When U.S. taxpayers engage in transactions involving foreign trusts, including creating or funding them, receiving large gifts or bequests from overseas, or serving as trust owners under grantor rules, IRS Form 3520 can become central to the required foreign information compliance picture. This filing obligation also extends to U.S. persons who receive gifts from foreign partnerships or corporations exceeding certain thresholds. In particular, U.S. persons with foreign pensions are frequently caught off guard by the complexity of Form 3520−related reporting requirements and confusion over whether to use Form 3520 or Form 3520-A.
If you need assistance with managing your foreign tax liability, contact the experienced California dual-licensed tax lawyers and CPAs at the Tax Law Offices of David W. Klasing today. With nearly three decades of experience handling complex foreign reporting requirements, we’re committed to helping you achieve your tax goals. Call the Tax Law Offices of David W. Klasing at (800) 681-1295 or use our online contact form to schedule a reduced-rate initial consultation.
Note: Because of the draconian 25% to 35% of the gift penalties for omitting a required for 3520, our firm does not typically prepare this form. We are happy to provide you with the form and form instructions, however. The hourly rate for preparing the form is simply not sufficient financial incentive for us to take on the astronomical amount of risk.
Why does the IRS Require Form 3520?
Form 3520 (“Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts”) informs the IRS about significant foreign gifts, bequests, and trust transactions. Failure to file or provide accurate information can trigger substantial civil tax penalties – often 25% to 35% of the gift’s value or trust assets – and, in cases of willful concealment, can trigger the IRS-Criminal Investigation Division to initiate an exponentially worse criminal tax investigation. While foreign trusts are frequently used for asset protection or estate planning, the U.S. government has expanded its enforcement efforts via Foreign Bank Account Reporting (FBAR), FATCA, and intergovernmental data-sharing to uncover undisclosed offshore wealth focusing on evaded offshore taxable income on foreign income generating assets coupled with omitted foreign information returns that would have flagged the evasion.
Offshore income generating assets include for example, offshore businesses, rental property, investments in the foreign markets, insurance policies, pension plans etc.
When IRS Form 3520 Applies
1. Foreign Gifts or Inheritances
- Over $100,000 from a Nonresident Alien or Foreign Estate: If, in a single calendar year, you receive foreign gifts or bequests that collectively exceed $100,000, Form 3520 is generally required.
- Over $15,601 from a Foreign Corporation or Partnership: Form 3520 obligations also arise when total gifts from certain foreign partnerships or corporations exceed this threshold in a calendar year. (This figure may adjust slightly for inflation in different tax years.)
2. Transactions with a Foreign Trust
- Creating or Funding the Trust: If you transfer money or property into a foreign trust, you must report the details on Form 3520.
- Receiving Distributions: U.S. beneficiaries who receive direct or indirect distributions from a foreign trust must also file.
- Ownership Under Grantor Rules: If you are deemed the “owner” of a foreign trust (for instance, you retain specific powers over its assets), you typically must file Form 3520, plus ensure the trustee files Form 3520-A or attach a substitute to your return.
3. Loans or Property Use
- Loans from a Foreign Trust: A “loan” from your foreign pension or another foreign trust can be interpreted as a distribution, requiring disclosure on Form 3520.
- Use of Trust Property: Using a foreign trust’s assets without paying fair market value rent or fees also generally counts as a distribution event.
Why the IRS Requires Disclosure of Foreign Trusts and Pensions
Under U.S. tax law, a “U.S. person” (U.S. citizen, green card holder, or someone meeting the substantial presence test) is generally taxed on worldwide income. This means foreign trusts – including pension plans considered “foreign trusts” – must often be reported to the Internal Revenue Service (IRS). Key points include the following:
Foreign Pension Plans as Trusts
Many retirement and pension arrangements established abroad meet the legal definition of a “foreign trust.” If you, as a U.S. person, own or are treated as the owner under grantor trust rules or you receive distributions from that plan, it could trigger one or both of the following forms:
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- Form 3520: Reports foreign trust transactions and large foreign gifts.
- Form 3520-A: This is filed on behalf of certain foreign trusts themselves, usually by the trustee. If the trustee does not submit it, the U.S. owner must attach a substitute version to their Form 3520.
Penalties for Noncompliance
Failing to file Form 3520 or Form 3520-A – or filing inaccurate data – can lead to substantial civil fines, often based on a percentage of the trust or pension account’s value. More severe cases of willful non-reporting may prompt a criminal tax / foreign information fraud referral, subjecting the taxpayer to felony prosecution.
Key Differences: Form 3520 vs. Form 3520-A
Form 3520 (“Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts”)
- When to File: Due by April 15 (or October 15 with an automatic extension) for calendar-year filers. If you live outside the U.S. or Puerto Rico, it may be due two months later.
Pro Tip: Never file your income tax returns BEFORE your foreign information returns while on extension. They will be considered late!! They are due with or before your personal income tax returns!!!
- Who Files:
- U.S. Owners of foreign trusts (including certain grantor trusts).
- U.S. Recipients of distributions or loans from a foreign trust.
- U.S. Persons receiving large foreign gifts or bequests, typically exceeding $100,000 in a calendar year, from nonresident aliens or foreign estates.
- What It Covers:
- Transfers of money or property to a foreign trust.
- Distributions or loans received from a foreign trust.
- Certain foreign gifts or bequests above threshold amounts.
Form 3520-A (“Annual Information Return of Foreign Trust with a U.S. Owner”)
- When to File: Typically due by the 15th day of the third month after the end of the foreign trust’s tax year (often March 15), though a six-month extension is possible via Form 7004.
- Who Files:
- The trustee of a foreign grantor trust with a U.S. owner. If the trustee does not file, the U.S. owner must submit a substitute Form 3520-A along with their Form 3520.
- What It Covers:
- Detailed financial information about the trust’s activities, including contributions and distributions.
- Annual statements for the U.S. owner and any U.S. beneficiaries, ensuring they properly report income on individual returns.
Pro Tip: If a foreign pension plan does not meet the requirements to be treated as the equivalent of a U.S. pension it will be treated as a foreign trust and form 3520-A (if supplied by pension administrator) or a self-prepared form 3520 and substitute 3520-A will be required on an annual basis. Additionally, the income earned by the pension plan may be taxable on an annual basis even in the absence of distributions. Foreign pensions are also reportable on the FBAR (FinCen form 114) and form 8938. You, or your preparer, additionally may have to track your basis in the pension plan to determine the taxability of future distributions.
Reporting Foreign Pension Plans as Foreign Trusts
If you are a U.S. person with a foreign pension plan, you may unwittingly have a “foreign grantor trust.” In that situation:
- You, as a U.S. owner:
- Must ensure the trustee files Form 3520-A each year, or else you must attach a substitute version to your personal Form 3520.
- Disclose any pension distributions or transfers using Form 3520.
- Potentially file FBAR (FinCEN Form 114) and/or Form 8938 (Statement of Specified Foreign Financial Assets) if your pension plan meets the requisite monetary thresholds.
Exemptions
Certain tax-favored or treaty-recognized retirement accounts (e.g., certain Canadian RRSPs or RRIFs) may be exempt from filing Form 3520 and 3520-A. However, they still must often appear on other forms (e.g., Form 8891 in past years, replaced by a tax treaty statement). Similarly, the IRS’s March 2020 guidance (Revenue Procedure 2020-17) waived some filing obligations for certain foreign trusts if they meet definitions of tax-favored retirement or non-U.S. education and disability plans.
When You Don’t Need Form 3520 or 3520-A
Fair Market Value (FMV) Transfers
Transferring assets into a foreign trust at FMV might not need Form 3520 reporting for that transaction, though other trust filings can still be required if you remain an owner or beneficiary.
Service Compensation
If you receive distributions from a foreign trust as payment for services rendered, you typically report it as regular income on Form 1040, not on Form 3520.
New IRS Exemptions for Tax-Favored Trusts
Particular pension or educational trusts abroad may be exempt from Form 3520 or 3520-A if they meet the definition of a “tax-favored foreign trust.” Double-check the eligibility under Revenue Procedure 2020-17.
No Maximum for Overseas Gifts
There’s no upper limit to how much you can receive from an overseas relative or friend, but once the gift surpasses $100,000 in a year (or $15,601 from a foreign corporation or partnership), reporting kicks in. This reporting does not necessarily make the gift taxable!
Pro Tip: Never let a foreigner gift any U.S. situs assets to you or you could face a 40% transfer tax.
Examples: U.S. real estate, bank accounts, investment accounts, stock bonds and securities (even held in offshore accounts), interests in U.S. companies.
Don’t ever let them wire money directly to your U.S. bank account, instead have them make the transfer from their offshore account to your offshore account and then transfer the funds home to yourself. Give your banker a heads up on what the incoming wire is all about to avoid a suspicious activity report being sent to the IRS. Beware of foreign laws and OFAC restrictions on getting funds out of foreign jurisdiction as you could have criminal liability for assisting a foreigner violate them.
Penalties for Mistakes or Omissions
Civil Tax Fines
- Minimum $10,000 for failing to disclose a foreign trust or significant gift on Form 3520.
- 5% to 35% of unreported property in serious trust violations, depending on the circumstances.
- Criminal Tax Exposure
If the IRS concludes you willfully omitted or misstated foreign trust details – especially over multiple years or large sums – your case may be referred to the clandestine IRS criminal investigation division. The IRS-CID boasts a 92%+ conviction rate in criminal tax cases, which refers to the DOJ, making early, strategic legal representation critical if you suspect your audit might escalate to a criminal tax matter. Conviction can lead to hefty fines, restitution, and up to five years in prison.
Reasonable Cause Defense
Taxpayers with credible explanations (e.g., reliance on incorrect professional advice) and thorough documentation may secure penalty relief. However, the IRS is often stringent, requiring detailed proof.
Note: As long as a taxpayer that has willfully committed tax crimes (potentially including non-filed returns coupled with affirmative evasion of payment) self-reports the tax fraud (including a pattern of non-filed returns) through a domestic or offshore voluntary disclosure before the IRS has started an audit or criminal tax investigation/prosecution, the taxpayer can ordinarily be successfully brought back into tax compliance and receive a nearly guaranteed pass on criminal tax prosecution and simultaneously often receive a break on the civil penalties that would otherwise apply.
It is imperative that you hire an experienced and reputable criminal tax defense attorney to take you through the voluntary disclosure process. Only an Attorney has the Attorney-Client Privilege and Work Product Privileges that will prevent the very professional that you hire from potentially being forced to become a witness against you, especially where they prepared the returns that need to be amended in a subsequent criminal tax audit, investigation or prosecution.
Moreover, only an Attorney can enter you into a voluntary disclosure without engaging in the unauthorized practice of law (a crime in itself). Only an Attorney trained in Criminal Tax Defense fully understands the risks and rewards involved in voluntary disclosures and how to protect you if you do not qualify for voluntary disclosure.
As uniquely qualified and extensively experienced criminal tax defense tax attorneys, Kovel CPAs, and EAs, our firm provides a one-stop-shop for efficiently achieving optimal and predictable results that simultaneously protect your liberty and your net worth. See our Testimonials to see what our clients have to say about us!
Contact the Tax Law Offices of David W. Klasing for Experienced Guidance on Foreign Gifts, Trusts, and Inheritance
At the Tax Law Offices of David W. Klasing, we handle complex civil and criminal tax controversies, with a focus on Form 3520 compliance for foreign gifts, trusts, and pension plans. Our dual-licensed Tax Attorneys and CPAs integrate both legal and accounting knowledge essential for navigating advanced cross-border scenarios. We will help you with:
- Representation in Egg Shell Audits likely to Uncover Undisclosed Foreign Accounts and/or Unreported Taxable Offshore Income.
- Representation in Full Blown or Streamlined Offshore Voluntary Disclosures
- Pinpointing Filing Obligations: Assess whether your foreign trust, pension, or significant overseas gift triggers Form 3520 (and possibly Form 3520-A, FBAR, Form 8938, or other disclosures).
- Validating Exemptions: Determine if you qualify under new IRS relief for “tax-favored” foreign trusts (e.g., certain pension or education accounts) or whether fair market value transfers or other carve-outs apply.
- Mitigating Civil Tax Penalties: Negotiate with examiners or push for penalty waivers if you acted in good faith. We also handle abatement requests for older penalties if your trust is newly exempt.
- Preventing Criminal Tax Referral: Build robust defenses if the IRS signals potential willfulness, safeguarding your financial well-being and liberty.
Form 3520 mistakes or oversights can invite daunting fines and, in willful cases, possible felony charges. By clarifying your obligations early and correcting any lapses proactively, you stand a far stronger chance of avoiding ruinous penalties or a criminal investigation. With the IRS steadily enhancing global information-sharing and cross-border enforcement, procrastination only magnifies risk.
Contact the Tax Law Offices of David W. Klasing at (800) 681-1295 or use our online contact form to schedule a reduced-rate initial consultation. Choose our firm—where unmatched tax knowledge merges with aggressive, strategic representation—and let us ensure your Form 3520 obligations for foreign trusts, gifts, and pension plans are fully addressed.
