Form 3520 Late Filing Penalty: How to Seek Abatement

Form 3520, “Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts,” is an information return required for U.S. persons who have certain transactions with foreign trusts or receive large gifts from foreign sources. Failing to file this form by its due date can lead to significant financial penalties from the Internal Revenue Service (IRS), but there is a process for preventing their assessment.

Understanding the Late Filing Penalty

The penalties for failing to file Form 3520 on time are substantial and vary depending on the unreported transaction. The calculations differ for transactions involving foreign trusts versus those involving foreign gifts, and taxpayers should understand which rules apply to their situation.

For transactions involving a foreign trust, penalties are calculated based on the gross value of the reportable amount. If a U.S. person creates a foreign trust, transfers property to it, or receives a distribution from one, the penalty is 35% of the gross value of that transaction. If a U.S. person is treated as the owner of a foreign trust and fails to report it, the penalty is the greater of $10,000 or 5% of the gross value of the trust’s assets owned by that person.

For the failure to report large gifts or bequests from a foreign person or estate, the penalty is 5% of the gift’s total value for each month the failure continues. This penalty is capped at a maximum of 25% of the total value. For example, failing to report a $200,000 foreign gift could result in a penalty of $10,000 per month, up to a total of $50,000.

The IRS can assess additional penalties if a taxpayer fails to file the form after receiving a notice from the agency. This continued non-compliance can lead to further financial consequences beyond the initial assessment.

Grounds for Penalty Prevention

To prevent a late-filing penalty, a taxpayer must demonstrate “reasonable cause” for the failure to file on time. This legal standard requires showing they exercised ordinary business care and prudence but were still unable to file. The taxpayer must prove the failure was not due to willful neglect, and the IRS considers all facts and circumstances of the situation.

Reasonable cause can include the death, serious illness, or unavoidable absence of the taxpayer or an immediate family member. The taxpayer must show how the event directly prevented them from filing on time. For instance, a prolonged hospitalization leading up to the tax deadline could be a valid reason, while a brief illness might not be sufficient if there was other time to file.

The destruction of a taxpayer’s home, business, or records from a fire, flood, or other casualty can also be a basis for reasonable cause. The event must have occurred close to the filing deadline, making it impossible for the taxpayer to gather the necessary information and complete the return.

Relying on erroneous advice from a competent tax professional can establish reasonable cause. The taxpayer must show that the advisor was competent, that they provided the advisor with all necessary and accurate information, and that they relied in good faith on the professional’s advice that a Form 3520 was not required. Forgetting to give the advisor information about a foreign gift or trust would undermine this defense.

Ignorance of the law is not usually an excuse, but it can be a factor in a reasonable cause argument for a first-time filer with a clean compliance history. The taxpayer must show their lack of awareness was reasonable given their background and that they made efforts to determine their obligations. This argument is best when combined with other mitigating factors.

Information and Documents for Your Submission

To request penalty prevention, you must first submit a completed and accurate Form 3520 for the tax year in question. Even though it is late, the form must correctly report all required transactions, as submitting the delinquent form is a prerequisite for the request.

A key part of the submission is a detailed reasonable cause statement. This is a formal letter, signed under penalty of perjury, explaining why the failure to file on time was justified and should include a heading with the taxpayer’s name, identification number, and the tax year.

The statement should present a clear, chronological narrative of the facts that led to the late filing. It must connect these facts to the reasonable cause standard by explaining how the events show the taxpayer exercised ordinary business care. The statement must also include a declaration that the failure to file was not due to willful neglect.

The reasonable cause statement must be supported by objective, third-party documentation, which will depend on the reason for the late filing. For a serious illness, this could include doctor’s notes or hospital records. For a natural disaster, insurance claims or police reports would be relevant, and for reliance on a tax professional, a letter from the advisor explaining their advice is persuasive.

The Penalty Prevention Process

Due to a recent policy change, the IRS no longer automatically assesses penalties for late-filed Forms 3520. Instead, the agency will first review a reasonable cause statement attached to the late filing to determine if a penalty is warranted, giving taxpayers an opportunity to explain their situation beforehand.

The submission package must include the late-filed Form 3520, the original signed reasonable cause statement, and copies of all supporting documents. Be sure to retain the original documents for your records.

Mail the complete package to the IRS service center where the form is filed. Use a trackable service, like U.S. Postal Service Certified Mail with a return receipt, to create a legal record of when the IRS received the submission.

After submission, the review process can take several months. If the IRS accepts the reasonable cause argument, no penalty will be assessed. If the request is denied, the IRS will issue a notice assessing the penalty and explaining the taxpayer’s right to appeal the decision to the IRS Independent Office of Appeals.