For more detailed information about what gets reported under IRS Form 3520, including definitions for key terms mentioned in this article, please refer to the IRS Instructions for Form 3520.
The IRS will impose harsh penalties if Form 3520 is not timely filed or if the information reported is incomplete or inaccurate. Typically, the initial penalty is equal to the greater of $10,000 or the following:
- 35% of the gross value of property transferred to a foreign trust where the U.S. transferor fails to report the trust creation or the transfer.
- 35% of the gross value of distributions received from a foreign trust where the U.S. person fails to report receipt of the distribution.
- 5% of the gross value of the portion of the foreign trust’s assets treated as owned by a U.S. person if that person fails to file timely, completely or accurately.
Additional penalties will be imposed if noncompliance continues beyond 90 days after the IRS has mailed a notice of failure to comply. If the taxpayer can demonstrate that the failure to comply was due to reasonable cause and not willful neglect, there may be an opportunity to abate the penalties.
Do You Need a Tax Attorney?
The laws surrounding international taxation and the reporting requirements involving foreign trusts and foreign gifts are complicated. Given that the failure to comply with reporting obligations under IRS Form 3520 will invariably result in the assessment of significant penalties, taxpayers with foreign financial interests or who receive property from abroad are encouraged to consult with an experienced tax attorney who can evaluate filing requirements, advise on remedying any noncompliance issues, and assist with penalty abatement, where applicable.
Filing compliance requirements may extend beyond Form 3520 for taxpayers who have financial interests abroad. A U.S. person that has a financial interest in, or signature authority over, foreign financial accounts must file a Foreign Bank Account and Financial Asset statement with the Financial Crimes Enforcement Network (FinCEN) if the aggregate value of the foreign financial account exceeds $10,000 at any time during the calendar year. You will also need to file IRS Form 8938, Statement of Specified Foreign Financial Assets, with the IRS if the total, aggregate value of those assets exceeds the IRS reporting requirement which is currently set at $50,000.
The experienced tax attorneys at Segal, Cohen & Landis can help you evaluate any filing and reporting requirements triggered by your dealings with foreign trusts, accounts and/or gifts, address noncompliance issues, and assist with penalty abatement where the circumstances warrant same. It may be possible to participate in an IRS amnesty program which allows the taxpayer to become compliant through a voluntary disclosure process thereby reducing or eliminating some of the penalties.
If you are interested in having a complimentary consultation with our of our partner attorneys regarding your tax matter, please feel free to contact us at 866-505-1872. We would be happy to advise you as to how we can resolve your case and how much it would cost.