United States citizens and residents are often not aware of the myriad of foreign information return filing obligations that exist under federal tax laws. For example, buried within the Code are reporting obligations associated with the receipt of a foreign gift and participation and ownership in foreign trusts. The failure to file these information returns—referred to as Forms 3520 and Forms 3520-A—can result in significant civil penalties.
Worse yet, IRS procedures currently in place automatically assess the civil penalties when a late Form 3520 or Form 3520-A is filed. Thus, even if the taxpayer files a late Form 3520 or Form 3520-A with a reasonable cause statement, the IRS often ignores those statements until the taxpayer receives administrative appeals rights of the civil penalty determination. But even receiving an administrative appeal is not a given with the IRS often losing those submissions.
In these instances, the only remedy available to taxpayers is often to file a refund claim and lawsuit to recover the penalties. As with any refund suit, the taxpayer must full pay the amount of the civil penalty assessment prior to utilizing this method. Therefore, this method can be costly and expensive, particularly to taxpayers without the means to full pay an erroneous assessment or fund refund litigation against the government in federal district court.
Two recent federal court cases demonstrate the hardship taxpayers must overcome to ultimately find resolution of unlawfully assessed Form 3520 and Form 3520-A civil penalties. These cases are discussed in more detail below.
The Wrzesinski Case.[i]
Mr. Wrzenski was born and raised in Poland. He immigrated to the United States and found employment as a police officer.
As luck would have it, his mother, a Polish citizen, won the lottery and decided to gift some of her fortune to her son. In 2010 and 2011, she gifted Mr. Wrezenski $830,000. Mr. Wrezinski recognized that there may be reporting obligations associated with the large gift and sought advice from his tax preparer. Unfortunately, the tax preparer advised Mr. Wrezinski that because the foreign gift was not taxable under United States income tax laws, there was no reporting obligation.
Mr. Wrezinski later learned on the internet that the foreign gifts gave rise to Form 3520 filing requirements. He contacted a tax attorney who advised him to file the Forms 3520 under the IRS’s disclosure procedures. Under these procedures, Mr. Wrezenski provided the IRS with a reasonable cause statement explaining why he filed the Forms 3520 late.
Almost a year later, the IRS notified Mr. Wrezenski that it had assessed over $200,000 of civil penalties against him for the late-filed Forms 3520. During the administrative appeals process, the IRS agreed to an 80% concession of the civil penalties. Mr. Wrezinski full paid the remaining 20% penalty amount and filed a refund suit.
Prior to filing an Answer in that federal court case, the Department of Justice conceded that Mr. Wrezinski should not be liable for the remaining 20% Form 3520 penalty.
The Ueland Case.[ii]
The Uelands, husband and wife, were United States citizens who lived in Australia. They participated in an Australian superannuation retirement fund. Based on advice they received from their tax professional, the Uelands conservatively opted to treat the Australian superannuation fund as a foreign grantor trust. Accordingly, they filed Forms 3520 and 3520-A with the IRS.
The IRS initially took issue with both the Form 3520 and 3520-A filings. In a letter to their tax professional, the IRS alleged that the Form 3520 was incomplete and threatened to impose penalties with respect to that filing. The tax professional responded to the IRS correspondence and did not hear anything from the IRS for nearly two years.
The IRS later imposed a “miscellaneous penalty” in the amount of approximately $100,000, but only against Mr. Ueland. The IRS never issued a CP15 or other penalty notice to the Uelands related to the penalty assessment. Rather, the IRS levied an overpayment from the Uelands’ 2019 tax year and applied it against the penalty assessment.
The Uelands could not get clear answers from the IRS regarding the penalty assessment. Their counsel therefore filed a Freedom of Information (FOIA) request and determined that the IRS had imposed the penalty for failure to timely file a Form 3520-A. The Uelands attempted to fight the penalty assessment through the appeals administrative process, but were denied the right to an appeal. Accordingly, they filed a complaint with the United States Court of Federal Claims.
In their complaint, the Uelands made numerous arguments. First, they contended that the Form 3520-A was timely filed. Second, they contended that the IRS had failed to follow proper administrative procedures, including issuing a notice and demand and complying with section 6751(b) of the Code.
On September 20, 2023, the parties filed a joint status report with the court indicating that they had settled in favor of the Uelands. The status report indicated that the government had conceded the penalty assessment in full and that the parties were waiting for the IRS to issue a refund.
The IRS automatic assessment of civil penalties for Forms 3520 and Form 3520-A is truly unfortunate given the litigation costs to challenge those assessments. Taxpayers with Forms 3520 and 3520-A civil penalty matters should therefore be mindful that they may need to exercise their statutorily-provided litigation rights to obtain a full and fair resolution of Form 3520 and Form 3520-A civil penalty matters.
[i] Wrzesinki v. U.S., No. 2:22-cv-03568 (E.D. Penn. 2022).
[ii] Ueland v. U.S., No. 23-cv-00931 (Ct. Cl. 2023).