Lingering Issues with IRS Easing of Foreign Trust Requirements

Did the IRS Do Enough to Ease Foreign Trust Filing Requirements?

How Much Did the IRS Really Ease Foreign Trust Reporting

In early May of 2024, the Treasury Department and Internal Revenue Service issued proposed regulations for foreign trusts and large foreign gifts. While there are some bright spots in the proposed regulations, in general, U.S. taxpayers across the globe remain at the mercy of the IRS when it comes to foreign gift and trust reporting. In fact, in some instances it looks like the U.S. government wants the Taxpayers to provide more information (for example, more information about foreign transferors of foreign gifts) — and the proposed regulations still limit the parameters for Taxpayers seeking to claim the reasonable cause exception when filing late Forms 3520 and 3520-A. Let’s take a brief look at some of the lingering tax problems contained within the proposed regulations.

Increased Disclosure of Foreign Gifts Transferors

It is important to understand the purpose of IRC 6039F. Unlike U.S. persons who file Form 709 to report gifts, foreign non-resident aliens are not required to report the transfer of a gift to a U.S. person (excluding covered expatriates, once Form 708 is published). Still, the IRS wants to have this information because they want to see what assets are being transferred to U.S. persons — and ultimately it may impact estate tax when the U.S. person passes away, depending on the value of their estate. Generally, when the gift is from a foreign individual it only requires bare information about the transfer, including the date of the transfer, what assets were transferred, and the value of the transfer. Based on the proposed regulations, it looks like the IRS wants additional information from the recipient of the gift as part of the reporting process.

As provided by the IRS:

• • • “Specific identifying information about the transferor is not currently required to be provided on Form 3520. The Treasury Department and the IRS are of the view that the additional identifying information would assist the IRS in its determination of whether these amounts are properly treated as foreign gifts, and the burden imposed on the U.S. person should be minimal because the U.S. person would need to know the transferor’s identity in order to know whether the transferor is foreign and in order to apply the aggregation rule.”

No Deficiency Procedures Means No Advanced Notice to Taxpayers 

One of the biggest failures of this proposed regulation is that it affirms the fact that the IRS can operate by issuing assessable penalties against taxpayers who did not comply with Forms 3520/3520-A instead of following deficiency procedures.

In an all-too-common example, a U.S. person receives a gift from a foreign person. The U.S. person may be a recent Green Card Holder or H-1B visa holder for example, and unaware of the complexities of foreign gift laws. Likewise, their current CPA or tax professional may not be aware of Form 3520 filing requirements either. Instead of the IRS providing the taxpayer with notice and an opportunity to challenge the penalty before it is assessed, rather the IRS can simply issue a CP-15 Notice and an automatically assessable penalty, which then requires the taxpayer to have to fight on the defensive. Likewise, in the recent case of Farhy, the DC Circuit reversed the U.S. Tax Court and held that automatically assessable penalties for form 5471 were valid — which presumably means that form 3520 assessable penalties will remain valid as well, at least for now.

As provided by the IRS:

• • • “Subchapter B of chapter 63 (relating to deficiency procedures for income, estate, gift, and certain excise taxes) does not apply in respect of the assessment or collection of any penalty imposed under this section.”

Reasonable Cause is Still a Steep Climb

Taxpayers who have no unreported income but simply fail to file certain international reporting forms such as Forms 3520 and form 3520-A were previously able to successfully avoid penalties by submitting under the Delinquent International Information Return Submission Procedures. But, since November of 2020, the IRS modified this program making it harder to disclose without being penalized at the outset. To avoid penalties, oftentimes taxpayers will have to make a successful showing of reasonable cause, but reasonable cause is a very nebulous standard and will vary from agent to agent depending on their experience level and overall attitude toward non-compliant taxpayers.

As provided by the IRS:

• • • “In general. Paragraph (a) of this section does not apply to any failure to file information with respect to a foreign trust if the person required to file such information submits a reasonable cause statement to the Commissioner under penalties of perjury and demonstrates to the satisfaction of the Commissioner that the failure is due to reasonable cause and not due to willful neglect. The determination of whether a taxpayer acted with reasonable cause and not with willful neglect is made under the principles set out in §1.6664-4 and §301.6651-1(c) of this chapter. This determination is made on a case-by-case basis, taking into account all pertinent facts and circumstances.”

Still Big Hurdles for Some Taxpayers Wanting to Comply

The IRS further affirms the fact that taxpayers cannot show reasonable cause by showing that the foreign trust jurisdiction would impose a civil or criminal penalty for disclosing that information.

Think about that for a minute –

A taxpayer who is otherwise ethical and wants to comply but does not want to face a criminal violation in the jurisdiction where the foreign trust is located has to risk a criminal sanction (usually in their home country) to try to make a showing of reasonable cause to the IRS.

As provided by the IRS:

• • • “The fact that a foreign jurisdiction would impose a civil or criminal penalty on such person (or any other person) for disclosing the required information.”

Joint and Several Liability

Another unfair issue is that taxpayers can be joint and several liable for one person’s non-compliance. Imagine the situation in which taxpayers file the joint return, but then the taxpayers divorce, and then the return is audited and penalties assessed. In these types of situations, it can be very difficult for the taxpayer who is not paying the penalty to claim an injured or innocent spouse defense — and so now that taxpayer is on the hook for a penalty born from their divorced spouse.

• • • “Joint and several liability. If married U.S. persons are treated as a single U.S. person for a tax year, such married U.S. persons have joint and several liability with respect to any penalties imposed under this section.”

Limit on Value is Still ‘Lower’ for Tax-favored Foreign Retirement Trust.

While the IRS affirmed revenue procedure 2020-17 which provides limited form 3520 and 3520-A reporting for tax-favored foreign retirement trusts, it is important to note that the threshold value is relatively low. That is not to say that $600,000 is not a good chunk of change, but for a taxpayer who worked for 30 to 40 years and was consistently contributing to their foreign pension plan, their foreign pension may exceed that amount and thereafter be disqualified for the exemption. And, just because the taxpayer’s foreign pension is worth $800,000 or $1,000,000+ does not mean the foreign financial institution that houses the foreign pension is going to provide the Taxpayer with any additional information sufficient to substantially comply with filing Form 3520/3520-A — thereby still making it very difficult to comply with these already onerous international information reporting requirements.

• • • “Value threshold. The aggregate value of the trust(s) in the trust’s jurisdiction is limited to no more than $600,000 at any point during the taxable year (as adjusted under paragraph (b)(2)(iv)(3) of this section) regardless of the number of trusts established.”

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. 

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure. 

Contact our firm today for assistance.