Delinquent International Information Return Submission Procedures – The Ultimate Guide

What do I do if I have a delinquent international information return?

Taxpayers who have identified the need to file delinquent international information returns who are not under a civil examination or a criminal investigation by the IRS and have not already been contacted by the IRS about the delinquent information returns should file the delinquent information returns through normal filing procedures.

Penalties may be assessed in accordance with existing procedures.

• All delinquent international information returns other than Forms 3520 and 3520-A should be attached to an amended return and filed according to the applicable instructions for the amended return.
• All delinquent Forms 3520 and 3520-A should be filed according to the applicable instructions for those forms.
• Taxpayers may attach a reasonable cause statement to each delinquent information return filed for which reasonable cause is being asserted. During processing of the delinquent information return, penalties may be assessed without considering the attached reasonable cause statement. It may be necessary for taxpayers to respond to specific correspondence and submit or resubmit reasonable cause information.

Information returns filed with amended returns will not be automatically subject to audit but may be selected for audit through the existing audit selection processes that are in place for any tax or information returns.

Reasonable Cause Statement for Delinquent International Information Return Submission Procedures

The Delinquent International Information Return Submission Procedures Reasonable Cause statement is crucial.

As part of the reasonable cause statement, taxpayers must also certify that any entity for which the information returns are being filed was not engaged in tax evasion.  If a reasonable cause statement is not attached to each delinquent information return filed, penalties may be assessed in accordance with existing procedures.

For all of the foreign information return penalties, reasonable cause is a defense.. The IRS applies the same standards for reasonable cause for failure to file income tax returns under I.R.C. § 6651 to failure to file foreign information returns, i.e., the exercise of ordinary business care and prudence. See e.g., Chief Counsel Advisory200748006. Many clients simply cannot meet this standard (at least as the IRS interprets it). These are taxpayers who were not willful and who did not intend to evade tax (and in many cases, there is no tax liability related to the late filing of the foreign information returns), but who may have been negligent or could have made a better effort at understanding their filing obligations.

In Notice 2022-36, the IRS recently provided some limited relief to taxpayers who had not filed, or had already been assessed penalties for late filing of, several different forms, including Forms 3520, 3520-A, and some Forms 5471. This relief is limited to the 2019 and 2020 tax years, and penalties “assessed by the campus assessment program” with respect to Forms 3520 and 3520-A (Annual Information Return of Foreign Trust with U.S. Owner). The IRS also limited relief to taxpayers who were able to file their delinquent returns within the 37-day period between August 24, 2022, the date that IRS announced Notice 2022-36, and the September 30, 2022, deadline. In addition, Notice 2002-36 stated that the IRS will cancel penalty charges for those forms and years, and issue refunds, as appropriate.

Notice 2002-36 provided cold comfort as it did not provide relief for earlier years and applied to a limited category of forms, and did not guarantee that the IRS would not assess penalties, only that they would not systematically assess them. It is noteworthy that this limited relief was in no way a recognition of the harsh consequences to taxpayers from the systematic assessment of penalties. The only stated reason for the relief was that there are better uses of IRS resources given its backlog after the pandemic and budget constraints, stating “[t]he Treasury Department and the IRS have determined that the penalty relief described in this notice will allow the IRS to focus its resources more effectively, as well as provide relief to taxpayers affected by the COVID-19 pandemic.”  Notice 2022-36 did not come close to alleviating the burdens on taxpayers who want to be compliant by filing delinquent foreign information returns.

There are no other programs or procedures available for a taxpayer who has not understated their income to file a delinquent foreign information return without being subject to penalties. Other than Notice 2022-36, which was of limited utility, the IRS has not offered a method of self-correcting with reduced penalties. Instead, the only option for a taxpayer who wants to come into compliance is to file late and incur penalties. Theoretically, a taxpayer could make a voluntary disclosure, but the penalty of 50% of the unreported offshore asset makes this option untenable, and the voluntary disclosure procedure is intended to apply in situations where the taxpayer has acted willfully and has concern about criminal liability, which is not the case where a taxpayer missed a filing deadline but does not owe any additional tax.

The IRS’s Streamlined Filing procedures are not available for taxpayers who do not owe any additional tax related to their non-compliance. This is an oddity of the current system – that a U.S. taxpayer who lives in the U.S., and has not reported income from a foreign asset is offered an opportunity to self-correct in exchange for payment of the tax and a reduced penalty of 5% of the value of the unreported foreign asset, while a taxpayers who lives in the U.S. and has not underreported their income will be subject to the maximum amount of penalties.

It is also important to note, as Les discussed in Tax Court To Consider IRS Procedure For Imposing Information Reporting Penalties, that foreign information return penalties are “assessable penalties,” meaning that they are “paid upon notice and demand” and are not subject to the deficiency procedures, and thus cannot be challenged in Tax Court (with one narrow exception under Collection Due Process if the taxpayer is not offered review by the IRS Independent Office of Appeals).Despite the IRM allowing for pre-payment review, the IRS sometimes initiates enforced collection before the taxpayers have completed their appeal, and frequently sends collection notices, including notices of intent to levy, before the taxpayers’ deadlines to submit a protest has even passed. This means that the taxpayer will receive a notice and demand for the payment and will not have any pre-assessment right to challenge the penalty or raise any defenses. The taxpayer should receive Appeals review, and also has a right to pay the penalty and bring a claim for refund, and then bring a suit in district court or the federal court of claims if the IRS denies the refund. Full payment and the Flora rule can impose a significant barrier. Moreover, these procedures are burdensome, and also may not be successful, as the taxpayer will have the burden of providing reasonable cause, which is the only defense available if the penalty was otherwise properly assessed.

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.

The Problem

The IRS’s practice of assessing penalties against taxpayers who voluntarily attempt to get into compliance with their filing of foreign information returns puts tax practitioners in a difficult position. Most practitioners understand that they have an obligation to the tax system and genuinely strive to comply with that obligation to assist their clients with compliance. And, indeed, most taxpayers believe in tax compliance. See Comprehensive Taxpayer Attitude Survey, 2017 Executive Report, Practitioners also have duties to their clients to ensure that they are not recommending actions that will cause them to unnecessarily incur penalties. In the past several years, as the IRS continues to impose the maximum level of penalties against taxpayers who file untimely or incomplete foreign information returns, it is getting harder for practitioners to recommend that clients should self-correct, as the outcome is the same if they do not self-correct and are later audited.  

Most of us would agree, for instance, that a young person who received a reportable (but nontaxable) gift from a foreign relative for the first time and who prepared her own return and did not know about the Form 3520 requirement at the time of filing, but then filed it 6 months after learning about the filing requirement should not have to pay a penalty of 25% of the foreign gift to the IRS. The IRS, however, would assess this penalty without a second thought – and indeed does so with regularity.