IRS Commissioner Danny Werfel made a welcome announcement to resounding applause yesterday during his keynote speech at the 40th annual UCLA Extension Tax Controversy Conference. The IRS will no longer be automatically assessing penalties for late-filed IRS Forms 3520, Part IV, which is the form required to be filed when a taxpayer receives a foreign gift. Commissioner Werfel announced that the IRS will no longer automatically assess the penalties for late-filed forms automatically and will review the reasonable cause statements taxpayers include with their late-filed forms before making a penalty determination.
The problem
International Information Return (IIR) Penalties were established to prevent taxpayers from hiding money overseas. The Internal Revenue Code requires the filing of certain information to the IRS to make the agency aware of foreign gifts and inheritances, even if there is no tax due on these gifts. Most taxpayers don’t know about the requirement to report certain foreign gifts and inheritances, and in fact, many tax professionals don’t know either. Why? Because it goes against the general rule that gifts and inheritances don’t have to be reported by the recipient of the gift or inheritance. Instead, they must be reported by the donor, and taxes due, if any, are also paid by the donor. Tax professionals who don’t practice in the foreign space and don’t know this exception to the general rule mistakenly give bad advice to their clients who ask for it. And taxpayers who themselves know this general rule often don’t think they need advice when they receive a foreign gift, because if the gift had been from a U.S. person, there would be no filing requirement at all.
Tax professionals have been complaining, loudly, that the IRS’s practice of automatically assessing penalties for late-filed 3520’s should stop. What motivation would any taxpayer have to voluntarily come in and file a form late if the IRS was going to assess the same penalty that would be assessed if the IRS caught the taxpayer?
Enter Erin Collins, National Taxpayer Advocate
The Taxpayer Advocate Service (TAS) is an independent organization within the IRS. TAS serves to ensure that every taxpayer is treated fairly, and that taxpayers know and understand their rights. The National Taxpayer Advocate, Erin Collins, has been fighting to change how the IRS approaches international penalties. Last year, the IRS’s approach to international penalties made it into the “Most Serious Problems” report that Collins sends to Congress each year as part of her annual report to Congress.
Besides being patently unfair on the merits, the application of the penalties was concerning, because it affected lower-income individuals at a disproportionate rate than those who have means. This makes sense – those individuals or corporations who have money are able to hire lawyers who help them obtain abatements. Lower-income individuals without such benefit of experienced tax attorneys struggle to learn of these reporting requirements, especially since tax is not due.
Just as problematic, having these penalties being assessed automatically is a waste of resources for the IRS and taxpayers, as a majority of these penalties have been found to be erroneous. The Taxpayer Advocate’s Office released numbers that showed over a four-year period from 2018-2021, more than 67% of the penalties and 78% of the dollars assessed were abated. If something is wrong two-thirds of the time, why is the penalty administered automatically?
During a keynote address yesterday, Commissioner Werfel announced the change in IRS policy and he gave Collins credit for effectuating the change. He explained why the IRS was making the change, noting, “a person may be with parents living overseas; a parent dies, now you’re dealing with the estate, you’re dealing with grief, you’re dealing with all the moving pieces, and maybe in the middle of all this, you late-file your form that you’re required to file. There’s a part of the IRS journey in serving taxpayers and meeting the Taxpayer Bill of Rights that involves empathy.”
During the course of the interview-style keynote with Steve Toscher yesterday, I heard Commissioner Werfel say “we are listening” several times. He said “we are listening” when explaining how the IRS has decided to change its policy of applying 3520 penalties and he also said the IRS is listening when it comes to processing of ERC claims. Sandra Brown also welcomed the IRS’s approach, commenting, “Yesterday my partner Steven Toscher had the opportunity to interview of the Commissioner at the 40th UCLA Tax Controversy Institute where the Commissioner announced penalty relief for certain delinquent filers of Forms 3520s. The relief is not only important for fair tax administration but also reflects the IRS is willing to listen to all stakeholders in an effort to help all taxpayers comply with the law.”
What’s Next?
While the IRS has not yet released details about how the change will be implemented, the Taxpayer Advocate press release has some details. For example, Collins notes, “While the changes the IRS has made with respect to Forms 3520 and 3520-A are beneficial for taxpayers, the IRS should expand its elimination of automatic assessments to all late filed IIRs and provide taxpayers the ability to raise a reasonable cause defense with the opportunity for an administrative review with Appeals prior to assessment. I will continue to advocate for these rights.” What that means is for right now, the change in policy does not extend to other International Information Returns.
The first question I had is – what about pending cases? What about cases that just settled? At a minimum, I hope it will apply to all pending cases, and taxpayers who have paid in full and settled cases recently should speak with a professional about filing a claim for refund. Megan Brackney, who has been ferociously fighting for this change noted, “it’s a very positive development, but we would also like to see relief for taxpayers who are burdened by prior penalty assessments who are still trying to resolve their cases with the IRS, and to offer first time abatement relief for taxpayers, including those who may not have reasonable cause but who did not act willfully and whose late filing did not relate to any unreported income.”
Welcome News
The news was very well received by the tax professional community. Dan Price, a former IRS employee who has been one of the loudest critics of the IRS’s automatic assessment practice was “thrilled with the IRS’ announcement that it will no longer systematically assess penalties under I.R.C. sec. 6039F for the late reporting of foreign gifts and foreign inheritances. This change has been long overdue. I applaud the IRS for listening to the National Taxpayer Advocate Erin Collins and tax practitioners that have lobbied for this change.”
Sitting in the room when this announcement was made yesterday was surreal for me. After so many years of advocating taxpayer by taxpayer for the IRS to give them a fair shake, and publicly calling for the IRS to change its policy, it was actually overwhelming to hear this announcement in person. Hearing Commissioner Werfel give credit to the National Taxpayer Advocate Erin Collins and repeatedly express his desire to listen and respond to taxpayer concerns gave me hope for the future of tax administration. Now about those ERC credits….
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