Received a Foreign Gift? File IRS Form 3520 or Face Significant Penalties.

By Jason Kovan

May 9, 2023

IRS Form 3520, officially named "Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts."

U.S. taxpayers, including individuals and businesses, must file form 3520 if they have certain types of interactions with foreign trusts or received significant gifts or bequests from foreign individuals or entities.

Imagine a scenario where you're a U.S. citizen, and you've been fortunate enough to receive a large monetary gift from a relative living in another country. Alternatively, let's say you're a business owner who has established a foreign trust to handle some of your company's assets. In both cases, you would need to file a Form 3520 with the IRS.

Form 3520 is a way for the U.S. government to keep tabs on large sums of money moving in and out of the country.

The goal is to prevent money laundering, tax evasion, and other financial crimes. The IRS wants to make sure that all money is accounted for and that the necessary taxes are paid.

Let's talk about the specifics.

If you're an individual who received more than $100,000 from a foreign individual or estate that you don't have to repay, you're obligated to report that on Form 3520. If you've received over $16,388 a.o. 2022/23 guidelines, but this value adjusts for inflation) from foreign corporations or partnerships, you also need to report that. The form is also required for U.S. owners of foreign trusts, U.S. recipients of certain foreign gifts, and U.S. persons treated as owners of any part of the assets of a foreign trust.

Filing this form doesn't necessarily mean you'll owe taxes on the money. The U.S. doesn't generally tax gifts, whether they come from within the country or from abroad. However, the IRS wants to know about these gifts and trusts to ensure that everyone is following the rules.

If you're a business owner, you might have set up a foreign trust to manage some of your company's assets.

If that's the case, you'll also need to file Form 3520. The form allows the IRS to track the money in the trust and ensures that you're paying the appropriate amount of tax.

Penalties for not filing Form 3520

Failing to file Form 3520 can lead to severe penalties. For example, if you don't report a gift, you could be fined 5% of the gift's value for each month the gift isn't reported, up to a maximum of 25%. For foreign trusts, the penalty can be even harsher: you can be fined 35% of the gross value of any property transferred to or distributed from the trust.

So, you can see why it's essential to comply with the requirements of Form 3520. Not only is it a legal obligation, but it also helps maintain financial transparency and prevents potential issues with the IRS down the line. It's always a good idea to seek advice from a tax professional if you're in a situation where you think you might need to file a Form 3520. We can provide you with guidance based on the most recent tax laws and regulations.

Form 3520 is used by the IRS to monitor large transactions with foreign entities and ensure that individuals and businesses are adhering to tax laws. Whether you're an individual receiving a significant foreign gift or a business with dealings in foreign trusts, compliance with the form's reporting requirements is a must to avoid hefty penalties and maintain financial integrity.

More about Form 3520 penalties

Understanding the potential penalties for failing to file IRS Form 3520 is critical because they can be quite substantial.

Let's start with foreign gifts. If you're a U.S. person who received a foreign gift or bequest and failed to report it on Form 3520, the penalty is 5% of the amount of such foreign gifts for each month for which the failure to report continues. The penalty cannot exceed 25% of the gift, but that's still a significant amount. For example, if you received a gift of $200,000 and didn't report it for a year, you could be penalized up to $50,000.

Now, let's consider foreign trusts. The penalties here can be even more significant. If you're required to file Form 3520 because you are the responsible party for reporting a reportable event, such as the creation of a foreign trust by a U.S. person, the penalty is 35% of the gross value of any property transferred to the trust if you fail to file or don't furnish accurate information.

Similarly, if you're a U.S. person treated as the owner of any portion of a foreign trust, you're subject to a penalty of the greater of $10,000 or 5% of the gross value of the portion of the trust's assets treated as owned by you if you fail to file Form 3520 or fail to report all of the information required by section 6048(b) or includes incorrect information.

The penalties get steeper for distributions from foreign trusts. If you're a U.S. person who received (directly or indirectly) a distribution from a foreign trust, you need to report it, and failure to do so can result in a penalty of 35% of the gross value of the distribution.

Also, there can be an additional penalty if the IRS sends you a notice demanding that you file Form 3520, and you do not comply. The additional penalty is 5% of the gross value of the trust's assets that are considered owned by you, capped at the lesser of $10,000 or the foreign trust's gross reportable amount.

Remember that these penalties apply separately and independently. It's possible to incur multiple penalties based on the same set of transactions or activities.

The IRS does understand that sometimes people make mistakes. If you can show that your failure to file was due to reasonable cause and not willful neglect, the IRS can waive these penalties. However, what constitutes "reasonable cause" is not well-defined and can be a bit subjective, so it's not a good idea to rely on this as a safety net.

The penalties for failing to file Form 3520 can be quite severe, ranging from thousands to potentially even hundreds of thousands of dollars. This is why it's so important to understand the requirements and ensure you're in compliance. If there's any doubt, contact Jason Kovan, international tax attorney who can provide you with guidance based on the most recent tax laws and regulations.

Are IRS form 3520 penalties for late filers or failure to file the same for individuals, businesses, non-profit entities, or trusts?

Penalties associated with Form 3520 are generally the same regardless of whether the entity required to file is an individual, a business, a non-profit, or a trust. However, the specific circumstances may impact how the penalties are calculated.

As mentioned earlier, the penalties for not filing or late filing of Form 3520 can be substantial. They are calculated as a percentage of the gross value of the gifts, assets, or distributions involved in the transaction. This means that while the percentage used for the penalty calculation is the same, the absolute dollar amount of the penalty can vary widely depending on the size of the transactions.

If an individual and a corporation both fail to report a foreign gift, they would each be penalized at a rate of 5% per month of the gift's value, up to a maximum of 25%. Likewise, if an individual, corporation, or trust is required to file Form 3520 due to transactions with a foreign trust and they fail to file or report inaccurate information, the penalty is 35% of the gross reportable amount. Again, the actual penalty amount would depend on the size of the transaction.

It is critical for all taxpayers - whether individuals, businesses, non-profits, or trusts - to understand their reporting requirements and ensure that they are in compliance to avoid penalties. If there's any doubt, it's always a good idea to seek advice from Jason Kovan, U.S. international tax attorney for a confidential consultation.

Let's summarize IRS form 3520 and form 3520-A

IRS Form 3520:

Form 3520, "Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts," is a tax form that U.S. persons must file if they have certain types of transactions with foreign trusts, or if they receive large gifts or bequests from foreign individuals or entities. It's used to track large sums of money moving in and out of the country to prevent money laundering, tax evasion, and other financial crimes.

The penalties for not filing or filing late can be substantial and are generally a percentage of the gross value of the transaction. It's important to understand your reporting requirements to avoid these penalties.

IRS Form 3520-A:

Form 3520-A, "Annual Information Return of Foreign Trust with a U.S. Owner," is a related form that must be filed by a foreign trust with a U.S. owner. It provides information about the foreign trust, its U.S. beneficiaries, and any U.S. person who is treated as an owner of any portion of the foreign trust.

The trust, not the owner, is generally responsible for filing Form 3520-A. However, if the trust fails to file, the responsibility falls on the U.S. owner. Like with Form 3520, the penalties for not filing or filing late can be quite substantial.

Both of these forms are a crucial part of the U.S. tax system's efforts to ensure financial transparency and compliance with tax laws. If you're involved in any of these types of transactions, it's a good idea to seek advice from a tax professional by contacting us.

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