Form 3520 Penalties
Section 6677 sets the civil penalty for a failure to report a foreign trust under section 6048. For the transfers and distributions the statute covers, the penalty is the greater of $10,000 or 35 percent of the gross reportable amount. The IRS has published a procedure for considering a reasonable-cause statement on Form 3520 and Form 3520-A before that penalty is assessed. Whether any statement is accepted is the Service's decision. We do not predict it.
This page is about a filing that is late, missing, or already the subject of an IRS notice. Who must file in an ordinary year, and how an FGT differs from an FNGT on the form, is the Form 3520 and Form 3520-A page. The deed itself is Foreign Trusts. The tax adviser prepares the return. We read the instrument so the return and any reasonable-cause statement describe the same trust.
Section 6048 is the reporting statute. A U.S. person who creates a foreign trust or transfers property to one, a U.S. person treated as an owner, and a U.S. person who receives a distribution, each have a filing duty. Section 6677(a) imposes a penalty for a failure to report a transfer or a distribution: the greater of $10,000 or 35 percent of the gross reportable amount. If the failure continues more than 90 days after the IRS mails notice, a further $10,000 can accrue for each 30-day period, and the penalty for that failure is capped at the gross reportable amount. The penalty can be due when no additional income tax is due. It does not turn on whether the family thinks of the wire as a gift.
Form 3520 is the U.S. person's return. Form 3520-A is the annual information return of a foreign trust with a U.S. owner, and the U.S. owner is responsible for seeing that it is filed. For that owner failure, section 6677 uses the greater of $10,000 or 5 percent of the gross value of the portion of the trust treated as owned by the U.S. person at year-end, not the 35 percent figure. A U.S. beneficiary, without more, does not make the trust file Form 3520-A. Filing the beneficiary's Form 3520 does not satisfy the owner's Form 3520-A, and the reverse is also true. The compliance page sets out who files which part, and when.
Large gifts and bequests from foreign persons are reported on Form 3520, but the penalty for omitting them is section 6039F: 5 percent of the gift for each month the failure continues, up to 25 percent. That is not section 6677. A distribution from a true foreign grantor trust is often treated as a gift from the foreign grantor and reported as a foreign gift, above the threshold, rather than as a trust distribution. After the grantor dies, the same wire can be a distribution from a foreign non-grantor trust, and the part of the form changes. Using the gift rules for an FNGT distribution, or the trust rules for a gift, is how a late file gets the wrong penalty attached to it. See U.S. beneficiaries of a foreign trust.
Section 6677(d) provides that no penalty shall be imposed if the taxpayer shows the failure was due to reasonable cause and not due to willful neglect. The statute also says that a foreign jurisdiction's civil or criminal penalty for disclosing the information is not reasonable cause. On its page for delinquent international information returns, the IRS states that a reasonable-cause statement attached to Form 3520 or Form 3520-A will be considered before a penalty is assessed, and it asks the filer to write "Reasonable Cause Statement attached" at the top of the first page. The same page says that for other delinquent international information returns, penalties may be assessed without considering an attached statement. The Taxpayer Advocate Service's 2023 report on international penalties records the IRS agreement to update the Internal Revenue Manual so that reasonable-cause statements filed with late Forms 3520 and 3520-A are reviewed before assessment, and the Service's later note that the manual was updated. That is a review of a statement. It is not a decision, and it is not relief by another name.
The statement goes with the late return, filed according to the instructions for that form. It is not a letter in place of Form 3520 or Form 3520-A. The IRS page also says the filer may still have to answer correspondence and submit the explanation again. A statement that calls the trust an FGT when the deed makes it an FNGT does not improve by being longer. The years, the transfers, the distributions, and the owner have to match the instrument. The tax adviser prepares the form and computes the exposure. Counsel's work, when it is needed, is to make that record accurate before the statement is written.
If the deed is clear, the years are known, and the preparer already has a beneficiary statement, the CPA can file the late return and attach the explanation. Counsel is the right addition when the family does not yet know which part of Form 3520 applies, whether anyone is a U.S. owner under sections 671 through 679, whether a loan or the use of an apartment was a distribution under section 643(i), or whether the year of the grantor's death changed a gift into an FNGT distribution. Those are the facts a reasonable-cause statement has to get right. If the IRS has already assessed the penalty, the response follows the notice and its deadline. We do not describe that response as a waiver. We do not try the penalty as a lawsuit on this engagement. Families who only need a return prepared should hire the preparer. Families whose trustee, bank, and prior returns describe three different trusts should have counsel and the preparer, with one scope each.
The files that hurt are rarely a mystery about a checkbox. They are a trust that relatives called a gift and the deed calls an FNGT, a U.S. child who has received wires for several years, or a trustee who never issued a beneficiary statement because no one asked while the grantor was alive. The Service's published process is to read a reasonable-cause statement on these two forms before assessing. Nothing on that page, and nothing in section 6677(d), tells a family what the answer will be. Reasonable cause is an exception the taxpayer has to show. Willful neglect is outside it. We do not tell anyone that a penalty will be reduced, declined, or removed.
What we can do is put the legal file in a state the tax adviser can use: who settled the trust, which powers still exist, which transfers were made, and which amounts a U.S. person received. That work is the foreign-trust practice, described on Foreign Trusts. The ordinary filing rules, apart from the penalty, are on Form 3520 and Form 3520-A. The adviser who already works with the family stays in that role. We coordinate with the CPA. We do not replace either of them.
Tell us whether a return was filed, whether a reasonable-cause statement went with it, and whether the IRS has already written. If you are the CPA or the family's adviser, say so. We will tell you whether the next step is counsel, the preparer, or both.