The IRS has long had a keen interest in foreign transactions because these transactions are often associated with tax evasion or money laundering. As a result, U.S. citizens or residents who have received foreign gifts or inherited assets from foreign trusts may need to file IRS Form 3520 or Form 3520-A with the IRS.
What is Form 3520?
Form 3520, Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts, is used to report information about foreign trusts and their beneficiaries and transactions between domestic and foreign trusts.
This form is an information return, meaning it’s used to report transactions to the IRS rather than to calculate or state a tax liability.
To complete Form 3520, you will need information about the foreign trust, including its name, country of organization, and any transfers made to or from the foreign trust during the tax year.
What is Form 3520-A?
Form 3520-A, Annual Information Return of Foreign Trust with a U.S. Owner, is similar to Form 3520. However, Form 3520-A must be filed by people who manage foreign trusts with U.S. beneficiaries.
Similar to Form 3520, Form 3520-A requires information about the foreign trust, including its name and country of organization. Additionally, this form asks for more detailed financial information about the trust, such as its assets and liabilities at the beginning and end of the tax year and a list of all trust distributions to U.S. owners and beneficiaries.
Trustees of foreign trusts are required to send each U.S. owner of the trust a copy of the owner’s statement portion of Form 3520-A (pages 3 and 4), and each U.S. owner must attach a copy of the statement to their own Form 3520.
What is a foreign trust?
Because both Form 3520 and Form 3520-A deal with foreign trusts, it’s helpful to know what a foreign trust is for U.S. tax purposes.
Unfortunately, the IRS doesn’t provide a clear-cut definition of a foreign trust. Instead, it defines a foreign trust as any trust that is not a domestic trust. So, to determine whether a trust is foreign, one has to analyze whether it qualifies as a domestic trust for U.S. income tax purposes.
Two tests determine whether a trust can be classified as domestic. The trust must satisfy both.
- Court Test. A court within the U.S. is able to exercise primary supervision over the trust administration. If a trust is governed by the laws of a state in the U.S. and administered exclusively in the U.S., it generally satisfies the Court Test.
- Control test. One or more U.S. persons have the authority to control all substantial trust decisions. Some examples of substantial decisions include whether to distribute income or principal, the amount and timing of distributions, and whether to add or remove a trustee.
If a trust doesn’t satisfy both of those tests, it’s a foreign trust subject to Form 3520 and Form 3520-A reporting requirements.
Who needs to file Form 3520?
U.S. citizens, residents, and domestic entities must file Form 3520 if they have any of the following foreign transactions:
Transactions with foreign trusts
This can include direct or indirect transfers to and distributions from a foreign trust as well as ownership of a foreign trust.
The receipt of large gifts from a foreign individual, estate, corporation, or partnership
The obligation to report arises once the aggregate fair market value of all gifts from a single person or entity exceeds the following:
- $100,000 from a nonresident alien individual or foreign estate, or
- The annual threshold amount for a foreign corporation or partnership ($17,339 for 2022).
The recipient must aggregate gifts from different foreign persons if the individuals are related to each other.
There are some exceptions to the reporting obligations outlined above. For example, the IRS does not require taxpayers to file Form 3520 for transfers made to certain tax-favored foreign trusts, including some employee benefit plans, trusts that are tax-deferred until distribution, and tax-exempt trusts.
When do these forms need to be filed?
Form 3520-A is due on the 15th day of the third month after the end of the trust’s tax year. So, for trusts with a December 31 year-end, the form is due on March 15. Trustees can request an automatic six-month extension by filing Form 7004 if they need more time.
Form 3520 is due on the same date as the taxpayer’s personal income tax return (including extensions). For individual taxpayers, that means April 15 or October 15 if they request an automatic six-month extension.
If the due date falls on a weekend or legal holiday, the deadline shifts to the following business day.
How to file Form 3520 and Form 3520-A
Currently, neither Form 3520 nor Form 3520-A can be filed electronically. Instead, they must be paper filed by mailing the completed form to:
Internal Revenue Service Center
PO Box 409101
Ogden, UT 84409
What are the penalties for not filing Form 3520 or Form 3520-A?
If a person fails to file Form 3520 or 3520-A (or fails to file these forms correctly), it can result in significant penalties. Those penalties are equal to the greater of $10,000 or:
- 35% of the gross value of trust property transferred to or distributions received from the foreign trust (Form 3520)
- 5% of the gross value of the portion of the foreign trust’s assets treated as owned by a U.S person (Form 3520 and 3520-A)
- Up to 25% for failure to report the receipt of foreign gifts or an inheritance from a foreign person (Form 3520)
In addition, if you receive an IRS notice about your failure to file and do not file Form 3520 or 3520-A within 90 days, the IRS can assess an additional $10,000 penalty for each 30-day period (or fraction thereof) that the failure continues.
If you were required to file Forms 3520 or 3520-A in a prior year but didn’t—either intentionally or because you were unaware of the requirements—it may be possible to get compliant and reduce or eliminate penalties by entering into one of the IRS’s amnesty programs.
Filing Form 3520 or Form 3520-A can be a complex process, so it’s helpful to consult a tax professional for assistance in completing these forms accurately and on time.
If you need help determining whether you’re required to report foreign trusts or gifts or complying with Form 3520 reporting requirements, get in touch with an AB FinWright advisor. We’re happy to help you determine what steps you need to take to comply with IRS regulations and avoid penalties.