Discovery of a Delinquent International Information Return – What Do You Do?

There is potential for extraordinarily high tax penalties if a taxpayer fails to timely file complete and accurate required international information returns. There are ways to remedy a missed filing requirement while reducing the taxpayer’s potential exposure to these penalties.

Since 2009, the IRS has released several versions of delinquent international information return submission procedures (“DSPs”). These procedures allow eligible taxpayers to file late international information returns without the imposition of penalties so long as the taxpayer can establish reasonable cause for the failure to file.

Under the most current guidance, a taxpayer is eligible if:

1. Taxpayer is not under a civil examination or criminal investigation by the Service, and
2. Taxpayer has not already been contacted by the Service about the delinquent information returns.

For international information returns that would have accompanied an income tax return, the taxpayer should attach the delinquent return to an amended income tax return and file it according to the applicable instructions for the amended return. Taxpayers are encouraged to attach a reasonable cause statement to each delinquent information return to request waiver of penalties.

Common International Information Returns and Penalties:

Taxpayers with foreign assets, and those who receive funds from overseas (whether income or gifts), should be very attuned to international information return reporting requirements. Failure to file these returns can result in steep penalties. There is a three-year statute of limitations on the Service’s ability to audit and impose penalties on international information returns. However, the statute of limitations does not commence until complete and accurate returns are filed.

Common international information returns and the corresponding penalties for failure to file are:

1. Form 3520 – Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts

1. Who Must File? U.S. persons must file Form 3520 to report certain transactions with foreign trusts, ownership of foreign trusts, and receipt of certain gifts or inheritance bequests from foreign persons.
2. When Must it Be Filed? Form 3520 is due on the 15th day of the fourth month following the end of the taxpayer’s tax year (i.e., April 15 for individuals), or as allowed upon valid extension.
3. Penalties for Failure to File: The greater of $10,000 or the following:

1. If failure by a U.S. transferor to report the creation or transfer to a foreign trust, then 35% of the gross value of the property transferred to the foreign trust.
2. If failure by a U.S. transferee to report a distribution from a foreign trust, then 35% of the gross value of the distributions received from the foreign trust.
3. If the foreign trust owned by a U.S. person fails to file a complete return, then 5% of the gross value of the portion of the foreign trust’s assets treated as owned by a U.S. person (under the grantor trust rules).
4. If a U.S. person fails to report a gift from abroad, then 5% of the amount of the foreign gift for each month that it is late (up to 25%).

For example, if a U.S. taxpayer receiving a gift of $900,000 from his parents overseas files Form 3520 three months late, a penalty of $135,000 would be imposed.

2. Form 3520-A – Annual Information Return of a Foreign Trust with a U.S. Owner

1. Who Must File? A foreign trust with a U.S. owner must file Form 3520-A and furnish the required annual statements to its U.S. owners and U.S. beneficiaries. If the foreign trust fails to file Form 3520-A, the U.S. owner must complete and attach a substitute Form 3520-A to his filed Form 3520. While Rev. Proc. 2020-17 provides some exceptions, Form 3520-A filings are common for U.S. taxpayers with foreign retirement plans or pensions.
2. When Must it Be Filed? A foreign trust must file Form 3520-A by the 15th day of the third month following the taxpayer’s tax year (i.e., March 15 for calendar year-end taxpayers), or as allowed upon valid extension. A U.S. owner of a foreign trust filing a substitute Form 3520-A must file it by the due date for Form 3520 (typically April 15), or as allowed upon valid extension.
3. Penalties for Failure to File: The greater of $10,000 or 5% of the gross value of the portion of the trust’s assets treated as owned by the U.S. person at the close of that tax year.

For example, if a U.S. taxpayer maintaining a foreign trust with a balance of $5,000,000 fails to timely file Form 3520-A, a penalty of $250,000 would be imposed.

3. Form 5471 – Information Return of U.S. Persons with Respect to Certain Foreign Corporations

1. Who Must File? Taxpayers, including U.S. citizens and resident aliens, U.S. domiciled corporations, U.S. domiciled partnerships, and U.S. domiciled trusts, may have a Form 5471 filing requirement. There are five specific categories of filing requirements. These filing requirements consider the portion of a shareholder’s acquisition and ownership in the foreign corporation. In considering a shareholder’s ownership, complex attribution rules need to be considered. All taxpayers with an interest in a foreign corporation should evaluate these categories to determine if they have a filing requirement.
2. When Must it Be Filed? By the filing due date, whether original or extended, of the taxpayer’s income tax return.
3. Penalties for Failure to File: $10,000 per missing or incomplete Form 5471, per year, as well as a reduction to applicable foreign tax credits.

4. Form 5472 – Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business

1. Who Must File? A reporting corporation (i.e., a 25% foreign owned U.S. corporation [including a foreign owned U.S. disregarded entity] or a foreign corporation engaged in a trade or business within the U.S.) that had a reportable transaction during the year with a foreign or domestic related party must file Form 5472.
2. When Must it Be Filed? By the filing due date, whether original or extended, of the taxpayer’s income tax return.
3. Penalties for Failure to File: $25,000 per missing or incomplete Form 5472, per year.

5. Form 8858 – Information Return of U.S. Persons with Respect to Foreign Disregarded Entities and Foreign Branches

1. Who Must File? Certain taxpayers that are tax owners of foreign disregarded entities (“FDEs”), operate a foreign branch (“FB”), or own certain interests in tax owners of FDEs or FBs.
2. When Must it Be Filed? By the filing due date, whether original or extended, of the taxpayer’s income tax return.
3. Penalties for Failure to File: $10,000 per missing or incomplete Form 8858, per year, and a reduction in the taxpayer’s allowed foreign tax credit.

6. Form 8938 – Statement of Specified Foreign Financial Assets

1. Who Must File? Taxpayers who have specified foreign financial assets (e.g., foreign bank account, stock issued by a foreign corporation, foreign partnership interest, promissory note issued by a foreign person, interest in a foreign estate or trust, etc.) with an aggregate value in excess of the appropriate reporting threshold (ranging from $50,000 to $600,000 depending on the type of taxpayer and whether located domestically or abroad).
2. When Must it Be Filed? By the filing due date, whether original or extended, of the taxpayer’s income tax return.
3. Penalties for Failure to File: $10,000 per missing or incomplete Form 8938, per year.

Reasonable Cause

The penalties for missing an international information return reporting requirement are steep. Often the filing requirement will go unnoticed for several years, thereby increasing the potential penalties even further. These penalties will not be imposed where the taxpayer makes an affirmative showing that the failure to file was due to reasonable cause and not willful neglect. Additionally, penalties that have already been imposed can be abated upon a showing that the taxpayer had reasonable cause for the failure to file.

The standards for reasonable cause are set forth in the applicable Internal Revenue Code provision and any accompanying regulations. Reasonable cause is often determined based on all the facts and circumstances, with a focus on whether the taxpayer exercised ordinary business care and prudence.

All delinquent international information returns should be accompanied by a reasonable cause statement. Reasonable cause statements should be crafted carefully, with a strong emphasis on the unique facts of the taxpayer’s situation. Additionally, more persuasive reasonable cause statements include a thorough review of applicable caselaw.

Depending on the type of return filed, it is possible that penalties will be assessed without considering the attached reasonable cause statement. In this case, the reasonable cause information can be resubmitted in a response to the Service’s penalty assessment notice.

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• Discovery of a Delinquent International Information Return – What Do You Do?