Foreign Trust Reporting and Tax Court Case Update

On February 23, 2023, the U.S. tax court upheld penalties for failing to file 3520s and 3520-As against petitioners Barbara and Leigh Fairbank for several tax years. Fines over $243,000 were assessed on April 12, 2018, for Income tax deficiencies and accuracy-related penalties for tax years 2003-2009 and 2011. Petitioners claimed these deficiencies fall outside the three-year limitation period described in section 6501(a). The tax court, however, upheld that the assessment period remains open as the petitioners failed to file per section 6501(c)(8). The findings leave a precedent of effectively no statute of limitation for failure to file the required U.S. tax forms for foreign trusts.

This indicates that failure to file for foreign trusts can present significant exposure to taxpayers. Penalties for failure to file are the greater of $10,000 or 5 percent of the trust assets owned by the U.S. person. There are a few ways to avoid these, including a preemptive reasonable cause statement, an abatement, appealing a failure-to-file, a due process hearing, or litigation through tax or federal court. The easiest and most effective way to avoid failure-to-file penalties is to file timely and accurate returns.

Form 3520 and 3520-A must be filed by each U.S. person who owns a trust, as defined by IRC 671 through 679, for each trust each year. These forms disclose trust ownership, receipt of certain gifts and bequests, and other transactions. The forms are disclosures and, therefore, should not specify, report, or generate a tax liability.

Required filings and ownership of trusts can be complicated. If you have any questions about this issue, do not hesitate to reach out.