Understanding Form 3520: Reporting Foreign Gifts and Distributions From a Foreign Trust

Jul 8, 2023

As trusted experts in tax compliance for US expats, we are here to provide you with accurate and detailed information to navigate the complexities of filing Form 3520. In this article, we will cover everything you need to know about this form, including its purpose, requirements, and how to file it correctly.

What is Form 3520?

Form 3520, also known as the Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts, is a crucial document that needs to be filed by U.S. taxpayers who either receive significant amounts of foreign gifts or are involved in transactions with foreign trusts.

The Internal Revenue Service (IRS) requires individuals to report any receipt of money, property, or other assets from foreign persons or entities. This includes gifts from foreign individuals, as well as inheritance from foreign estates. Additionally, if you are a beneficiary of a foreign trust, you must disclose any distributions or transactions related to that trust.

What is Form 3520 used for?

It is used for two distinct purposes:

  • Reporting an Interest in a Grantor Trust

Imagine having a special bank account known as a grantor trust. This account is typically established by a family member, wherein they deposit funds for your benefit. The IRS, the government agency responsible for taxation, requires individuals to disclose their interest in grantor trusts. Form 3520 serves as the means to report this interest, providing crucial information to the IRS. By completing this form, individuals are transparently notifying the government of their association with such trusts, ensuring regulatory compliance.

  • Receiving Gifts from Foreigners

In our globalized society, it is common for individuals to receive gifts from friends, family, or acquaintances residing in different countries. To ensure fairness and legality, the IRS requires the reporting of substantial gifts from foreigners. Form 3520 plays a vital role in tracking the flow of these gifts and enabling the government to monitor and regulate such transactions effectively. By completing the form, individuals provide the necessary information, helping the government evaluate the extent and nature of foreign gift inflows.

Related: Guide to US Gift and Estate Tax for US Expats

RESP and Rev. Proc. 2020-17

A specific case worth noting is the Registered Education Savings Plan (RESP) in Canada. An RESP is a dedicated savings account designed to fund education expenses. However, the IRS has introduced Rev. Proc. 2020-17, a ruling that simplifies reporting requirements for individuals with an RESP. This provision exempts certain RESP accounts from being reported on Form 3520, thereby reducing administrative burden and streamlining the reporting process for individuals.

Who Needs to File Form 3520?

Here are the circumstances that require its submission:

1) You are considered the responsible party for reporting a reportable event.

A reportable event includes:
a. Creating a foreign trust as a U.S. person.

b. Transferring money or property, directly or indirectly, to a foreign trust as a U.S. person. This includes transfers due to death.

c. The death of a U.S. citizen or resident, where either the decedent was considered the owner of a portion of a foreign trust, or a portion of a foreign trust was included in the decedent’s gross estate.

2) You are a U.S. person who, in the current tax year, was treated as the owner of any part of a foreign trust’s assets.

You are a U.S. person who directly or indirectly received a distribution (including uncompensated use of trust property) from a foreign trust, or a related foreign trust held an outstanding obligation issued by you that you treated as a qualified obligation.

3) You are a U.S. person who, during the current year, received:

a. More than $100,000 as a gift or bequest from a nonresident alien individual or a foreign estate. Failure to report such a gift on Form 3520 can result in a penalty of 5% per month, up to 25% of the amount. Additionally, if the form is not filed on time, the IRS has the discretion to categorize the gift as taxable income and issue a Notice of Deficiency to the taxpayer.

b. More than the section 6039F threshold amount from a foreign corporation or a foreign partnership. The threshold amount is $18,567 for 2023.

Tip: Joint Tax Returns

If both you and your spouse are transferors, grantors, or beneficiaries of the same foreign trust, and you are filing a joint income tax return for tax year 2022, you can file a joint Form 3520. If you are filing a joint Form 3520, mark the box on line 1i on page 1.

Exemptions from Filing Form 3520:

Certain transactions are exempt from the requirement of filing Form 3520, which we will explain in simple terms:

  • Transfers to certain foreign trusts mentioned in sections 402(b), 404(a)(4), or 404A are not required to be reported on Form 3520.
  • Most transfers of property at fair market value (FMV) by a U.S. person to a foreign trust do not need to be reported. However, there are exceptions, such as transfers involving qualified obligations, transfers of appreciated property where the gain is not immediately recognized, and transfers related to the foreign trust.
  • Transfers to foreign trusts that hold a current determination letter from the IRS, recognizing their exempt status under section 501(c)(3), do not require reporting on Form 3520.
  • Transfers to and ownership of Canadian retirement plans, including registered retirement savings plans (RRSPs) and registered retirement income funds (RRIFs), are exempt from reporting. This exemption is explained in detail in Revenue Procedure 2014-55 available on IRS.gov.
  • Certain eligible individuals’ transfers to and ownership of tax-favored foreign retirement trusts and nonretirement savings trusts, as described in Revenue Procedure 2020-17, are exempt. To determine eligibility and trust qualification, refer to Revenue Procedure 2020-17 available on IRS.gov.
  • Deemed transfers from domestic trusts becoming foreign trusts, to the extent they are treated as owned by a foreign person after the application of section 672(f), do not require reporting.
  • Distributions from foreign trusts that are taxable as compensation for services rendered, as long as the recipient reports the distribution as compensation income on their federal income tax return, are exempt from reporting.
  • Distributions from foreign trusts to domestic trusts holding a current determination letter from the IRS, recognizing their exempt status under section 501(c)(3), do not require reporting on Form 3520.

Understanding the Filing Process

When to file form 3520?

The due date for filing Form 3520 as a U.S. expat is the 15th day of the sixth month following the end of your tax year (June 15th). You are required to submit it separately from your income tax return. This extended deadline applies if you reside outside the United States and Puerto Rico or if you are serving in the military or naval service on duty abroad. For example, if your tax year ends on December 31, 2022, the deadline for filing Form 3520 for tax year 2022 would be June 15, 2023.

It’s important to note that if you receive an extension for filing your income tax return, the deadline for submitting Form 3520 is also extended. However, the extension does not go beyond the 15th day of the tenth month after the end of your tax year.

Where to mail form 3520?

Internal Revenue Service Center
P.O. Box 409101
Ogden, UT 84409

How to file form 3520?

To successfully complete Form 3520, pay close attention to the following key sections:

1. Part I: Identification of Transferor or Receiving Foreign Trust Provide personal information about the transferor or the foreign trust involved in the transaction.

2. Part II: Information on Foreign Gifts or Bequests Report details of any foreign gifts or bequests you have received during the tax year, including the value and description of the gifts.

3. Part III: Information on Foreign Trusts If you have an interest in a foreign trust, you must provide comprehensive details regarding the trust, its assets, trustees, and beneficiaries.

4. Part IV: Statements by Executors, Trustees, or Agents Executors, trustees, or agents must complete this section to declare their consent and acknowledge their obligations.

What’s the difference between form 3520 and 3520-A?

Form 3520 is used by U.S. persons to report certain transactions involving foreign trusts. It is generally filed separately from the individual’s income tax return and is primarily focused on providing information about the creation of a foreign trust by a U.S. person, transfers of money or property, and received distributions. Additionally, it is used to report substantial gifts received from foreign individuals or entities.

Form 3520-A, on the other hand, is filed by the foreign trustee of a foreign trust with at least one U.S. beneficiary. This form provides information about the trust’s operations, including income, distributions, and beneficiaries. The foreign trustee is responsible for filing this form annually and providing the necessary details to the IRS.

Penalties for Late Filing Form 3520

Late filing or incomplete/incorrect information on Form 3520 can result in penalties. The initial penalty is typically the greater of $10,000 or specific percentages based on the following circumstances:

  1. Failure to report the creation of or transfer to a foreign trust in Part I: A penalty of 35% of the gross value of any property transferred to the foreign trust applies for a U.S. transferor’s failure to report.
  2. Failure to report the receipt of distributions from a foreign trust in Part III: A penalty of 35% of the gross value of the distributions received from the foreign trust applies for a U.S. person’s failure to report.
  3. Failure of a foreign trust to file Form 3520-A or furnish required annual statements: A penalty of $10,000 or 5% of the gross value of the portion of the foreign trust’s assets treated as owned by a U.S. person applies if the foreign trust fails to file Form 3520-A on time or provide the necessary information to U.S. owners and beneficiaries. A U.S. owner must attach a substitute Form 3520-A to their Form 3520 by the due date of their Form 3520 to avoid the penalty.

Additional penalties may be imposed if noncompliance continues beyond 90 days after the IRS sends a notice of failure to comply. Penalties are reduced to ensure they do not exceed the gross reportable amount. For more details, refer to section 6677 and the instructions for Part II of Form 3520 and Form 3520-A.

It is crucial to understand and comply with the reporting requirements to avoid these penalties. Timely and accurate filing of Form 3520 is essential to maintain compliance with the IRS and fulfill reporting obligations related to foreign trusts.

Benefits of Seeking Professional Assistance

Given the complexity of Form 3520 and the potential consequences of non-compliance, it is highly recommended to seek professional assistance. Engaging a tax professional with expertise in international taxation can ensure the accurate completion and timely submission of Form 3520. This not only provides peace of mind but also helps you navigate the intricacies of the form more effectively.

At 1040 Abroad, we understand the complexities of US tax obligations for expats and are committed to providing free tax advice to all US expats via email and we charge a flat fee of $200 for the form. Our team of expert accountants can guide you through the process and ensure that you stay compliant with all applicable tax laws. Don’t hesitate to reach out to us for help navigating your state tax obligations as a US expat living abroad.

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