The IRS Commissioner Danny Werfel announced some good news for taxpayers on October 24, 2024. The IRS has ended its practice of automatically assessing penalties when a taxpayer voluntarily submits a late Form 3520, Part IV. This form deals with the obligation of U.S. persons to report to the IRS the receipt of certain foreign gifts and inheritances.
Generally, the recipient of a gift or bequest from a non-U.S. donor, will not pay tax on what he receives, but missing out on the reporting duties means that significant penalties may be assessed for a failure to file the Form 3520 when it is required. The penalty is 5% of the amount of the foreign gift / bequest for each month for which the failure to report continues; not to exceed a total of 25% of the value. In addition to the monetary penalty, the tax consequences of the receipt of the foreign gift may be determined and recharacterized by the IRS based on all the facts and circumstances,
Welcome Change for “Reasonable Cause”
If the taxpayer has “reasonable cause” for not filing the Form 3520, the penalty can be abated. Unfortunately, the IRS procedures for late filings did not consider the reasonable cause statement provided by taxpayers, resulting in automatic penalty assessments and protracted appeals to obtain a refund of the penalty.
For a good number of years, Taxpayer Advocate Service has recommended that foreign information return penalty procedures be changed. Now, the IRS is taking concrete action and the reasonable cause statements submitted by taxpayers will be reviewed prior to any penalty assessment.
This welcome change should reduce unwarranted penalty assessments since taxpayers will have the opportunity to explain their situation prior to the time IRS assesses a penalty. It is important to note that this is a procedural change and not a substantive change. A reasonable cause statement must be very carefully prepared and contain robust reasons for the tax noncompliance. Reasonable cause relief is not very easily granted.
IRS Form 3520 Foreign Gift And Inheritance Information Return
If a U.S. citizen or resident receives a gift (or inheritance) of money or other property from a foreign (non-U.S.) person or entity, the gift may need to be reported on Part IV of Form 3520, Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts. Form 3520 is an information return, not a tax return. So, while the gift or inheritance is not taxable, the IRS must be notified of it if the reporting dollar threshold is met. Practitioners have pointed out that the 25% late filing penalty is quite draconian in light of the fact that no tax has been unreported.
Under current rules, when a foreign gift or bequest is valued at more than $100,000 in any calendar year Form 3520 must be filed. This $100,000 reporting threshold may soon be indexed for inflation as indicated in IRS proposed Treasury Regulations. This is another item of good news from the IRS.
Gifts received from related parties must be aggregated to determine if the dollar threshold has been met. For example, assume that in calendar year 1, a non-U.S. father makes gifts to his U.S. citizen son of $70,000; in the same year, the father’s brother, also a non-U.S. person, makes a gift to the U.S. citizen of $35,000. The citizen must report the gifts on Form 3520 because the gift is more than $100,000; in other words, the separate gifts must be aggregated since they are from related parties.
The proposed Treasury Regulations will require more information on the form than is currently the case. Right now, Form 3520 does not require that the U.S. recipient report identifying information about the foreign donor. The proposed regulations would change this. Under proposed Regulations, the U.S. person must separately identify each foreign gift in excess of $5,000 received from the transferor and from each foreign person related to the transferor and must provide identifying information (for example, name and address) about the transferor and each such foreign person, including a foreign individual or a foreign estate.
Important Form 3520 Filing And Taxation Exceptions
A lower dollar threshold applies when reporting gifts that are received from foreign entities such as a foreign corporation or partnership. Gifts from entities can be recharacterized by the IRS and result in taxable income to the U.S. recipient. As such, it is critical that foreign gift-givers use their own personal financial accounts from which to make the gift transfer and not the account of an entity.
Another significant exception applies to the general rule that gifts are not taxed to the recipient. Gifts or bequests received by a U.S. person from certain former American citizens or long-term permanent residents can be subject to a special transfer tax currently equal to 40% of the gift/bequest. This is a very detailed area of law and currently, we lack guidance from the IRS on its application, but suffice to say that a gift or inheritance from a former U.S. person can be a Trojan horse.
Other Possible Reporting Requirements – FBAR And FATCA
So-called FBAR and FATCA reporting may also be required.
If the gift or inheritance is a foreign financial account (e.g., a foreign mutual fund or brokerage account), and the aggregate of all foreign accounts held by the U.S. person exceeds $10,000 annually, the U.S. person must file FinCEN Form 114, Report of Foreign Bank and Financial Accounts (FBAR). Penalties for unfiled FBARs can be very steep.
Additionally, the Foreign Account Tax Compliance Act (FATCA) requires filing IRS Form 8938, “Statement of Specified Foreign Financial Assets”, if the total value of all foreign financial assets exceeds certain thresholds each year. The annual thresholds depend on one’s tax filing status and whether the U.S. individual is residing stateside or abroad. Not only do penalties apply for not filing this form when required, the failure to file results in an open statute of limitations until such time as the IRS is provided the information.
I help with tax matters around the globe.
Reach me at vljeker@us-taxes.org
Visit my US tax blog www.us-tax.org It is an invaluable guide in all areas of US international tax. It will help you stay on top of legislative developments, keeping you ahead of US tax changes impacting your life, family or business.
Send a note about an area of tax you’d like to see me write about.
Read the full article here
