Threat of penalties for unreported transactions with foreign trusts as IRS launches new Audit Program

The Internal Revenue Service (IRS) has launched a new program that puts under scrutiny informational forms involving U.S. person’s transactions with foreign trusts, with the aim to improve compliance with respect to the timely and accurate filing of information returns. Treatment of unreported activities or late/incomplete submissions can vary from formal examinations to severe penalties amounting to up to 100% of the transaction, even when there is no unreported income attributable to it.

The forms interested by the new program are:

  1. Form 3520 “Annual Return to Report Transactions with Foreign Trusts and Receipts of Certain Foreign Gifts” which must be submitted by U.S. persons engaging in transactions with foreign trusts;
  2. Form 3520-A “Annual Information Return of Foreign Trust with a U.S. Owner” which involves U.S. persons regarded as owners of foreign trusts.

For form 3520, the initial penalty is equal to the greater of $10,000 or the following (as applicable):

  1. 35% of the gross value of the property transferred to a foreign trust
  2. 35% of the gross value of the distributions received from a foreign trust
  3. 5% of the gross value of the foreign trust’s assets owned by a U.S. person

A further 5% penalty (or $10,000 if greater) can apply if the foreign trust doesn’t file Form 3520-A timely or if the U.S. person doesn’t provide all of the information of section 6048(b) or includes wrong information. Moreover, further penalties ($10,000 every 30 days until the gross reportable amount is reached) will be charged if failure to comply continues for more than 90 days after the IRS notifies the subject.