The IRS continues to aggressively enforce certain foreign information return obligations. In many cases, these enforcement efforts are automatic—that is, the agency simply imposes the applicable penalty after receipt of the late-filed return. The IRS Form 3520 penalty related to foreign gifts and inheritances falls within this category. Because the agency may impose a penalty in these circumstances up to 25% of the amount of the reported gift or bequest, taxpayers need to be mindful of the reporting obligation and, for those unlucky few who were assessed penalties, knowledgeable of the methods in which to fight it.
Section 6039F
Section 6039F of the Code provides the requirements for U.S. persons to file information returns if they receive a foreign gift or inheritance from a foreign person (i.e., a nonresident alien, foreign estate, or a foreign entity). If a foreign individual made the gift or a foreign estate distributes the inheritance, the reporting obligation only applies to the extent the aggregate amounts received by the U.S. person exceeds $100,000 in the tax year. Smaller thresholds apply for gifts from foreign entities.
If a U.S. person does not qualify for an exception to the IRS Form 3520 filing requirement and files late, the IRS may impose civil penalties equal to 5% of the amount of the foreign gift or inheritance for each month the form is not filed up to a maximum of 25%.
IRS CP15 Notice
Titled a "Notice of Penalty Charge," the CP15 Notice notifies the taxpayer of the assessed penalty and its amount. It also instructs the taxpayer that it may make full payment of the assessed penalty if it agrees with the assessment. Conversely, if the taxpayer disagrees with the penalty, the notice advises the taxpayer of its right to file an administrative appeal within 30 days of the notice. Although the taxpayer can also disagree and challenge the penalty determination in litigation, the taxpayer must first pay the full amount of the penalty in order for the court to have jurisdiction over the dispute.
In most cases, it makes sense to file a timely administrative appeal. Indeed, in some cases, the administrative appeal route may be the taxpayer's only option, particularly if full payment can't be made. After the taxpayer makes the written appeal, the agency forwards the taxpayer's case to the IRS Independent Office of Appeals (IRS Appeals).
IRS Appeals
IRS Appeals is a quasi-independent branch of the IRS. Its goal is to resolve disputes without litigation in a manner that is fair and impartial to both the taxpayer and the agency.
When an IRS Appeals officer is assigned to the taxpayer's case, the officer usually reviews the taxpayer's written submission, including the reasons asserted for the late filing. Thereafter, the appeals officer generally follows up with the taxpayer (or the taxpayer's representative) to discuss the issues and whether the taxpayer meets the legal requirements for penalty relief (e.g., reasonable cause). At this stage, it is not unusual for the appeals officer to ask tough questions, particularly where the written submission leaves out significant details or where the taxpayer has a history of non-compliance. After the discussion, the appeals officer generally permits the taxpayer an opportunity to provide more details and any other authority the taxpayer may have for the penalty abatement prior to closing the case.
At its conclusion, the appeals officer will make a determination on whether to grant penalty relief or not. In determining whether a settlement should be made, the appeals officer analyzes the "hazards of litigation"—that is, the officer's determination on the agency's chances to succeed on the merits in litigation if the case were ultimately to make it that far.
Common Questions
Understandably, taxpayers who receive an IRS CP15 Notice often have questions. And there are two more common ones. First, many taxpayers question whether they can disregard the notice and wait to contest the penalty determination through a Collection Due Process (CDP) hearing. Second, and more predictably, they question their chances of success if they make an appeal.
As a general matter, there are benefits in most other tax controversies to waiting for a CDP hearing. The primary benefit is that any determinations made by IRS Appeals are subject to judicial review in the U.S. Tax Court. Unfortunately, this rule usually does not apply when a taxpayer receives an IRS CP15 Notice.
Under the CDP statutes, taxpayers are precluded from challenging the existence or amount of an underlying liability in a CDP hearing if they had a prior opportunity to do so. The CDP regulations clarify here that taxpayers may not challenge the existence or amount of the underlying liability if the taxpayer had "a prior opportunity for a conference with Appeals that was offered either before or after the assessment of the liability." An exception to this rule applies to underlying liabilities subject to deficiency procedures. However, because the IRS Form 3520 civil penalties are not subject to these procedures, the exception does not apply. Accordingly, the receipt of an IRS CP15 Notice—which provides an opportunity for an IRS Appeals hearing—can bar a taxpayer from challenging that same penalty in a subsequent CDP hearing, even if the taxpayer fails to exercise the appeal right.
A much more difficult inquiry relates to the taxpayer's chances of success if they appeal the penalty assessment. Understandably, taxpayers with great facts and good reasonable cause defenses have the best likelihoods of success. On the other hand, taxpayers who raise defenses that fail as a matter of law have the least likelihoods of success (e.g., reliance on a third party to file an IRS Form 3520 where the taxpayer was aware of the filing obligation prior to the filing deadline). Moreover, and much to the surprise of many taxpayers and even some tax professionals, the agency does not grant first-time penalty abatement relief with respect to failures to file IRS Forms 3520.
Summary
Taxpayers who file a late IRS Form 3520 for the receipt of a foreign gift or inheritance almost always receive an IRS Notice CP15, notifying them of the agency's penalty assessment. Because they only have 30 days from the date of the notice to request an administrative appeal of the penalty determination, these taxpayers must act quickly or lose those rights.
Originally published by Forbes.
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