This week, we are going to talk about reporting requirements for US tax persons who receive a foreign gift or inheritance from overseas (Form 3520).
Last week, an observing tax pro colleague noticed that the IRS had quietly made a change on their website, impacting one of the programs I had regularly been using since 2014: The Delinquent International Information Return Submission Procedures, or DIIRSP.
What is the DIIRSP?
The DIIRSP is a program that allows, or used to allow, according to Accounting Today’s November 9th interpretation, certain taxpayers who had not filed certain international information returns but were otherwise tax compliant and not under IRS civil investigation, to submit or amend their late or erroneous international information return without facing late filing penalties. What are examples of information returns? Form 5471 to report an interest in a foreign corporation, Form 8938 to report ownership of specified foreign financial assets, Form 8865 to report ownership interests in a foreign partnership, and others.
Participating in this program required having reasonable cause for the failure to timely file the international information return.
What is reasonable cause?
Reasonable cause is a facts and circumstances test. Under this facts and circumstances test, the IRS will consider the different reasons that resulted in the non-compliance, determine whether the taxpayer had used ordinary business care and prudence to meet their federal tax obligations, and that despite having behaved with care and prudence, was still unable to comply. If the IRS makes a positive determination, the taxpayer’s penalties are abated for reasonable cause.
Would you like examples of reasonable cause?
Here you go:
- A natural disaster prevented you from being able to comply with the tax obligation: fire, hurricane, earthquake, flood, tornado, etc.
- A serious illness or death prevented you from complying.
- You were unable to obtain records from third parties despite extensive efforts to do so.
Clear so far, right?
What did the IRS change in the DIIRSP?
It used to be that under this program, the taxpayer was allowed to file the late information return with a reasonable cause statement attached to it. The IRS would review the submission, including the attached reasonable cause statement, process the late information return, and if they agreed with the reasonable cause, that was it. Nothing else happened. The late or amended form was processed and no penalty was imposed. The taxpayer would never hear another word about it. Everyone was happy.
Lately, though, at least since late 2018 to early 2019, the IRS started to routinely ignore the attached reasonable cause statement. It would just pretend it hadn’t been attached. The IRS started routinely assessing penalties to the late filing taxpayers as if the reasonable cause statement hadn’t been filed and treated the taxpayer as if they had been negligent in their non-compliance.
What was the impact on taxpayers?
They would have to resubmit the whole thing a second time: the late information return plus the reasonable cause statement, remind the IRS of the existence of the DIIRSP Program, and how the taxpayer had met the criteria and specifications to qualify for it. Then the taxpayer would have to wait for the IRS to review the second submission, and normally within three months or so, the IRS would and the situation would be resolved.
This process was time consuming and annoying, but it was manageable.
Until the pandemic hit.
In late March the IRS had to close its offices and send its Customer Service Representatives, Revenue Agents, Revenue Officers, etc. to work from home. Millions of pieces of mailed IRS correspondence that were in the process of being reviewed got lost in the shuffle. Millions of additional pieces of correspondence started to pile up without being reviewed.
In an October 23rd article, Accounting Today reported that the IRS was resuming sending balance due notices to taxpayers despite the continued pandemic, and despite their correspondence review backlog, which, by October, was more than 5.3 million of unprocessed pieces of mail, per Commissioner Chuck Rettig’s own admission.
It is within this messy context that the IRS decides to turn the tables on the taxpayer on the Delinquent International Information Return Submission Procedure and change the rules.
One interpretation of the change to this program is that it amounts to an admission by the IRS that it had been ignoring this program for a long time already, and it had been processing the late filed or amended international information returns as if the program didn’t exist.
How did the IRS admit that this is what it had been doing lately?
It changed the description of the program on their website to the following (bolded words mark the changes):
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.
What is the plain English translation of the above phrase?
Dear taxpayer: you may attach a reasonable cause statement to your late filed information return all you want to. We are just going to ignore it. We are going to assess the standard penalties as if this program didn’t exist and you hadn’t attached anything. We will scare you, or if you are a professional, we will scare the beejesus out of your client. We will force you to send everything a second time. And because we are in the midst of a pandemic and things are a bit messy around here, we are likely going to ignore your re-submission too, and send you a notice of intent to ley to scare you even further. Isn’t this fun?
Why does this change matter?
This change matters because most international information returns carry high failure to file penalties, many of which start at $10,000 per failure and go up from there.
These penalties are easy money for the IRS. The change in the DIIRSP program makes it easier for the IRS to collect on those penalties even when the taxpayer has reasonable cause. Having to respond to unnecessary letters is a burden for us taxpayers. It costs us money, time and potential loss of sleep.
To boot, the IRS is currently conducting a campaign on one of the international information returns most commonly missed by US immigrants and expats: Form 3520.
Form 3520 is used mostly for two purposes: to report transactions with foreign trusts and to report the receipt of certain foreign gifts or bequests. (bequest = inheritance).
If you had a transaction with a foreign trust and didn’t realize you had to file Form 3520, your penalty can be as high as 35% of the gross value of the unreported transaction. If you received a reportable foreign gift or inheritance, and didn’t know you had to file Form 3520, your penalty can be as high as 25% of the value of the unreported gift or inheritance.
What gifts and inheritances are required to be reported on Form 3520?
- Foreign gifts or inheritances with an aggregate value of $100,000 received from a donor, or two or more related donors, during a calendar year, are reportable. For example: mom sends you a gift of EUR 50,000 from her French bank account and dad sends you a separate gift of EUR 45,000 from his French bank account. Since mom and dad are related, their gifts have to be aggregated. Since EUR 95,000 are worth more than $100,000, the gift is reportable. IT IS NOT TAXABLE: you are not required to pay any US tax on it, but it is reportable. And if you forget to report it, your penalty could be 25% of the total value of the gift.
- Foreign gifts received from a foreign corporation worth more than $16,388. If mom and dad own a foreign company and they want to send you a gift, make sure they send you the gift from their PERSONAL account and not they BUSINESS account. Gifts from business accounts have lower reporting thresholds and the IRS considers them suspect. How do they consider them suspect? They may believe that it isn’t really a gift, but rather that it’s corporate income disguised as a gift. So please make sure mom and dad are careful and send you money from the right account: a personal account. Otherwise, the IRS may recharacterize the gift as income and force you to pay income tax on the value of the gift in addition to paying the 25% penalty for not reporting the gift in a timely manner. If the IRS decides to recharacterize the corporate gift as income, there is nothing you can do about it. They have the legal right to do this and you will have to pay up. Double ouch!
Foreign gifts and inheritances are something that impact many of the readers of this newsletter, as they apply both to Americans living abroad, foreign families living in the USA and many other US citizens with relatives residing overseas. If you received a foreign gift or inheritance and later find out that it should have been reported, you should carefully consider your options to remedy the situation, particularly after this change to the DIIRSP program.
In certain cases, the Streamlined Filing Offshore Procedures may be a better alternative, even if this program requires more paperwork.
And with this, I let you go until next week.
Stay safe and take good care of one another.
Un abrazo y buena onda,