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

What do I need to file if I received a gift from a foreigner?

That question is common to many U.S. citizens, but the answer is not very familiar. Under the rules of the IRS, Form 3520 is the tax form needed to file when a U.S. person received gifts and bequests from a foreigner. However, many still misunderstand Form 3520. It’s not surprising as its nature is quite confusing and tricky to understand. But let’s get into the real topic – what is Form 3520 and what is its purpose?

Form 3520 is the annual return to report transactions with foreign trusts and receipt of certain foreign gifts. It is the tax form filed by a U.S. person upon receiving a gift or bequest from abroad. But generally, Form 3520 covers a lot of considerations before an individual can file it. And we are going to tackle the most important things here in this article.

The purpose of Form 3520

The filing of Form 3520 is for reporting certain transactions with foreign trusts, ownership of foreign trusts, and receipt of certain large gifts or bequests from certain foreign persons.

In simple terms, a U.S. person must file IRS Form 3520 if they received a gift or bequest from a foreign person. The foreign person is a foreign individual, corporation, partnership, trust, or estate that is not a U.S. person. And to qualify the gift or bequest for reporting, one or more of the below must be present:

1. You are the one responsible for reporting the event that happened during the current tax year. The responsible party also includes the one who transferred the property to a related foreign trust.
2. You own any part of the foreign asset of a foreign trust during the current tax year.
3. You received a distribution directly or indirectly from a foreign trust during the current tax year.
4. The value of the gift or inheritance is:
   1. more than $100,000 and you received it from a foreign individual or a foreign estate.
   2. more than $16,388 and you received it from a foreign corporation or a foreign partnership.

The due date and the place of filing

The due date falls on April 15 of the following year after you received the gift or bequest. But if you are a U.S. citizen or resident who is living outside of the United States and Puerto Rico, and your place of business or your post of duty is also outside the mentioned places, or in the military or naval service on duty outside the United States and Puerto Rico – then the due date is on June 15 of the following year after you received your gift or bequest.

However, if the due date falls on a Saturday, Sunday, or legal holiday, you can file it by Monday or the next day after the holiday.

But in case you have granted an extension of filing income tax return, the due date will be on October 15. That is the 15th day of the 10th month following the end of your tax year.

If you have completed all the requirements and conditions apply to you, you can send the Form 3520 to:

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

Keep in mind that IRS Form 3520 is crucial for income tax purposes. Reporting it on time and disclosing all necessary information to IRS will prevent you from penalties and future complications. You also need to attach all the required documents to consider it complete.

The Form 3520-A

Many are still confused with Form 3520 and Form 3520-A. These two tax forms are different from each other, and they must not treat the same way. The IRS Form 3520-A is the annual information return of foreign trust with a U.S. owner. This tax form is usually one of the attachments required when filing Form 3520. It only applies if a foreign trust has at least one U.S. owner of any portion of the foreign asset.

In the IRS Form 3520-A, the responsible owner should provide the following information – the trust, its U.S. beneficiaries, and any U.S. person who is treated as an owner of any portion of the foreign trust.

The deadline for Form 3520-A is different from Form 3520. It is on the 15th day of the 3rd month following the end of your tax year. In other words, it falls on March 15th.

It is important to have a broad understanding of Form 3520-A. Presenting the appropriate and correct disclosures to IRS will save you from any dilemmas. Talk to your legal counsel or tax advisor to have a better grasp on how to file Form 3520-A properly.

The RESP, the Form 3520 and the Form 3520-A

If you are a U.S. citizen living in Canada and a subscriber of RESP, it is important to know how the U.S. tax rules treat the RESP. RESP stands for Registered Education Savings Plan, and the Canadian government sponsors this special type of account. The RESP is a fantastic tool created to assist people in their children’s post-secondary education expenses. Most financial institutions such as banks, credit unions, investment dealers, mutual funds companies, and trust companies offer RESP.

If you are a parent and make contributions, the government will add money to the RESP in the form of a grant. This grant is the Canada Education Savings Grant (CESG), and it is mostly the main attraction of the RESP. In the basic CESG, the Canadian government adds 20% of the value of the contribution made. You will then enjoy the immediate boost of its value, aside from the returns you can get upon withdrawal.

There is also another separate grant aside from CESG, and this is the Canada Learning Bond or the CLB. It is a grant that can provide up to $2,000 from the government without requiring any contributions from the subscriber. 

So, how is RESP associated with filing Form 3520 and Form 3520-A?

It is a general rule that for every income received, there must be tax to file. Canada and U.S. tax rules differ from each other, and so it is when it comes to RESP. For U.S. persons, the income (including the grants) from RESP is taxable in the U.S. You need to file your income on your U.S. tax returns on the year you received your earnings.

Additionally, under IRS rules, RESP is also a foreign trust. This means that aside from the annual tax returns, you also need to file Form 3520 and Form 3520-A. You should report and disclose all the essential information and file them within any year of your contribution or withdrawal.

Reporting and filing Form 3520 and Form 3520-A can be complicated, especially when it concerns foreign trusts such as RESP. Moreover, you are likely to shoulder a substantial amount to cover the expenses of the filing process. You may need to get legal counsel so you can prevent any significant penalties from incomplete or delayed filing.

The penalty for late filing

Filing Form 3520 in the relevant year is a must to avoid penalties. There will be consequences for late and incorrect or incomplete filing. The initial penalty is equal to the greater of $10,000 or:

1. 35% of the gross value of any property transferred to a foreign trust. It applies if the U.S. transferor failed to report the reportable event (Part I of the form).
2. 5% of the gross value of the portion of the foreign trust’s assets treated as owned by a U.S. person under grantor trust rules. It applies if the U.S. person failed to report the U.S. owner information (Part II of the form).
3. 35% of the gross value of the distributions received from a foreign trust. It applies if the U.S. person failed to report receipt of the distribution (Part III of the form).

Notes to remember:

• The grantor trust pertains to any trust created by an individual who owns the assets for income and estate tax. Grantor trust rules are vital in understanding the tax implications of a grantor trust.
• The gross value is the gross amount of the property at the date it was received.

Is there a way to abate a penalty?

If in case you missed the due date for filing the Form 3520, abatement of the penalty is still possible. That is if the reason for the late filing is valid, and it is not because of willful neglect. You can demonstrate and disclose the reasons to IRS, following the legal standard for it.

Filing IRS Form 3520 and following its instructions can be complicated, especially to taxpayers that have little knowledge about U.S. taxes. There are indeed a lot of technical terms that are difficult to comprehend. We highly encourage those dealing with this event to get a legal counsel or tax advisor. In that way, you can be sure that you will not have any complications in the future.