Filing Mechanics: Form 3520 and 3520-A

A. Form 3520

Form 3520 has several uses, which may cause confusion. Generally, Part 1 covers transfers to a foreign trust by a U.S. person, including a U.S. citizen or resident alien, a U.S. domestic partnership, corporation, trust or estate. Part II provides information on the owner of a foreign trust settled by a U.S. person. However, Part III is only used for beneficiaries of nongrantor trusts and should not be completed by U.S. foreign trust settlors. Part IV is not at all related to trust distributions and is only used for U.S. persons that receive large gifts from foreign donors. Note that a trust distribution will not constitute a foreign gift and should be reported on Part III rather than Part IV.

Form 3520 is filed separately from the personal income tax return of the U.S. settlor, transferor or recipient and is due on the date of such personal income tax return, including extensions. The 2006 Instructions for Form 3520 indicate that the Form 3520 should be sent to: Internal Revenue Service Center, P.O. Box 409101, Ogden, UT 84409. It is a good practice to attach a copy of the personal tax return extension to the Form 3520 to avoid notices concerning late filing penalties.

1. Potential Penalties

There are significant penalties for not filing the form in a timely manner. For failure to file or incomplete filing of Form 3520, section 6048 imposes a penalty of 35% of the gross value of property transferred to the foreign trust or 35% of the value of distributions received from a foreign trust. This penalty is imposed on the trust settlor or beneficiary. Recipients of large foreign gifts are subject to penalties of 5% of the amount of the gift per month for each month that the failure to file continues, up to a maximum of 25%.

Further, if the IRS mails a notice of a failure to file, and the person does not comply within a 90 day period, section 6677 imposes an additional penalty of $10,000 for each 30-day period. The penalties cannot, however, exceed the gross reportable amount. The penalties may not be imposed if the failure to file is shown to be due to reasonable cause.

To avoid penalties under section 6677, it is advisable to a file Form 3520 by attaching it to a settlor's or transferor's timely filed income tax return (with regard for any applicable extensions).74 In the case of a testamentary transfer of property, as well as the death of a U.S. citizen or resident who was considered to own any portion of a foreign trust or in whose estate are included a foreign trust's assets, Notice 97-34 appears to put the burden on the decedent's executor to file Form 3520 with the decedent's final income tax return.

2. Schedules to Form 3520

U.S. owners of foreign trusts should complete Parts I and II and it is usually advisable for them to appoint a U.S. agent in the first filing year and to obtain a Foreign Grantor Trust Owner Statement ('FGTOS') which the Trustee has engaged a U.S. tax preparer to complete from the Trust financials to attach to the Form 3520.

U.S. beneficiaries of foreign trusts should complete Part III and it is usually advisable for them to obtain a Foreign Nongrantor Trust Beneficary Statement ('FNGTBS') or a Foreign Grantor Trust Beneficiary Statement ('FGTBS')which the Trustee has engaged a U.S. tax preparer to complete from the Trust financials to attach to the Form 3520.

Recipients of large foreign gifts should complete Part IV for gifts received with values of more than $100,000 from a nonresident alien individual or estate or more than $12,760 from foreign corporations or foreign partnerships.

B. Form 3520-A

Form 3520-A is generally filed by the trustee or fiduciary of the foreign grantor trust, unless the trust is a Canadian registered retirement savings plan, a Canadian registered retirement income fund, or another Canadian eligible plan.75

To avoid penalties, a complete Form 3520-A must be filed with the Internal Revenue Service Center, P.O. Box 409101, Ogden, UT 84409, by the 15th day of the 3rd month after the end of the trust's tax year.76 The trust must also provide copies of the FGTOS and FGTBS to the U.S. owners and U.S. beneficiaries by the 15th day of the 3rd month after the end of the trust's tax year or the Form 3520-A filing due date including extensions.

1. Potential Penalties

Penalties for failure to file or incomplete filing for Form 3520-A can be significant. In particular, the U.S. owner of the foreign trust is subject to a penalty equal to 5% of the gross value of the portion of the foreign trust assets he is treated as owning under U.S. law.77 Therefore, it is in the interest of the grantor to alert the foreign trustee to the importance of timely and accurate filing of Form 3520-A.

In addition, if the IRS notifies the grantor of a failure to file, and Form 3520-A is not filed within 90 days of the date of mailing of the IRS notice, an additional penalty of $10,000 per 30 days (or fraction thereof) is assessed until the Form 3520-A is filed.78 The total monetary penalty for a trustee's failure to furnish the annual trust return or to provide the specified trust accounting information to any U.S. grantor or beneficiary cannot exceed the gross value of the trust assets considered owned by the U.S. grantor.79 The monetary penalty is in addition to any applicable criminal penalty.80 As with most failure to file timely penalties, the IRS can abate the section 6677(b) penalty if the person responsible for filing Form 3520-A can demonstrate that the failure to file timely was due to reasonable cause, and not willful neglect.81

2. Schedules and Attachments to Form 3520-A

The trustee must attach to the Form 3520-A the "Foreign Trust Income Statement," the FGTOS and the FGTBS. Further, as noted above, the trustee must provide a copy of the FGTOS to each U.S. person considered to own a portion of the trust and a copy of the FGTBS to each U.S. beneficiary who received a trust distribution during the taxable year.82

Note that the "Foreign Trust Income Statement" requires a substantial amount of information to be disclosed to the IRS, including: (i) certain background information (which, for practical purposes, requires that the foreign trust obtain a U.S. employer identification number, since a 5% penalty can be imposed for failure to furnish complete information to the IRS); (ii) a trust balance sheet indicating both beginning and year-end balances and that establishes the trust's assets, liabilities, and retained earnings; (iii) an annual income statement determined under U.S. tax accounting principles; (iv) the "owner statement," which includes a statement of net trust income attributable to the owner (with separate statements attached for each U.S. owner); and (v) the "beneficiary statement" (with separate statements attached for each U.S. beneficiary receiving a trust distribution during the taxable year).83

It may also be beneficial for the trustee to retain a U.S. tax preparer to ensure that the "Foreign Trust Income Statement," the "Foreign Grantor Trust Owner Statement" and the "Foreign Grantor Trust Beneficiary Statement" correctly report, using U.S. generally accepted accounting principles, the income arising in and distributions from the trust. Further, it is advisable for the foreign Trustee to retain a U.S. tax preparer to analyze the trust financials and prepare the "Foreign Grantor Trust Owner Statement" for income arising in the trust taxable to the grantor or "Foreign Grantor Trust Beneficiary Statement" for income arising in the trust distributed to someone other than the settlor.

Returns Relating to Foreign Bank Accounts

A. In General

Each U.S. person having a financial interest in, or signature or other authority over, any foreign financial accounts with an aggregate value exceeding $10,000 at any time during the calendar year must report such relationship by filing Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts ("FBAR"), in addition to noting that they have such foreign account filing requirement on Schedule B of Form 1040 and including the income from these accounts on the United States person's U.S. federal income tax return.84

The Form TD F 90-22.1 was recently revised in October 2008. The revised form provides additional definitions and clarifications. It also generally expands the class of individuals and companies required to make annual reports, including certain foreign persons in and doing business in the United States (including a branch of a foreign entity) and certain trusts with U.S. settlors. There are also more detailed rules regarding consolidated reports for corporate parents and subsidiary corporations. The revised form confirms that there is no extension of time for filing the form.

B. Who Must File

Form TD F 90.22-1 is required to be filed by every U.S. person for each calendar year in which such person has a financial interest in, or signature or other authority over, any foreign financial accounts with an aggregate value exceeding $10,000 at any time during the calendar year.85 Note that the test is based in the alternative – financial interest in or signature authority over the account. Thus, there may be multiple potential filers for a single account, with certain exceptions, noted below, for officers and employees of widely-held or publicly-traded companies.

1. Definitions

For purposes of FBAR, the term "United States person" means a citizen or a resident of the United States, or a person in and doing business in the United States.86 A foreign subsidiary of a U.S. person is not required to file this report, although its U.S. parent corporation may be required to do so.87 A branch of a foreign entity that is doing business in the United States is required to file this report even if not separately incorporated under U.S. law.88

The term "financial account" generally includes any bank, securities, securities derivatives or other financial instrument accounts, including any accounts in which the assets are held in a commingled fund, and the account owner holds an equity interest in the fund.89 The term also means any savings, demand, checking, deposit, time deposit, or any other account (including debit card and prepaid credit card accounts) maintained with a financial institution or other person engaged in the business of a financial institution.90 Individual bonds, notes, or stock certificates held by the filer are a financial account, nor is an unsecured loan to a foreign trade or business that is not a financial institution.91

Any of the financial accounts described above is considered to be a foreign financial account for purposes of FBAR, if it is located outside the United States, Guam, Puerto Rico, and the Virgin Islands.92 However, an account maintained with a military banking facility93 is not considered to be a foreign financial account for purposes of FBAR, even if the military banking facility is located in a foreign country.94 The geographical location of the account, not the nationality of the financial entity institution in which the account is founds determines whether it is in an account in a foreign country.95 That is, the situs of a financial account is determined by the location where the branch is, not the location of the institution's home office. Thus, for example, an account maintained at a German branch of a U.S. bank is a foreign financial account, but an account maintained at a U.S. branch of a German bank is not a foreign financial account.

2. Ownership of Accounts

The instructions to Form TD F 90-22.1 explain that a U.S. person has a financial interest in a bank, securities, or other financial account in a foreign country under either of the following circumstances:

1. A U.S. person is the owner of record or has legal title, whether the account is maintained for his or her own benefit or for the benefit of others including non-U.S. persons. If an account is maintained in the name of two persons jointly, or if several persons own a partial interest in an account, each of those U.S. persons has a financial interest in that account.96

2. A U.S. person has a financial interest in each bank, securities, or other financial account in a foreign country for which the owner of record or holder of legal title is:

  • A person acting as an agent, nominee, attorney, or in some other capacity on behalf of the U.S. person;
  • A corporation in which the U.S. person owns directly or indirectly more than 50 percent of the total value of shares of stock or more than 50 percent of the voting power of all shares of stock;
  • A partnership in which the U.S. person owns an interest in more than 50 percent of the profits (distributive share of income) or more than 50 percent of the capital of the partnership; or
  • A trust in which the U.S. person either has a direct or indirect present beneficial interest in more than 50 percent of the assets or from which such person receives more than 50 percent of the current income.97

3. A U.S. person has a financial interest in each bank, securities, or other financial account in a foreign country for which the owner of record or holder of legal title is a trust, or a person acting on behalf of a trust, that was established by such U.S. person and for which a trust protector has been appointed.98

3. Signature Authority

For purposes of Form TD F 90.22-1, a U.S. person is considered to have signature authority over a foreign financial account if such person can control the disposition of money or other property in the account by delivering his or her signature (or his or her signature and that of one or more other persons) to the bank or other person maintaining the account. In addition, a U.S. person has "other authority" subject to FBAR reporting if such person can exercise comparable power over an account by direct communication to the bank or other person maintaining the account, either orally or by some other means.

4. Exceptions

Notwithstanding the general rules, Form TD F 90.22-1 is not required to be filed under the following circumstances:

  1. An officer or employee of a bank which is currently examined by Federal bank supervisory agencies for soundness and safety need not report that he or she has signature or other authority over a foreign bank, securities or other financial account maintained by the bank, if the officer or employee has NO personal financial interest in the account.99
  2. An officer or employee of a domestic corporation whose equity securities are listed upon U.S. national securities exchanges or which has assets exceeding $10 million and 500 or more shareholders of record need not file such a report concerning the other signature authority over a foreign financial account of the corporation, if he has NO personal financial interest in the account and he has been advised in writing by the chief financial officer of the corporation that the corporation has filed a current report, which includes that account.100 There are additional exceptions for domestic and foreign subsidiaries.
  3. As noted above, a U.S. person is not required to report any account maintained with a branch, agency, of other office of a foreign bank or other institution that is located in the United States, Guam, Puerto Rico, and the Virgin Islands.101

C. Mechanic of Filing

Reporting on Form TD F 90-22.1 is required for each calendar year that a U.S. person maintains such interest or authority over foreign financial accounts.102

The Form TD F 90-22.1 must be filed on or before June 30 each calendar year. An extension for filing one's U.S. income tax return does not extend the deadline for making a TD F 90-22.1. That is, there is no extension of time available for the late filing.103

D. Practical Considerations

Each U.S. person subject to this reporting requirement must also maintain records showing, (1) the name in which each such account is maintained, (2) the number or other designation of such account, (3) the name and address of the foreign bank or other person with whom such account is maintained, and (4) the type of such account, and the maximum value of each such account during the reporting period.104 These records must be retained for a period of 5 years and must be kept at all times available for inspection as authorized by law.105

Potential IRS Penalties

The failure to file the required tax returns and information returns may result in civil and criminal penalties, as discussed below.

A. Form 1040NR, Form 3520 and Form 3520-A

  1. Failure to file tax returns or to pay tax (section 6651): In addition to the tax due, if a taxpayer fails to file a return, there may be imposed a penalty of 5% per month of the amount of tax required to be shown on a tax return. There is an exception if the failure was due to reasonable cause, not willful neglect.
  2. Substantial underpayment of tax (section 6662):  In addition to the tax due in (1) above, taxpayer could be subject to a penalty of 20% of the amount of the underpayment.  This penalty is imposed on both (a) negligence or disregard of rules or regulations, and (b) any substantial underpayment of tax (understatement of greater than 10% or $5,000).  Note that this penalty is imposed in addition to the amount of tax due.

  3. EXCEPTION 1:  There is a reasonable cause exception whereby the substantial underpayment of tax penalty may be alleviated if there was a reasonable cause for the underpayment (i.e., there is "substantial authority" for or adequate disclosure of the position and the position is not a tax shelter) and the taxpayer acted in good faith with respect to the underpayment.106

    EXCEPTION 2:  If the taxpayer is subject to the (worse) fraud penalty, then the substantial underpayment penalty does not apply.  Fraud penalty (section 6663):  If the underpayment is based on fraud, in addition to the tax due, taxpayer could be subject to a penalty of 75% of the portion of the underpayment attributable to fraud.  However, the Code provides an exception for reasonable cause.

  4. Failure to file returns (section 6046):  In addition to (1) and (2) above, there may be imposed a penalty of $10,000 for failure to file a return or for filing a return which does not show the information required under section 6046. The amount of the penalty can go up to $50,000 if taxpayer fails to correct the failure within 90 days after receiving notice from the IRS.  However, there is also a reasonable cause exception.
  5. Information with respect to certain foreign trusts (section 6048): Section 6048(a) imposes a penalty equal to 35% of the gross value of the property transferred to a trust on the person responsible for filing Form 3520. Section 6677(b) imposes an additional penalty of $10,000 per 30-day period for failing to comply within 90 days of notification by the IRS that Form 35020 has not been filed.107 The total penalty for failure to report a trust transfer, however, cannot exceed the amount of the property transferred.108 The monetary penalty is in addition to any applicable criminal penalty.109 If the person responsible for reporting can demonstrate that the failure to timely file was due to reasonable cause, and not willful neglect, the Secretary can abate the penalty under section 6677(a) or 6677(b).110

  6. To avoid penalties under section 6677, preparer must file Form 3520 by attaching it to a settlor's or transferor's timely filed income tax return (with regard for any applicable extensions).111 In the case of a testamentary transfer of property, as well as the death of a U.S. citizen or resident who was considered to own any portion of a foreign trust or in whose estate are included a foreign trust's assets, the burden appears to be on the decedent's executor to file Form 3520 with the decedent's final income tax return.112

  7. Failure to file correct information return (section 6721):  In addition to (1), (2) (3) and (4) above, there may be imposed a penalty of $50 for each return (not to exceed $250,000 per year) which fails to include all of the required information or includes incorrect information.  There is an exception to this penalty if the failure is corrected within 30 days after the required filing date.  However, if the failure is based on intentional disregard, then no exception applies (including the $250,000 cap) and the amount of the penalty is the greater of $100 or 10% of the aggregate amount of the items required to be reported.  There is no reasonable cause exception.
  8. Failure to comply with other information reporting requirements (section 6723):  In addition to (1), (2), (3) (4)and (5) above, there may be imposed a penalty of $50 for each failure to comply with a required information reporting (not to exceed $100,000 per year).  There is no exception, including a reasonable cause exception.
  9. Criminal penalties: In addition to the above, criminal penalties under sections 7203 (monetary and penal penalties for willful failure to file supply information), 7206 (monetary and penal penalties for fraud and false statements) and 7207 (monetary and penal penalties for fraudulent statements) may apply.

B. Form TD F 90.22-1

A willful violation of the Form TD F 90.22-1 requirements (i.e., failure to file Form TD F 90.22-1, failure to supply information on the report, or filing a false or fraudulent report) could result in the imposition of civil and/or criminal penalties.113

For example, if any U.S. person willfully violates the Form TD F 90.22-1 filing requirement, such person may be liable to the U.S. government for a civil penalty of not more than $25,000114, in addition to the following criminal penalties:

  1. If a U.S. person willfully violates the reporting requirement, such person may be subject to a fine of not more than $250,000, or imprisoned for not more than 5 years, or both;115 and
  2. If a U.S. person willfully violates the reporting requirement while violating another law of the United States, or as part of a pattern of any illegal activity involving more than $100,000 in a 12-month period, such U.S. person may be subject to a monetary fine of not more than $500,000, or imprisoned for not more than 10 years, or both.116

In addition, if a U.S. person, with respect to Form TD F 90.22-1, (1) falsifies, conceals, or covers up by any trick, scheme, or device a material fact, (2) makes any materially false, fictitious, or fraudulent statement or representation, or (3) makes or uses any false writing or document knowing the same to contain any materially false, fictitious, or fraudulent statement or entry, such person may be fined, or imprisoned for not more than 5 years, or both.117

Footnotes

74. Treas. Reg. § 1.6081-1; see also Notice 97-34, section VIII A; Instructions for Form 3520.

75. See Instructions for Form 3520-A; see also Rev. Proc. 2002-23, 2002-15 I.R.B. 744, section 3, for other eligible Canadian plans.

76. See Instructions for Form 3520-A.

77. I.R.C. § 6677(b)(2).

78. I.R.C. § 6677(a).

79. Id.

80. I.R.C. § 7203.

81. I.R.C. § 6677(d).

82. Notice 97-34.

83. Notice 97-34; see also Instructions for Form 3520-A.

84. See Instructions for Form TD F 90-22.1 (revised October 2008).

85. See id.

86. See id.

87. See id.

88. See id.

89. See id.

90. See id.

91. See id.

92. See id.

93. Such facilities are generally known as a "United States military banking facility" or a "United States military finance facility" that are operated by a U.S. financial institution designated by the U.S. government to serve U.S. government installations abroad.

94. See id.

95. See id.

96. See id.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

97. See id.

98. See id.

99. See id.

100. See id.

101. See id.

102. 31 CFR § 103.24. Such persons will be required to provide detailed information concerning each account when so requested by the Secretary or his delegate. Id.

103. See id.

104. 31 CFR § 103.32.

105. Id.

106. I.R.C. § 6662(d)(2)

107. I.R.C. § 6677(a).

108. Id.

109. I.R.C. § 7203.

110. I.R.C. § 6677(d).

111. Treas. Reg. § 16.3-1(e); Treas. Reg. § 1.6081-1; Notice 97-34, § VIII A; Instructions for Form 3520.

112. Notice 97-34.

113. The instructions for Form TD F 90.22-1 specifically provide that criminal penalties for failing to comply with FBAR are provided in 31 U.S.C. § 5322(a) and (b), and 18 U.S.C. § 1001. In addition, civil penalties for failure to comply with the BSA or regulations issued under the authority of the BSA are generally provided in 31 U.S.C. § 5321.

114. 31 U.S.C. § 5321. Section 5321 generally provides that if a U.S. person willfully violates a provision of the BSA or a regulation issued under the BSA, such person may be liable for a civil penalty of not more than the greater of the amount (not to exceed $100,000) involved in the transaction (if any) or $25,000. With respect to reporting on Form TD F 90.22-1, a U.S. person is not reporting a transaction but, rather, reporting his interest or signature authority over a foreign financial account. Thus, the maximum amount of potential civil penalty is $25,000.

115. 31 U.S.C. § 5322(a).

116. 31 U.S.C. § 5322(b).

117. 18 U.S.C. § 1001.

This article is designed to give general information on the developments covered, not to serve as legal advice related to specific situations or as a legal opinion. Counsel should be consulted for legal advice.