June 25, 2024

Tullio Corradini

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What are International Reporting Penalties: Global Tax Counsel

What are International Reporting Penalties: Global Tax Counsel


What are International Reporting Penalties: Global Tax Counsel

Exploring International Reporting Penalties

International Reporting Penalties 

Exploring International Reporting Penalties: When it comes to international reporting penalties, the Internal Revenue Service has consistently, year-after-year — made enforcement a key compliance priority. International reporting penalty enforcement is a big moneymaker for the IRS, because oftentimes they are assessable penalties which simply means they are assessed without providing the Taxpayer an opportunity to dispute the penalty or challenge the penalty beforehand — rather, they must wait until after the penalty has been issued. it is an absolute injustice to US Persons, because more often than not there is no unreported income — and thus the taxpayer has not run afoul of tax law. Rather, the Taxpayer was simply unaware that they had a reporting requirement for receiving things like a foreign gift, foreign trust distribution — or ownership of a foreign trust or other entity. Making matters more complicated is that the process to try to eliminate assessable penalties is disjointed at best — and requires the taxpayer to actively seek the IRS to put a hold on the penalty — although the enforcement aggressively continues. It would be literally impossible to describe “everything” a Taxpayer would ever need to know about international reporting penalties in a single article without copying and pasting the entire Internal Revenue Code — but we will go through and identify the key important aspects of the different international reporting penalties and what you may be able to do to challenge them.

What are Assessable International Reporting Penalties?

The reason why most international reporting penalties or so intrusive, is because they are what is referred to as assessable penalties. In other words, it is because the penalty is assessed before the taxpayer has an opportunity to dispute it. For example, possibly you are in an audit or examination and the Agent is considering penalizing you for income underreporting — when you turn on the charm and you are able to avoid that penalty from being issued. In other words, at the time before the penalty is issued you are aware that the penalty may be issued and you take the opportunity to try to circumvent the penalty from being issued. With international reporting penalties usually what will happen is (especially post 11/20 DIIRSP), a Taxpayer will realize they missed an international reporting form such as a Form 3520. They then file the form late and are hit with a penalty — sometimes upwards of 25% value of the unreported gift when it is a form 3520 penalty for receipt of large gift from a foreign person. Now, the taxpayer has to work against the clock to try to update the penalty while strategically determining which route they want to pursue (Appeals, CDP, Tax Court, Federal Court, etc.)

7 common International Reporting Form Violations

There are many different types of international information reporting forms in which noncompliance may results in international reporting penalties — but these seven are the main culprits that result in penalties. Noting, that the FBAR is not actually a tax form but rather a FinCEN Form (FinCEN Form 114), and the process for updating the penalty (removal) is different than other types of international information reporting form penalties.

  • FBAR
  • 3520
  • 3520-A
  • 5471
  • 5472
  • 8865
  • 8938

What Are the International Reporting Penalties for these Forms?

These types of international reporting penalties begin at $10,000 penalty per form, for items such as form 8938, 8865, 8938 and 5471 — in addition to potential continuing failure to file penalties. The penalty for form 5472 was recently increased to $25,000. And the forms 3520/3520-A will vary extensively depending on the value of the foreign gift and/or trust.

How Is Tax Payer Put on Notice of International Reporting Penalties

Unless the taxpayer is in the middle of an audit or examination when they are on notice of the non-compliance — they would typically learn about an international information reporting form penalty by way of a CP15 Notice.

Can Taxpayer Challenge International Reporting Penalties?

Yes, but it is a detailed comprehensive and exhaustive analysis.

We have put together a scenario on a separate blog post involving international reporting penalties and using a form 3520 large gift situation as the example scenario (since it is very common).

Let’s work through the basics of an Form 3520 Penalty:

CP15 Notice of Penalty for Form 3520

Peter receives a gift from his relatives in Taiwan for $900,000. He hired a CPA — who misunderstood the foreign gift and trust reporting rules — to handle his international tax return.  The CPA realizes (after the fact) that the Form 3520 should have been filed, so they hire a “self-proclaimed tax expert” to handle the case. The reasonable cause letter is not an IRS form, and the law firm does not know how to write an effective reasonable cause letter. The Lawyer slaps together a sloppy Reasonable Cause letter. The letter is received by the IRS and then radio silence.

16-months later, Peter receives a CP15 Notice for $225,000.

What happened!?

26 USC 6039F

The $225,000 penalty was issued based on the penalty being 5% (of the value of the gift) per month — for a maximum of 25%. 

The Attorney Files the Initial Protest to the International Reporting Penalty

Before it is time to litigate a Form 3520 penalty, the IRS CP15 Notice provides an opportunity to dispute the penalty based on reasonable cause and the CP15 Notice gives Taxpayer 30-days to respond.

Most CP15 Notices provide the following:

6039F Reasonable Cause

      • “If you believe you have reasonable cause for your failure to comply, you may send us a written statement (include any documents that will support your position) within 30 days from the date of this notice.

      • The statement must list all the facts you’re claiming as reasonable cause for the failure, and it must contain a declaration that the statement is made under penalties of perjury.”

The CP15 Notice is from the IRS and the initial protest (pre-appeal) goes back to the IRS for the first round of Reasonable Cause penalty abatement review.

Form 3520 Reasonable Cause Letter Rejected LTR 854C

If the Form 3520 protest letter is rejected, Taxpayer will usually receive a follow-up Letter 854C — and here is where it can get (unnecessarily) complicated. At this stage, the Taxpayer can submit a supplemental response to their initial protest letter that was sent to the IRS — if they have “additional information” to present. The IRS Office of Appeals may reconsider the request, and may schedule a conference with Appeals — or not — depending on the specifics of the presentation and officer assigned to the matter.

The Form 3520 penalty may be abated (removed) based on the letter alone. When this type of abatement occurs, a 21C Letter is issued.  Taxpayer should work with their counsel to assess the different strategies and how to proceed on this issue before submitting the appeal letter.

Here are two examples of letters we received for different clients with extensive Form 3520 Gift Penalties (each case is different and no outcome is guaranteed):

21C Letter Example Language (Protest Letter Response from IRS)

      • “We changed the civil penalty amount that we previously charged.                     

        • Our action is the result of your inquiry of

        • Account balance before this change: $xxx,xxx.xx

        • Decrease in Failure to File Form 3520 to Report Receipt of Certain Foreign Gifts or Bequests penalty -$xxx,xxx.xx

      • As a result you don’t owe us any money, nor are you due a refund.”

*This letter was the outcome of a protest letter only.

1278 Letter Example Language (Post-Protest Letter from IRS Office of Appeals)

      • “I completed my review of your request to adjust the penalties assessed against you. Based on the information submitted, I am pleased to advise you the penalties will  be abated  (removed) in full. When this action has been completed, you will receive an adjustment notice from the Service Center, which originally assessed the penalty.

      • If you have any additional questions, please contact the person shown at the top of this letter.

**This letter was the outcome a protest letter and follow-up appeals conference.

In this situation, the Taxpayer will have saved significantly in attorney’s litigation fees (and time) than if the Taxpayer had chosen a different strategy, such as going to Tax Court — which is costly and comes with its own set of risks.

Would an Appeals Conference Prevent a CDP?

If the Taxpayer may want to litigate Form 3520 penalties in the future, a proper strategy should be developed from the outset. If Taxpayer submits the follow-up to the initial protest and has a chance to speak with appeals — but is still rejected — and does not pay the penalty — they will at some point in the future receive a Notice of Lien or Intent to Levy — which opens the door to pursue a CDP. The IRS can then try to take the position that the prior conference with the supervisor was the bite at the apple and the CDP would be rejected. Therefore, before sending any post-protest letter to the IRS, Taxpayers and their counsel should review the pros and cons of each approach.

Beware that CDP is an End-Game Opportunity

The benefits of a Collection Due Process hearing is that it permits the Taxpayer to essentially get two bites of the apple — and it opens the door to go to Tax Court on multiple different arguments. But, the Taxpayer usually has to wait until they receive a Notice of Federal Tax Lien or Intent to Levy before they can pursue a CDP. To the inexperienced international tax attorney — these are just hurdles the Taxpayer must overcome in order to get to the Collection Due Process Hearing stage.

But, to the people involved — these are real concerns that impact their day-to-day life.

Notice of Federal Tax Lien

Imagine the situation in which a person plans on selling their home or applying for a line of credit — and then they receive a Form 3520 penalty notice. Some aggressive tax attorney convinces them to wait until the Collection Due Process Hearing instead of pursuing an appeal — without properly explaining to them the pros and cons of that strategy — and that the CDP is not ripe until Taxpayer receives a Notice of Federal Tax Lien or Intent to Levy. If the Taxpayer is in escrow for a example and a Notice of Federal Tax Lien hits — and the buyer does not want to deal with the hassle — they can just walk away (which is their right to do in California unless all contingencies have been removed).

Was waiting for the CDP worth it?

The NTFL may also impact their employment, ability to obtain credit or a HELOC, etc.

Wrongful Bank Levy

There is probably not a single person alive who would describe the IRS as a well-oiled machine. Several times throughout our many years of tax practice, we have been contacted by Taxpayers who were hit with a wrongful/premature levy. This can occur in a situation in which the Collection Due Process Hearing request is not processed in time before the levy was issued. Moreover, removing the wrongful levy can take a very long time — all the while the Taxpayer has lost out on the ability to access those funds — which may severely impact their day-to-day life.

Interest Continues to Accrue

It can take several months — if not years — for the Taxpayer receive the final notice sufficient to pursue a CDP. Still, interest continues to accrue all the while — and if the Taxpayer is not successful at the Collection Due Process Hearing or at Tax Court — they could be in for a significantly increased fine based on the accrued interest — in addition to the Form 3520 penalty.

Form 3520 International Reporting Penalty Collection Due Process Hearing

If the Taxpayer has not had the penalty removed, and chooses not to prepay penalty — at some point in the future they will receive either a Notice of Federal Tax Lien or Intent To Levy and Right To a Hearing. It is at that point that the Taxpayer will have the opportunity to submit a Collection Due Process (CDP) request using form 12153. The main benefit of a form 12153 request is that the Taxpayer will have the opportunity to present the case to an Officer who has significant authority to resolve the matter. In addition, the Taxpayer has the chance to prove reasonable cause. Moreover, if the penalty abatement is rejected, the taxpayer will then still have the opportunity to bring the matter to Tax Court — armed with multiple legal arguments. Still, there are potentially serious tax (and life) implications for a Taxpayer who waits for a CDP to become ripe instead of pursuing an appeal.

Litigating a Form 3520 International Reporting Penalty in Tax Court 

Most of the time, Tax Court cases involving Form 3520 penalties involves a significant amount of penalties. As a result, certain small case options are not available. Thus, Taxpayers should keep in mind that the Attorney’s Fees for an experienced Attorney are usually very high — and billed hourly — which may not be feasible for many Taxpayers. Moreover, since Form 3520 penalties are not considered tax liabilities, but rather reporting penalties — in general courts have not been as inclined to provide the Taxpayers with much deference in using Tax Court to reduce a Foreign Gift Reporting Penalty as opposed to a tax liabilty or tax penalty.

Federal Court for Litigating Form 3520 Penalties

Another option for the Taxpayer is to pay the penalty upfront and then seek a refund from the IRS for the international reporting penalties. If the refund request is denied — then the Taxpayer can sue in District Court. The idea behind having to pay upfront is the Flora Rule — which requires a Taxpayer to pay the debt at the IRS before moving forward in pursuing a federal claim. It is important to note that Form 3520 penalties are not the result of tax liability — but rather the result of a reporting penalty. Therefore, the Taxpayer may want to take the position that similar to a recent ruling in an FBAR case, prepayment is not required up-front.

CAP (9423) Before Tax Court

When it comes to litigating Form 3520 penalties, the CAP 9423 is not the proper mechanism. A Taxpayer cannot file a Collection Appeal Process (CAP 9423) and then use this as a basis for going to Tax Court. Moreover, technically, a Taxpayer cannot even submit a CDP 12153 after they submitted a form 9423. Thus, if the Taxpayer is considering litigation and wants to dispute a penalty, then when they begin receiving notices such as a 503 — they have to fight the urge to file a form 9423 if their intent is to dispute and litigate the outcome.

From 9423 to 12153 to Tax Court

It is not uncommon for a CPA or other Tax Practitioner who is very nervous about having not initially filed the form 3520, and then received a CP15 notice — and subsequent rejection of the initial protest letter — to go ahead and file inform 9423 in response to the 504/503 letter. 

Is all hope lost?

Of course not.

If this was to happen and Taxpayer later received a Notice of Federal Tax Lien or Intent to Levy — they would still try their hand at filing a form 12153 — because if they can show there are some different issues in order to distinguish it from the 9423 — then they may be able to pursue the CDP and then go to Tax Court.

For example, a Form 9423 is not technically even used to dispute a penalty. Thus, if the purpose of the 12153 (CDP) is to dispute the penalty via Reasonable Cause whereas the filing of the 9423 was to stave off collections and/or filed by mistake — Taxpayer may still have a lane to pursue Tax Court.

IRC 6751

Chances are your Form 3520 Penalty met the “electronically assessed” exception under IRC 6751 for being assessed through electronic means — but maybe not. Making a request under FOIA has its pros and cons — and timing is important. If you are considering making a FOIA request involving international reporting penalties — you should speak with a Board-Certified Tax Specialist first.

International Tax Lawyers Represent Clients Worldwide

Our International Tax Lawyer team specializes exclusively in international tax, and specifically IRS offshore disclosure and international reporting penalties.

Contact our firm for assistance.