Received an IRS Notice of Penalty Charge for a Foreign Gift?

A U.S. taxpayer may have to file many different international information reporting forms each year to disclose their foreign accounts, assets, investments, businesses, gifts, and trusts to the IRS. One of the most common types of international information reporting forms that Taxpayers are required to file (especially for those with family members overseas) is IRS Form 3520 — which is used to report foreign gifts and trusts. Our International Tax Lawyers have represented many Taxpayers across the globe with Form 3520 issues. When it comes to late Form 3520 filing and penalties, it is always crucial to assess each Taxpayer’s specific facts and circumstances — along with strategizing the response and post-response objectives — before any submission is made to the IRS. While a Form 3520 CP15 Notice Response is time-sensitive, Taxpayers (and their counsel) should still be sure to have their ducks in a row before submitting their response. Some key issues to consider before submitting the CP15 Penalty Notice response are:

- - Can the Taxpayer endure a multi-year penalty challenge process with the IRS?
  - Is the Taxpayer willing to risk receiving a Notice of Federal Tax Lien?
  - Is paying the penalty and challenging the IRS in Federal Court a viable option?
  - Is the Taxpayer worried about a Notice of Levy being submitted to their employer?
  - Are there potentially more Form 3520 penalties coming down the pipeline for other years?

*Golding & Golding previously published the Did You Receive a CP15 Notice from the IRS (Form 3520)? and How to Challenge a Late-Filed Form 3520 Penalty & Defenses articles in 2021, along with the video Responding to a 3520 CP15 Penalty Notice is Time Sensitive and has updated and expanded these articles.

Why Did Taxpayer Receive a Form 3520 Penalty?

When a Taxpayer receives the Form 3520 CP15 Notice, it is usually because the Taxpayer received a foreign inheritance, gift, or series of gifts from a nonresident alien(s) with an annual aggregate total that exceeds $100,000. Taxpayers may also receive a Form 3520 penalty for failing to report foreign trusts and trust distributions but most of the time Taxpayers receive a Form 3520 CP15 Notice because they fail to report a foreign gift.

30-Days to Show Reasonable Cause

The Taxpayer has 30 days from the date of the notice to protest the letter and show reasonable cause. The protest letter is only the first step in what may become a long and arduous penalty challenge process with the IRS. Since Form 3520 penalties are assessable penalties, the Taxpayer’s first notice of a Form 3520 penalty is usually when they receive a CP15 penalty assessment notice. If the Taxpayer wants to protest the penalty, they must submit the protest letter within 30 days and show reasonable cause. While it should be done timely, Taxpayers should not be too quick to submit a submission that is incomplete or sloppy.

*Before submitting the protest letter, it is important to carefully assess the facts. For example, if the Taxpayer can show that the gift was actually for medical or educational purposes and they meet the requirements for these types of gifts, then possibly Form 3520 should not have been filed in the first place and this may lead to a penalty abatement.

Did The Taxpayer Already Submit a Reasonable Cause Statement with Form 3520?

If at the time the Taxpayer received the CP15 notice, they had already submitted a reasonable cause statement (typically this is submitted when the late Form 3520 was filed), then the IRS does not give the Taxpayer a second bite at the apple regarding resubmitting a reasonable cause statement, but…

Was Taxpayer’s Reasonable Cause Statement Even Considered?

Unfortunately, IRS Agents are very overworked, and it is not uncommon that when the late Form 3520 was submitted with a reasonable cause statement, the IRS did not review the letter. Thus, the Taxpayer should carefully discuss their CP15 response strategy with counsel before responding to the protest letter.

Should Taxpayers Appeal the CP15 Form 3520 Penalty?

One of the toughest decisions a Taxpayer may have to make if their protest letter or reasonable cause statement is rejected is whether they should pursue an appeal or not. That is because when a Taxpayer submits an appeal, they are limited in their post-appeal submission options. If the Taxpayer loses the appeal, they are required to pay the amount due and then sue the IRS in Federal Court if they want to continue to challenge the IRS. And, since many Form 3520 penalties can reach the high six and seven figures, it is important to carefully assess the strategy before appealing.

What About a Collection Due Process (CPD) Hearing?

Instead of submitting an appeal, the Taxpayer may pursue a Collection Due Process (CDP) Hearing — noting, that the IRS usually takes the position if the Taxpayer already filed an appeal then they do not get a second chance by requesting a Collection Due Process Hearing. Technically a CDP Hearing is a type of appeal, but it goes through a different process than a standard IRS appeal. Taxpayers do not have an opportunity to submit a CDP request until they are at the end of the collection process. By the time the Taxpayer receives an opportunity to submit a CDP request, they will have received a final notice of intent to levy, a notice of a state refund levy, a notice of a federal tax lien, or possibly a different type of IRS notice or letter. They will also have received multiple CP504 Notices and notices of interest accruing (Taxpayers may seek to cut off interest by submitting interest payments, but a misapplied interest payment by the IRS comes with its own set of hurdles and risks).

Let’s look at the pros and cons of a CDP Hearing request.

Pros of a Collection Due Process Hearing

There are several benefits to a CDP Hearing. First, the Taxpayer will usually have the opportunity to negotiate with a Settlement Officer (SO) instead of an Appeals Officer (AO) – the SO usually has more authority to settle the matter (and related penalties if applicable). In addition, the Taxpayer gets another opportunity to prove reasonable cause or penalty mitigation — and if the Taxpayer is unsuccessful at the Collection Due Process Hearing they may be able to take the case to Tax Court which gives him another chance to challenge the IRS without first having to pay the penalty.

Cons of a Collection Due Process Hearing

There are also disadvantages to waiting for a Collection Due Process Hearing. First, it can take the IRS several months or years before the Taxpayer receives that final notice — and along the way, it can be very stressful for the Taxpayer. In addition, the Taxpayer may receive a notice of federal tax lien and not just a final notice of proposed levy. For Taxpayers who are considering selling their home or taking out a mortgage or other loans, having a notice of federal tax lien on their record may impact their ability to obtain approval. It could also turn off potential buyers if the Taxpayer intends to sell their home.

Update: Farhy

In the case of Farhy, the Tax Court took the position that the IRS did not have the power to automatically assess Form 5471 penalties. Many Taxpayers hoped this ruling would extend to Form 3520 penalties as well. But, the Court of Appeals reversed the tax court’s ruling and so now the IRS is free again to automatically assess Form 5471 penalties, and presumably Form 3520 penalties as well – at least until a new case comes down the pipeline — though some Taxpayers may still try to seek Form 3520 refuge by relying on the Tax Court’s ruling in Mukhi.

Update: LT38 Notice, Post-Covid CP15 Cases Being Reignited

Many Taxpayers who may have received a CP15 Notice for Form 3520 penalties during COVID may have not heard back from the IRS for several months and even years about their case. However, the IRS recently began issuing LT38 Notices to remind Taxpayers that the IRS has not forgotten about their CP15 Notice and the penalties that are still due and owing.

CP15 Penalty Notice Response is Not a One-Size-Fits-All Strategy

Taxpayers who receive a CP15 Notice for Form 3520 should be sure to speak to a Board-Certified Tax Law Specialist to get a better understanding of their situation and the potential strategies they have to respond to the notice. While Taxpayers may have a limited time to respond — especially if they are going to protest the CP15 Notice — it is also important to submit a persuasive and accurate protest letter and avoid being rushed into slapping together an incomplete response.

Late Filing Penalties May Be Reduced or Avoided

For Taxpayers who did not timely file their FBAR and other international information-related reporting forms, the IRS has developed many different offshore amnesty programs to assist Taxpayers with safely getting into compliance. These programs may reduce or even eliminate international reporting penalties.

Current Year vs. Prior Year Non-Compliance

Once a Taxpayer missed the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, Taxpayers should consider speaking with a Board-Certified Tax Law Specialist who specializes exclusively in these types of offshore disclosure matters.

Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)

In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful Taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties.

**Need Help Finding an Experienced Offshore Tax Attorney?**

When it comes to hiring an experienced international tax attorney to represent you for unreported foreign and offshore account reporting, it can become overwhelming for Taxpayers trying to trek through all the false information and nonsense they will find in their online research. There are only a handful of attorneys worldwide who are Board-Certified Tax Specialists and who specialize exclusively in offshore disclosure and international tax amnesty reporting.

*This resource may help Taxpayers seeking to hire offshore tax counsel: How to Hire an Offshore Disclosure Lawyer.

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Contact our firm today for assistance.