Court Upholds IRS Penalties on Unreported Foreign Wedding Gifts

In many cultures, family and friends give newly married couples substantial wedding gifts to start their new lives together. But when those gifts come from overseas, they come with a tax reporting requirement. A recent decision by the United States District Court for Northern California upheld the IRS’s penalties against a new bride for her unreported foreign wedding gifts, at least for now.

Chinese Citizen and US Taxpayer Fails to Report Foreign Wedding Gifts

Jinming Zhang is a Chinese citizen who came to the United States to receive her masters in accounting, take her CPA exam, and ultimately marry her husband in California. When the couple married in December 2016, Zhang, by that point a US taxpayer, received foreign wedding gifts from her family in China totaling $287,108. But she did not include those gifts on her 2017 income tax return by including Form 3520. She later learned of the reporting requirement and filed a late Form 3520 in October 2018.

US Taxpayers’ Duty to Report Foreign Gifts

U.S. tax law says that taxpayers must report any foreign gifts received exceeding $10,000 per tax year along with their annual tax return. The penalty for failing to file Form 3520 is 5% of the amount of the foreign gifts each month, up to a cap of 25% of the amount in aggregate. However, taxpayers can avoid being penalized if they can show their failure to file was because of “reasonable cause and not due to willful neglect.”

Based on this statute, on November 2, 2020, the IRS assessed a penalty against Zhang for $71,777, the maximum 25% penalty allowed. Zhang requested an abatement asserting she had reasonable cause for failing to report the foreign wedding gifts, but the IRS rejected the request. Later, the IRS Independent Office of Appeals reduced the penalty to 20% or $57,422 in November 2022. She paid the penalty on April 2, 2024, and then requested a refund. When the IRS failed to respond within six months, she filed a lawsuit in the United States District Court for Northern California.

Court Upholds IRS Penalties on Unreported Foreign Wedding Gifts

The IRS filed a partial motion to dismiss soon after, which the District Court judge granted on three bases:

The IRS May Use Assessment Process for Penalties on Unreported Foreign Gifts

Zhang’s first claim said that the IRS did not have statutory authority to assess penalties against her for her unreported foreign wedding gifts and instead, should have filed a civil lawsuit to collect them. She argued that taxes and assessable penalties were not the same thing, so the statute allowing the IRS to assess taxes did not apply.

But the District Court disagreed. It relied on Fahry v Commissioner, a Circuit Court decision involving the failure to report foreign trust income. The D.C. Circuit Court reversed a Tax Court decision striking down the assessment, saying that Congress had rendered penalties assessable by implication, not just explicit reference. The foreign trust reporting statute said the penalty “shall be assessed” and allowed taxpayers to assert a “reasonable cause” defense through the IRS’s administrative process. The Fahry Court emphasized that if the “penalty was not assessable, there would be no post-assessment administrative process in which the taxpayer could make a reasonable cause showing to the Secretary.” The District Court here said the same reasoning applied to unreported foreign gifts as well.

In addition, the District Court looked at the language of the assessment statute, Section 6201, which gave the Treasury Secretary the authority to assess “all taxes (including interest, additional amounts, additions to the tax and assessable penalties) imposed by this title.” Section 6039F says, if a person has unreported foreign gifts, they:

“[S]hall pay (upon notice and demand by the Secretary and in the same manner as tax) an amount equal to 5 percent of the amount of such foreign gift for each month for which the failure continues (not to exceed 25 percent of such amount in the aggregate).”

The Court said the “upon notice and demand” language referenced an IRS assessment, and said the penalty “shall be paid ‘in the same manner as tax.’” Since assessment is the standard recovery method for “all taxes,” it applied here as well.

Zhang had an Adequate Remedy, Blocking Her Administrative Procedures Act Claim

Ms. Zhang also argued that she was entitled to relief under the Administrative Procedures Act (APA), because there was “no other adequate remedy in a court.” But an APA claim cannot “duplicate existing procedures for review of agency action.” Nor does it apply when a statute includes “special and adequate review procedures.” These procedural options need not be identical as long as they provide “relief of the same genre.”

The District Court dismissed Ms. Zhang’s APA claim because she could, and in fact did, seek another remedy challenging the penalty on her unreported foreign wedding gifts by arguing she had “reasonable cause” for not reporting the gifts sooner. The Court characterized the “genre” of her requested relief as challenging the penalty assessed against her to obtain a refund, which meant she had no claim under the APA.

The Penalty on Unreported Foreign Wedding Gifts Was Not an Excessive Fine

Finally, the IRS sought to dismiss Zhang’s argument that the penalty on her unreported foreign wedding gifts was an excessive fine, prohibited by the Eighth Amendment. As has been discussed on this blog before, the question of whether the Eighth Amendment applies depends on whether the payment to the government is “punishment for some offense” and primarily retributive, rather than deterrent or remedial. Tax penalties, the District Court noted, have been consistently ruled remedial, and not subject to the Excessive Fines Clause.

This applied to the penalty for unreported foreign gifts as well. This is because the amount of the penalty was tied to the time the gifts went unreported. The Court said the government would face greater costs to investigate the unreported gifts and collect the assessed penalties as time went on. Therefore, the penalty was remedial and the Eighth Amendment did not apply.

Zhang’s case isn’t over. As the Court noted in considering her APA claim, the IRS conceded that her substantive claim that she had reasonable cause to fail to report her foreign wedding gifts should go forward. Even though the District Court granted the IRS’s motion to dismiss several of her claims, she could still receive a late wedding gift from the courts in the form of a penalty refund.

Attorney Joseph R. Viola is a tax attorney in Philadelphia, Pennsylvania with over 30 years experience. If you are facing penalties for unreported foreign gifts, contact Joe Viola to schedule a free consultation.