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In this digital age, having documents “cross in the mail” is almost obsolete. However, IRS processing delays in reviewing foreign trust beneficiaries’ reasonable cause applications for forgiveness of reporting penalties can mean taxpayers receive new notices even while their applications are pending. If they don’t resubmit their application it can create trouble and financial consequences for beneficiaries, even while they are waiting for the IRS to process their original request.
If you are the owner or beneficiary of a trust located overseas, you may assume that the IRS doesn’t need to know about it until you receive a distribution or make a withdrawal from the account. That assumption is wrong. The Internal Revenue Code (IRC) section 6048 requires U.S. taxpayers to disclose their foreign trust accounts every year, even if they received no benefit from them that year. They must file Form 3520, Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts, and Form 3520-A, Annual Information Return of Foreign Trust With a U.S. Owner (Under section 6048(b)). A recently announced change to the IRS Guidance excludes certain foreign retirement, health, disability, and education accounts from this reporting requirement. However, for anyone who does not qualify for this exemption, the failure to file these annual reports can be expensive.
Another section of the IRC allows the IRS to assess a penalty of $10,000 or 35% of the gross value of the account for each unreported foreign trust account and each year the report is missing. If the IRS issues a notice for failure to file the forms, the U.S. taxpayer must correct the error within 90 days or suffer an additional $10,000 penalty for each additional 30-day delay.
In May 2018, the IRS announced it was going to start focusing on foreign trust accounts to increase compliance. That means that taxpayers are now receiving notices that they have failed to file Form 3520 and 3520-A even when they didn’t know they had to file them in the first place. If you had good reason to miss the filing deadline, you can ask the IRS to forgive the penalties. IRC Section 6677 says the penalties won’t be imposed for “any failure which is shown to be due to reasonable cause and not due to willful neglect.” You can do this by working with your tax attorney and CPA to submit a “reasonable cause statement” along with your forms.
However, unlike your foreign tax returns, you can’t e-file your Forms 3520, 3520-A, or reasonable cause statement. Tax attorneys say it can take a very long time to get any response to those filings. Even the IRS acknowledges it is “constrained by resources” that result in delays processing the paper forms.
The trouble is that the subsequent penalty notices are automated. While the paper forms sit waiting for an IRS investigator’s review, your account could be flagged for non-compliance, and the notice of non-filing could be sent out, triggering that 90 day deadline to avoid additional penalties. Even worse, if the 90 days pass before your forms rise to the top of the pile, you could begin accruing penalties even after you have submitted your reasonable cause statement.
The IRS’s answer to these processing delays is, ironically, more paper. RaDel Lloyd, an international technical specialist at the IRS responded to concerns over forms and notices crossing in the mail, saying taxpayers shouldn’t assume their explanation has been rejected. Instead, they should resubmit their reasonable cause statement after every notice. Lloyd explained taxpayers will get a different letter explaining that the IRS has received their reasonable cause statement and accepting or denying their explanation.
This process creates a burden on taxpayers who may not realize the notices are automatically generated. Once the penalties start to apply, it could become expensive for taxpayers to prove they filed a timely response and avoid unnecessary penalties because their statement and the IRS notices crossed in the mail.
Attorney Joseph R. Viola is a tax attorney in Philadelphia, Pennsylvania with over 30 years experience. If you have questions regarding foreign trust account reporting requirements, contact Joe Viola to schedule a consultation.