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Recent changes to the IRS website acknowledged an existing policy to assess penalties for failure to file Form 3520 regarding foreign trust assets without considering taxpayer-provided reasonable cause statements. The website warns that taxpayers will need to resubmit their defenses after the penalties have been assessed.
Any time you are an owner, grantor, or beneficiary of a foreign trust account, the IRS requires you to submit Form 3520 disclosing the foreign trust asset and all contributions to or distributions from that asset. This form is filed separately from your 1040 individual tax return, but it is due to the IRS the same day -- April 15 (except for in 2020 when the Coronavirus delayed filing deadlines). Failure to file Form 3520 can be costly. The penalty for beneficiaries failing to report foreign trust account income is 35% of the gross reportable amount of the assets. Owners face 5% penalties.
Sometimes beneficiaries may fail to file because of circumstances beyond their control. When that happens, the U.S. Tax Code says “no penalty shall be imposed” for failures “due to reasonable cause and not due to willful neglect.” According to the IRS, typical cases where reasonable cause relief is granted could include:
The fact that you don’t have the money to pay your taxes or penalties on time is generally not enough. Similarly, simply relying on your CPA or tax advisor to file everything is often not a defense for untimely filing. However reasonable reliance on a tax advisor's advice can sometimes result in abatement.
If you believe you had reasonable cause for failing to file your tax return or Form 3520, you and your tax attorney will need to submit a reasonable cause statement establishing the facts related to the delay. This could include:
Until recently, it has been common practice for tax attorneys to prepare and submit reasonable cause statements along with the delinquent Form 3520 and related documents. However, a recent change to the IRS website suggests that may not be enough to assert the reasonable cause defense and avoid the assessment of penalties. The newly updated site says:
“Taxpayers may attach a reasonable cause statement to each delinquent information return filed for which reasonable cause is being asserted. During processing of the delinquent information return, penalties may be assessed without considering the attached reasonable cause statement. It may be necessary for taxpayers to respond to specific correspondence and submit or resubmit reasonable cause information.”
The new language reflects a standing IRS policy that penalties may be assessed first and then abated later if the taxpayer demonstrates reasonable cause for the delayed filing. This would seem to be contrary to the Tax Code’s requirement that “no penalty shall be imposed.” The process for seeking abatement can be costly and time consuming, and in the meantime the IRS will be attempting to collect the assessed penalty, including by withholding future tax refunds. While a taxpayer can generally request those collections be put on hold while the reasonable cause defense is considered, it may take several extensions of that hold before the matter is resolved.
So why is the IRS ignoring reasonable cause statements submitted with delayed Forms 3520? According to Daniel Price, a senior attorney with the IRS Office of Chief Counsel, it is “just a result of the processing environment.” At a webinar hosted by the American Bar Association’s Section of Taxation, Price said:
“Ideally, if we had unlimited resources, we’d have personnel with bandwidth to read every reasonable cause statement during processing.”
But because of constrained resources, taxpayers may be asked to resubmit reasonable cause information after the decision to assess penalties has already been made. This policy makes it harder and more expensive for taxpayers to raise reasonable cause defenses and makes it likely that sometimes collections of improper assessments will need to be refunded after the determination has been made. Price’s only recommendation is essentially for taxpayers to manage their expectations, be patient, follow instructions, and go through the process.
Attorney Joseph R. Viola is a tax attorney in Philadelphia, Pennsylvania with over 30 years experience. If you have questions regarding foreign trust asset reporting penalties, contact Joe Viola to schedule a free consultation.