The Expatriate tax specialists.

3520 and 3520A compliance

Problems arising from the roll out of the IRS campaign centred on 3520 and 3520A compliance.  Will the campaign do more harm than good?

On May 21, 2018, the IRS Large Business & International Division (“LB&I”) announced its fourth set of compliance campaigns. 

The six new campaigns include one campaign centered on Forms 3520 and 3520-A compliance. A Form 3520, Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts, must be filed to report certain transactions regarding foreign trusts under section 6048 of the Internal Revenue Code, including:

  • Creation of a foreign trust by a U.S. person
  • Any transfer of money or property to a foreign trust, including by reason of death
  • Ownership of foreign trusts, including death of the U.S. owner of a foreign trust
  • Loans and distributions from foreign trusts
  • Gifts or bequests from foreign individuals or estates
  • Gifts from foreign corporations or partnerships
  • A Form 3520-A, Annual Information Return of Foreign Trust With a U.S. Owner, must be filed annually by a foreign trust with a U.S. owner.

Yawn, right. Well, maybe not.

The general aim of the compliance campaigns is to increase compliance with applicable laws.  No-one can have a problem with that, can they?  The problem arises when those who are responsible for ensuring compliance are not familiar with the law themselves.

Most reasonable people do not expect that the person who actually processes the forms need be a doctorate level tax adviser.  We do, however, expect that they have good training, and good guidelines to work within.

It only makes sense that if you are to provide the ability to issue a penalty to a taxpayer of $10,000, that you should be comfortable that the penalty is valid and that the checks/balances in place to prevent erroneous penalties being issued exist.  There should also be a clear explanation of the reason for the penalty.

Since the introduction of the above compliance program all the penalty assessments that we have seen lack a good description of the reason for the penalty.

After several months of phone calls, follow up and general badgering, we have learned that the penalties are generally being issued because in the view of the person who has ‘processed’ the return, the forms haven’t been filed on time.

The problem is, that of the penalties that we have seen, not one of them is due.

Form 3520

The penalties are focused on not filing / late filing of form 3520.  The IRS has the ability to determine the filing deadline of a tax return by considering its filing date as extended by any relevant extension.  If an extension is filed, then a notification appears on an individual’s account.  If a form 4868 is filed on a timely basis, then the due date for the form 3520 becomes 15 October.  Provided that the form 3520 is received by 15 October, no penalty should be issued. 

We have seen several cases where a penalty has been issued despite the extension being filed.  On discussions with IRS representatives on the point, we have been able to determine that it was indeed visible that the extension was properly filed, but because the abatement of the penalty requires a ‘manager approval’, that the request can only be considered if made in writing.

In my last discussion with the IRS I was informed that the wait time for someone to be able to consider a written request was 250 days.

So, we have a position of taxpayers being under the understanding that the IRS erroneously wants $10,000+ from them and they are unable to ‘shake the monkey from their back’ for the best part of a year.

I fail to see how that will engender tax compliance from those who haven’t filed and are becoming aware that even if they do file (on time and correctly) that an error by a processor can result in a year of stress.

Form 3520-A

At a high level, the IRS is distrustful of foreign trusts, due to instances in the past where non-US trusts were used to evade tax.  The lack of visibility of the content of the trust is the rationale behind the extortionate penalties for non-compliance.

Of course, in New Zealand, trusts are widely held.  The two positions do not correlate well.

The extent of trust reporting requirements is however expounded when you consider that US person who participates in pension scheme that is established as a trust outside of the US can be considered to be an owner of that trust to the extent of their funds invested. 

In short, if you are a US person who is in a Kiwisaver fund, you may well have this trust problem.

Kiwisaver funds are required to hold your funds, allowing you access to those funds only under certain conditions as set out within the trust document (reaching 65 etc). The trustee of the funds is generally a corporate entity that is affiliated (or engaged by) the institution that you place your money with.

Under US rules, trustees should be filing form 3520-A and providing you with a copy. Clearly, there is no impetus for them to do so, and as such, US legislation allows you to prepare a substitute form 3520-A instead.

The ability to prepare a substitute form 3520-A is not buried deep within tricky tax legislation.  It is on page 2 of the instructions to form 3520 and the first page of the instructions to form 3520-A.

In the discussions I have had with over 20 different IRS representatives about penalties received by my clients, not one was familiar with a substitute form 3520-A.

The deadline for submitting a substitute form 3520-A is set out within the Internal Revenue Manual. The Internal Revenue Manual provides guidance to IRS staff on technical matters and guidance as to how to deal with informational forms such as forms 3520 and 3520-A.  This deadline is relatively hard to find, but states that the deadline for filing a substitute form 3520-A is the same deadline as for filing form 3520.

Our experience in dealing with notices that refer to unfiled form 3520-A leads me to the conclusion that the IRS has not processed the substitute as a substitute filed in time.

The wait time to deal with an appeal relating to form 3520-A notices is the same as per above.

This article details the experience of a (doctorate level) tax adviser in trying to deal with ‘late’ filed substitute forms 3520-A.

We will be adding our voice to those who have contacted the National Taxpayer Advocate on this matter.  We will be asking for better training (which encompass the points above) for IRS processing personnel, along with better resourcing for the resolution of errors.  We know that the IRS has funding issues and that resourcing will be a tough ask, but surely, it’s only fair that they adequately address the mess that has been created by rolling out their new initiative without proper training.

The above is not tax advice and should not be read as such.