IRS to end automatic penalties for late filing of foreign gift, bequest forms

The IRS will end its practice of automatically assessing penalties for the late filing of forms dealing with foreign gifts and bequests, a change long advocated by the AICPA and the Taxpayer Advocate Service.

National Taxpayer Advocate Erin Collins discussed the updated policy in a Thursday blog post, the same day IRS Commissioner Danny Werfel announced the changes at the UCLA Tax Controversy Conference.

Werfel said the IRS will no longer automatically assess penalties at the time of filing for a late-filed Form 3520, Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts, Part IV.

That modification and the review of reasonable-cause statements attached to the late-filed forms are important changes for many taxpayers, Werfel said.

“A person may be with parents living overseas; a parent dies, now you’re dealing with the estate, you’re dealing with grief, you’re dealing with all the moving pieces, and maybe in the middle of all this, you late-file your form that you’re required to file,” Werfel said at the conference.

By the end of 2024, the IRS will begin reviewing any reasonable-cause statements taxpayers attach to late-filed Forms 3520 and Forms 3520-A, Annual Information Return of Foreign Trust With a U.S. Owner, for the trust portion of the form before assessing any Sec. 6677 penalty, according to Collins’s blog.

The changes will “relieve [the] burden on taxpayers by giving them the opportunity to explain their situation before the IRS assesses a penalty,” she said.

Last year, Collins included the issue of international penalties in her “Most Serious Problems” report that is sent to Congress, describing the IRS’s approach as “draconian and inefficient.”

Taxpayers often would file a Form 3520 late because they were unaware of the filing requirement since there is no underlying tax liability, Collins wrote. Some were assessed huge penalties of up to 25% of their gift or inheritance. In the foreign gift context, from 2018 to 2021, taxpayers who reported $400,000 or less in income received an average penalty of over $235,000, she wrote.

Over the same period, the IRS abated Sec. 6039F penalties totaling over $179 million related to Form 3520, Part IV, for an abatement rate of 67% of the penalties assessed and 78% of the dollars assessed, Collins wrote.

“The significant abatement rate illustrates how often these penalties were erroneously assessed,” she wrote. “The automatic assessment of the penalties causes undue hardship, burdens taxpayers, and creates unnecessary work for the IRS. Stopping this practice will benefit everyone.”

AICPA advocacy

The AICPA has long advocated for these changes, including in letters in February 2023 and August 2023.

“For many years, the AICPA Form 3520 Penalties Task Force has advocated for the IRS considering reasonable-cause exceptions to penalties when included with Forms 3520 before penalty notices are issued and for the IRS stopping automatically assessing the outsized Form 3520 penalties for a failure to timely or fully comply with the many information and return filing requirements,” said Eileen Sherr, CPA, CGMA, director–Tax Policy & Advocacy for the AICPA. “So we are pleased that the IRS is moving forward with these changes, and we look forward to hearing more details about them. We will continue to advocate on related issues and monitor and remain in dialogue with our IRS contacts in this area.”

— To comment on this article or to suggest an idea for another article, contact Martha Waggoner at Martha.Waggoner@aicpa-cima.com.