IRS Commissioner Danny Werfel announced good news for taxpayers on October 24, 2024. The IRS has ended its practice of automatically assessing penalties when a taxpayer voluntarily submits a Form 3520, Part IV late. This form addresses the obligation of U.S. persons to report the receipt of certain foreign gifts and inheritances to the IRS.

Generally, the recipient of a gift or bequest from a non-U.S. donor will not pay tax on what they receive, but failure to comply with the reporting requirements means that significant penalties may be imposed in failure to file form 3520 when required. The penalty is 5% of the amount of the foreign donation/bequest for each month for which the failure to declare continues; must not exceed a total of 25% of the value. In addition to the monetary penalty, the tax consequences of receiving the foreign gift may be determined and reclassified by the IRS based on all facts and circumstances,

A welcome change for “reasonable cause”

If the taxpayer has “reasonable cause” for not filing Form 3520, the penalty may be reduced. Unfortunately, the IRS’s late-filing procedures did not take into account the taxpayers’ statement of reasonable cause.which leads to automatic sanctions and lengthy appeals to obtain reimbursement of the penalty..

For many years, The Taxpayer Advocate Service has recommended that foreign information reporting penalty procedures be changed. Now, the IRS is taking concrete action and reasonable cause statements submitted by taxpayers will be reviewed prior to any penalty assessment.

This welcome change should reduce unwarranted penalties since taxpayers will have the opportunity to explain their situation before the IRS assesses a penalty. It is important to note that this is a procedural change and not a substantive change. A reasonable cause statement must be prepared very carefully and contain solid reasons for tax non-compliance. Repair for reasonable cause is not very easy to obtain.

IRS Form 3520 Foreign Gift and Inheritance Information Return

If a U.S. citizen or resident receives a gift (or inheritance) of money or other property from a foreign (non-U.S.) person or entity, the gift may need to be reported on Part IV of Form 3520 , Annual report to report transactions with foreign trusts and receipt of certain foreign donations. Form 3520 is an information return, not a tax return. So, while the the gift or inheritance is not taxable, the IRS must be informed if the reporting threshold is reached. Practitioners have pointed out that the 25% penalty for late filing is quite draconian given that no taxes were undeclared.

Under current rules, when a foreign gift or bequest is valued at more than $100,000 in a calendar year, Form 3520 must be filed. This $100,000 reporting threshold could soon be indexed to inflation as outlined in the IRS proposed Treasury regulations. This is more good news from the IRS.

Gifts received from related parties must be aggregated to determine whether the dollar threshold has been met. For example, suppose that in calendar year 1, a non-U.S. father gives a gift of $70,000 to his U.S. citizen son; that same year, the father’s brother, also non-American, donated $35,000 to the American citizen. The citizen must report the gifts on Form 3520 because the gift exceeds $100,000; in other words, separate donations must be grouped together since they come from related parties.

The proposed Treasury regulations will require more information on the form than is currently the case. Currently, Form 3520 does not require the U.S. beneficiary to provide identifying information about the foreign donor. The proposed regulations would change that. Under the proposed regulations, the U.S. person must separately identify each foreign gift over $5,000 received from the transferor and each foreign person related to the transferor and must provide identifying information (e.g., name and address) on the transferor and each of these foreigners. person, including a foreign individual or a foreign estate.

Important Exceptions for Filing and Taxing Form 3520

A lower dollar threshold applies when reporting gifts received from foreign entities such as a foreign corporation or partnership. Gifts from entities may be recharacterized by the IRS and generate taxable income for the U.S. recipient. As such, it is essential that foreign donors use their own personal financial accounts to transfer gifts and not an entity’s account.

Another important exception applies to the general rule that gifts are not taxed for the benefit of the recipient. Gifts or bequests received by a U.S. person from certain former U.S. citizens or long-term permanent residents may be subject to a special transfer tax currently equal to 40% of the gift/bequest. This is a very detailed area of ​​law and currently we lack guidance from the IRS on its application, but suffice it to say that a gift or inheritance from a former U.S. national may be a Trojan horse.

Other possible reporting requirements – FBAR and FATCA

So-called FBAR and FATCA reports may also be required.

If the gift or inheritance is a foreign financial account (for example, a foreign mutual fund or brokerage account) and the total of all foreign accounts held by the U.S. person exceeds $10,000 per year, the U.S. person must file FinCEN Form 114, Report of Foreign. Bank and Financial Accounts (FBAR). Penalties for unfiled FBARs can be very severe.

Additionally, the Foreign Account Tax Compliance Act (FATCA) requires the filing of IRS Form 8938, “Report of Specified Foreign Financial Assets,” if the total value of all foreign financial assets exceeds certain thresholds each year. The annual thresholds depend on the individual’s tax filing status and whether the U.S. person resides in the United States or abroad. Not only do penalties apply if you fail to file this form when required, but failure to file results in an open statute of limitations until the IRS receives the information.

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