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DOJ Argues Against Penalty Decision in Foreign Trust Case

JUN. 29, 2020

Emily S. Wilson et al. v. United States

DATED JUN. 29, 2020
DOCUMENT ATTRIBUTES

Emily S. Wilson et al. v. United States

[Editor's Note:

To view the brief, including attachments, see the PDF version.

]

EMILY S. WILSON, AS EXECUTRIX OF THE ESTATE OF JOSEPH A. WILSON,
THE ESTATE OF JOSEPH A. WILSON,
Plaintiffs-Appellees
v.
UNITED STATES,
Defendant-Appellant

IN THE UNITED STATES COURT OF APPEALS
FOR THE SECOND CIRCUIT

ON APPEAL FROM THE JUDGMENT OF THE UNITED STATES
DISTRICT COURT FOR THE EASTERN DISTRICT OF NEW YORK

BRIEF FOR THE APPELLANT

RICHARD E. ZUCKERMAN
Principal Deputy Assistant Attorney General

JOSHUA WU
Deputy Assistant Attorney General

ELLEN PAGE DELSOLE (202) 514-8128
ELISSA HART-MAHAN(202) 305-7397
Attorneys
Tax Division
Department of Justice
Post Office Box 502
Washington, D.C. 20044

Of Counsel:
RICHARD P. DONOGHUE
United States Attorney


TABLE OF CONTENTS

Table of contents

Table of authorities

Glossary

Statement of jurisdiction

Statement of the issue

Statement of the case

A. Procedural overview

B. Introduction to the relevant statutory scheme

C. Statement of facts

D. The District Court proceedings

1. The parties' motions in District Court

2. The District Court's opinion

Summary of argument

Argument:

The District Court erred in holding that taxpayer could not be subject to a penalty for his failure to report the $9.2 million distribution he received from his foreign trust in 2007

Standard of review

A. The plain text of the statutes requires the imposition of a penalty for taxpayer's failure to report the 2007 distribution

B. The history and purpose of the statutes at issue demonstrate that separate penalties apply to each violation of § 6048's reporting requirements

C. The District Court erred in holding, as a matter of law, that taxpayer was not liable for a penalty for his failure to report his receipt of the 2007 distribution

1. Section 6677 does not provide that only one penalty can apply when a taxpayer violates multiple reporting requirements

2.The District Court misinterpreted § 6677(a)

3. The District Court's analysis of the required forms was erroneous

D. A beneficiary's duty to report a distribution from a foreign trust does not depend on the tax consequences of the distribution

1. Section 6048(c)(1) does not require that the distribution at issue be a taxable event

2. Section 6048(c)(2) did not excuse taxpayer's failure to report the distribution he received in 2007

Conclusion

TABLE OF AUTHORITIES

Cases:

Adler v. Commissioner, 330 F.2d 91 (9th Cir. 1964)

Barnhart v. Sigmon Coal Co., 534 U.S. 438 (2002)

California Bankers Ass'n v. Shultz, 416 U.S. 21 (1974)

Commissioner v. Acker, 361 U.S. 87 (1959)

Connecticut Nat'l Bank v. Germain, 503 U.S. 249 (1992)

Filler v. Commissioner, 74 T.C. 406 (1980)31

Gilman v. Commissioner, 933 F.2d 143 (2d Cir. 1991)

Gould v. Gould, 245 U.S. 151 (1917)

Gudmundsson v. United States, 634 F.3d 212 (2d Cir. 2011)

Hibbs v. Winn, 542 U.S. 88 (2004)

Johnson v. Commissioner, 620 F.2d 153 (7th Cir. 1980)

Kidd v. Thomson Reuters Corp., 925 F.3d 99 (2d Cir. 2019)23

Kingdomware Techs., Inc. v. United States, 136 S. Ct. 1969 (2016)

Life Techs. Corp. v. Promega Corp., 137 S. Ct. 734 (2017)

Montgomery v. Commissioner, 127 T.C. 43 (2006)

New York v. Mountain Tobacco Co., 942 F.3d 536 (2d Cir. 2019)

Pavelic & LeFlore v. Marvel Entm't Grp., 4793 U.S. 120 (1989)

Robinson v. Shell Oil Co., 519 U.S. 337 (1997)

Rowland v. California Men's Colony, Unit II Men's Advisory Council, 506 U.S. 194 (1993)

Fid. Int'l Currency Advisor A Fund, LLC ex rel. Tax Matters Partner v. United States, 661 F.3d 667 (1st Cir. 2011)

Trusted Media Brands, Inc. v. United States, 899 F.3d 175 (2d Cir. 2018)

United States v. Bisceglia, 420 U.S. 141 (1975)

United States v. Corley, 556 U.S. 303 (2009)

United States v. Dauray, 215 F.3d 257 (2d Cir. 2000)

United States v. Menasche, 348 U.S. 528 (1955)

United States v. Rutherford, 442 U.S. 544 (1979)

In re Wyly, 552 B.R. 338 (Bankr. N.D. Tex. 2016)

Statutes:

Internal Revenue Code (26 U.S.C.):

§ 1

§ 61(a)(4)

§ 63(a)

§§ 671-679

§ 671

§ 674

§§ 677-679

§ 6038

§ 6038A

§ 6038B

§ 6038C

§ 6039F

§ 6039F(c)

§ 6046

§ 6046A

§ 6048

§ 6048(a)

§ 6048(a)(3)

§ 6048(a)(4)

§ 6048(b)

§ 6048(b)(1)

§ 6048(c)

§ 6048(c)(1)

§ 6048(c)(2)

§ 6048(c)(2)(A)

§ 6048(d)(1)

§ 6048(d)(4)

§ 6511

§ 6651

§ 6651(a)(2)

§ 6662

§ 6662A

§ 6662A(e)(2)(A)

§ 6662(b)

§ 6663

§ 6667

§ 6677

§ 6677(a)

§ 6677(b)

§ 6677(b)(2)

§ 6677(c)

§ 6677(c)(2)

§ 6677(c)(3)

§ 6677(d)

§ 6679

§ 7422

§ 7701(a)(30)(A)

28 U.S.C.:

§ 1291

§ 1346

31 U.S.C.:

§ 5314

§ 5321

Hiring Incentives to Restore Employment Act, P.L. 111-147, March 18, 2010, 124 Stat. 71

Revenue Act of 1962, Pub. L. No. 87-834, § 7, 76 Stat. 960, 985, 988

Small Business Job Protection Act of 1996, Pub. L. No. 104-188, § 1901, 110 Stat 1755

Tax Reform Act of 1976, Pub. L. No. 94-455, sec. 1013, § 6048, 90 Stat. 1520

Fed. R. App. P. 4(a)(1)(B)(i)

IRS Notice 97-34, 1997-1 C.B. 422

Norman J. Singer, Statutes and Statutory Construction § 46.06 (6th rev. ed. 2000)

Joint Committee on Taxation, General Explanation of Tax Legislation Enacted in the 104th Congress (Dec. 18, 1996)

GLOSSARY

Acronym

Definition

The Estate

The Estate of Joseph Wilson

I.R.C.

Internal Revenue Code (26 U.S.C.)

IRS

Internal Revenue Service

U.S.

United States

Taxpayer

Joseph Wilson

The Trust

The Perfect Partner Trust


STATEMENT OF JURISDICTION

In 2015, the IRS determined that Joseph Wilson (“taxpayer”) owed a penalty under Internal Revenue Code (“I.R.C.”) § 6677(a) (26 U.S.C.) for his failure to report a $9.2 million distribution he received from his foreign trust in 2007.1 (JA155.) The IRS assessed a penalty against taxpayer in the amount of $3,221,183, and assessed underpayment interest of $268,652. (JA9.) Taxpayer paid the assessments in full, and filed a timely administrative refund claim. (JA10, JA23-92); I.R.C. §6511. Taxpayer died while his refund claim was pending with the IRS. (JA7, JA10.) When six months had passed without the IRS acting on his refund claim, taxpayer's estate (“the estate”) timely filed this refund suit. (JA6-22.) The District Court had jurisdiction under I.R.C. §7422 and 28 U.S.C. § 1346.

The District Court (Judge Brian M. Cogan) granted partial summary judgment to the estate, holding that taxpayer's failure to report the 2007 distribution he received from his trust was not subject to the penalty described in I.R.C. § 6677(a). (JA181-87.) After the parties stipulated to certain facts (JA188-91), the District Court entered judgment for the estate (JA192). That order was a final, appealable order that disposed of all claims of all parties. On February 14, 2020, the Government timely filed its notice of appeal to this Court. (JA193); Fed. R. App. P. 4(a)(1)(B)(i). This Court has jurisdiction under 28 U.S.C. § 1291.

STATEMENT OF THE ISSUE

Section 6048 of the Internal Revenue Code imposes three distinct reporting requirements relating to U.S. persons' transactions with foreign trusts: (a) one for a U.S. person's transfer of property to a foreign trust, (b) one requiring a U.S. owner to ensure filing of an annual trust return reporting the trust's activities, and (c) one for a U.S. person's receipt of distributions from the trust. I.R.C. § 6048(a), (b), (c). Section 6677 imposes a penalty for any failure to comply with any of § 6048's three distinct reporting requirements. A taxpayer who fails to file a return reporting a transfer to a trust or a distribution from a trust is subject to a penalty equal to 35 percent of the transfer or distribution at issue. I.R.C. § 6677(a), (c). An owner who fails to ensure that his foreign trust meets annual reporting requirements is subject to a penalty equal to 5 percent of the trust's assets at the close of the year. I.R.C. § 6677(b), (c).

Here, taxpayer was the sole owner and sole beneficiary of a foreign trust. In 2007, he liquidated the trust and distributed the trust's assets to himself. Taxpayer did not ensure that the foreign trust timely filed an annual return for 2007, nor did taxpayer timely file a return reporting his receipt of the distribution.

Did the District Court err in holding that taxpayer could not be liable for the 35-percent penalty that applies to a beneficiary who fails to report receipt of a distribution from a foreign trust, but instead was only liable for the 5-percent penalty that applies to owners of foreign trusts who fail to ensure the filing of an annual return, which here was zero because the value of the assets of the trust at the end of the year was zero?

STATEMENT OF THE CASE

A. Procedural overview

Taxpayer's estate brought this refund suit seeking the refund of a $3.2 million penalty that was assessed as a result of taxpayer's failure to timely report a $9.2 million distribution that he received from his foreign trust in 2007, as I.R.C. § 6048(c) requires. (JA6-22.) In addition to failing to report this distribution, taxpayer also failed to ensure that the trust timely filed the required 2007 annual return reporting the trust's activities, as I.R.C. § 6048(b) requires. (JA8, JA150, JA155, JA159.) The estate argued below that taxpayer was only liable for the penalty applicable to a trust owner's failure to ensure the filing of the annual return, which was equal to 5 percent of the trust's assets at the end of the year, and that he could not also be liable for the penalty for failure to report receipt of a distribution from the trust, which was equal to 35 percent of the distribution at issue. (Doc. 17 at 8-26.) The Government argued that distinct reporting requirements apply to owners and beneficiaries of foreign trusts, and each failure was subject to a separate penalty under the statute, so that, in addition to the 5-percent penalty that applied to owners, taxpayer was also liable for the 35-percent penalty that applied to a failure to report a distribution, because he had not reported the Trust's distribution to himself. (Doc. 20 at 12-24.)

The District Court granted partial summary judgment to the estate, holding as a matter of law that taxpayer could not be liable for the 35-percent penalty for failing to report receipt of the distribution. (JA181-87.) Instead, the District Court held that taxpayer could only be liable for the 5-percent penalty for failure to file the trust's annual return. (Id.) Because taxpayer liquidated the trust in 2007, the trust  had no assets at the end of the year. (JA188-89.) Accordingly, application of the 5-percent penalty to the year-end balance of zero meant the penalty for taxpayer's failure to ensure the trust filed its annual return was zero. The District Court thus ordered a full refund of the penalty and statutory interest. (JA192.)

The United States now appeals from the District Court's determination that taxpayer could not be liable for the penalty that applies to the failure to report a distribution from a foreign trust. Reversal of this determination would require a remand for further proceedings to determine whether the estate nonetheless can avoid the penalty by showing that taxpayer had reasonable cause for his failure to report the $9.2 million distribution that he received in 2007.

B. Introduction to the relevant statutory scheme

Section 60482 of the Internal Revenue Code imposes three separate reporting requirements with respect to dealings of U.S. persons with foreign trusts. Section 6048(a) requires reporting the creation of and transfers to a foreign trust. Section 6048(b) requires the U.S. owner of a foreign trust to ensure that the trust files an annual return reporting its activities and operations for the year. And Section 6048(c) requires that “any United States person” receiving a distribution from a foreign trust must file a return reporting the name of the trust and the aggregate amount of distributions received from the trust in that year. I.R.C. § 6048(c)(1). Absent action by the Secretary to modify or suspend the statute's requirements (see I.R.C. § 6048(d)(4), which has not occurred), the statute provides no exceptions to these mandatory reporting requirements.3

During 2007, the year at issue, the IRS prescribed two different forms for the reporting required by § 6048(a), (b) and (c). A return reporting a transfer to a trust — required by § 6048(a) — was to be made on Part I of Form 3520. IRS Notice 97-34, 1997-1 C.B. 422, § III; (JA113-14). The trust's annual return — required by § 6048(b) — was to be made on Form 3520-A. See IRS Notice 97-34, 1997-1 C.B. 422, §IV; (JA128-32). A return reporting receipt of a distribution — required by § 6048(c) — was to be made on Part III of Form 3520. See IRS Notice 97-34, 1997-1 C.B. 422, § V (JA114-17).

For each failure to comply with I.R.C. § 6408's reporting requirements, I.R.C. § 6677 subjects the taxpayer to a distinct penalty. Section 6677(a), as in effect in 2007, provided that, in addition to any criminal penalty provided by law, any taxpayer who failed to timely file accurate returns as required by § 6048 “shall pay a penalty equal to 35 percent of the gross reportable amount.” I.R.C. § 6677(a).4 Section 6677(b) adds a special rule for trust owners who fail to ensure the filing of the annual trust return required under § 6048(b), making the U.S. owner liable for 5 percent (rather than 35 percent) of the “gross reportable amount.” Section 6677(c) defines the “[g]ross reportable amount” that is used for computing the applicable § 6677 penalty, but the statute provides three different definitions of the “gross reportable amount” — one for each of the three distinct reporting obligations under

§6048. As relevant here, if a U.S. person fails to report their receipt of a distribution as § 6048(c) requires, the “gross reportable amount” means the gross value of the distribution. I.R.C. § 6677(c)(3). If the trust's U.S. owner fails to ensure the trust meets it reporting obligations under § 6048(b), the “gross reportable amount” means “the gross value of the portion of the trust's assets at the close of the year treated as owned by the United States person.” I.R.C. § 6677(c)(2). Section 6677(d) provides an exception, under which no penalty shall be imposed if the taxpayer shows the failure to file a return was due to reasonable cause.

C. Statement of facts

Taxpayer was a citizen and resident of the United States. (JA154.) In 2003, taxpayer created a foreign trust called the Perfect Partner Trust (“the Trust”) in anticipation of a divorce dispute, and he transferred approximately $9 million to the Trust. (JA7.) Taxpayer was both the owner and the sole beneficiary of the Trust. (JA188.) As owner of the Trust, taxpayer was responsible for ensuring that the Trust filed the annual returns required by I.R.C. § 6048(b); he was also required to report the Trust's income on his individual income tax returns. (JA8, JA150.) For the 2005, 2006, and 2007 tax years, taxpayer failed to ensure that the Trust filed the required annual returns (Form 3520-A), and he failed to report the Trust's income on his individual returns.5 (JA8, JA150, JA155, JA159.)

In 2007, taxpayer liquidated the Trust and distributed the Trust's $9.2 million in assets to himself. (JA8, JA155.) Taxpayer did not timely file a Form 3520 reporting that distribution, nor did he file any other return with the IRS reporting that distribution. (JA155, JA159.) Only after the IRS opened an examination of taxpayer's income tax liabilities for 2007 did taxpayer belatedly file amended federal income tax returns reporting income from the Trust, as well as untimely Forms 3520 and 3520-A. (JA8, JA159.) The IRS assessed a penalty of $3,221,183, equal to 35 percent of the $9,203,381 distribution, because of taxpayer's failure to timely file a return reporting the distribution.6 (JA155, JA160.)

In 2017, taxpayer paid the assessed penalty, along with statutory interest. (JA189.) Two years later, taxpayer filed an administrative claim for refund with the IRS.7 (JA23-92.) In his refund claim, taxpayer asserted that, pursuant to I.R.C. § 6677(b), only a 5-percent penalty should apply. (JA25-29, JA155.) In computing that penalty, taxpayer argued that the 5-percent penalty applied to the amount that was distributed to him in 2007 — not to the Trust's year-end balance. (Id.); see I.R.C. § 6677(c). Taxpayer also argued that he was entitled to a refund because his failure to report the distribution was due to reasonable cause. (JA42-43.)

D. The District Court proceedings

1. The parties' motions in District Court

The complaint in this case continued to assert that taxpayer was subject only to a 5-percent penalty on the amount of the 2007 distribution as the owner of the account and that taxpayer was not subject to the 35-percent penalty for failing to report the 2007 distribution. (JA11-13.) The estate also contended that taxpayer was entitled to a refund because § 6677(d)'s reasonable cause exception applied. (JA20.)

The Government moved to dismiss the estate's claim that only a 5-percent penalty could apply, on the ground that taxpayer's administrative refund claim was inadequate to support the claims now made in the complaint, because taxpayer's administrative claim did not include a penalty computation under the proffered 5-percent theory, leaving it unclear to what amount the 5 percent should be applied. (Doc. 11.) The Government noted that, while the refund claim appeared to take the position that taxpayer was liable for 5 percent of the 2007 distribution, the penalty applicable to the owner of a foreign trust is 5 percent of the trust's assets at the close of the year in question. (Id.); I.R.C. §§ 6048(b), 6677(a), (b)(2), (c)(2).

During the hearing on the Government's motion to dismiss, counsel for the estate admitted that they had misread § 6677 and had failed to recognize that the penalty applicable to a failure to comply with § 6048(b) was 5 percent of the year-end account balance, which in this case was zero. (JA201-03.) The estate argued, however, that taxpayer's refund claim adequately stated the facts and legal theories supporting his claim. (JA203; Doc. 15.)

While the Government's partial motion to dismiss was pending, the estate moved for partial summary judgment on its argument that taxpayer could only be liable for the 5-percent penalty that applies to a foreign trust owner's failure to ensure the timely filing of the trust's annual return. (Doc. 17.) In support of its motion, the estate argued that the statutory framework suggested that only a 5-percent penalty applied to taxpayer, and that the legislative history, the statutory provisions relating to grantor trusts, and the instructions for Forms 3520 and 3520-A all supported the estate's position. (Doc. 17 at 8-16, 20-26.) The estate further contended that any ambiguity in the statute should be construed against the Government. (Id. at 16-20).

In its opposition to the estate's motion, the Government argued that the plain text of the statute made clear that taxpayer was liable for the 35-percent penalty applicable to a failure to report the receipt of a distribution from a foreign trust. (Doc. 20 at 12-19.) The Government further argued that the estate misconstrued the legislative history; that the grantor trust rules, which the estate contended supported its reading of the statute, are irrelevant to the statutes at issue here; and that the instructions to Forms 3520 and 3520-A did not excuse taxpayer's failure to report the $9.2 million distribution that he received in 2007. (Id. at 19-24.) The Government argued that the estate's motion for partial summary judgment should be denied, and contended in the alternative that, if the Government's pending motion to dismiss were not granted, the District Court should grant partial summary judgment to the Government by holding that taxpayer was subject to a 35-percent penalty on the amount distributed, absent the estate showing in further proceedings that taxpayer had reasonable cause for failing to report the distribution. (Id. at 24-25.)

2. The District Court's opinion

The District Court denied the Government's partial motion to dismiss and its alternative request for partial summary judgment and granted the estate's motion for partial summary judgment. (JA174-87.) In denying the Government's motion to dismiss, the District Court reasoned that taxpayer's administrative refund claim adequately apprised the IRS of taxpayer's claim that only a 5-percent penalty could apply.8 (JA177-81.)

The District Court went on to grant partial summary judgment to the estate. It held (1) that taxpayer was subject only to a 5-percent penalty for failing to timely file a Form 3520 under §§ 6048 and 6677 and (2) that the 5-percent penalty should be assessed against the Trust's account balance at the close of 2007, which was zero. (JA181-87.)

The court first observed that the Government did not disagree that taxpayer could be liable for a 5-percent penalty for failure to comply with § 6048(b). (JA182-83.) The court rejected the Government's argument that taxpayer also could be independently subject to a penalty as a beneficiary for untimely filing of Form 3520 as required under § 6048(c). (JA183-85.)

The court opined that § 6048(b) applies to the “'United States Owner of [a] Foreign Trust,'” whereas § 6048(c) applies to “'United States Beneficiaries of Foreign Trusts.'” (JA183 (quoting § 6048's subparagraph headings).) The court further looked to § 6677(a)'s language imposing a 35-percent penalty on any person who failed to timely file a return required by § 6048 and to § 6677(b)(2), which substitutes 5 percent for 35 percent in the case of returns required to be filed by the owner of a foreign trust. (JA184.) In the court's view, these provisions meant that “a person in [taxpayer's] situation — i.e., a sole grantor/owner and sole beneficiary of a foreign trust — would have only been required to a file a single Form 3520 for fiscal year 2007.”9 (Id.) In the court's view, § 6677 did not “permit[ ] a single person untimely filing a single IRS form to be penalized as two different people — as an owner and as a beneficiary.” (Id.)

The court relied on two aspects of § 6677 to support its conclusion that a trust owner could not be penalized as a beneficiary. First, the court interpreted § 6677(b)(2)'s language regarding the substitution of a 5-percent penalty for the 35-percent penalty as meaning that, where a trust owner fails to satisfy § 6048(b) so that 5 percent is substituted for 35 percent, then the 5-percent penalty is the only penalty that can apply. (JA184-85.) The court further opined that, even if it were not limited to 5 percent in that circumstance, any doubt in construing statutes levying taxes should be construed against the Government. (JA185 (citing Gould v. Gould, 245 U.S. 151, 153 (1917).)

The court also concluded that the Government's reading conflicted with § 6677(a)'s provision in flush language that additional penalties shall apply if the reporting failure continues for more than 90 days after the IRS notifies the taxpayer of the failure, but that the IRS must ensure that the aggregate penalties under § 6677 “'do not exceed the gross reportable amount.'”10 (JA185 (quoting I.R.C. § 6677(a)).) While noting that this provision “is primarily concerned with subsequent late fees” that accrue after the IRS notifies a taxpayer of a reporting violation, the court interpreted this language as providing that “a taxpayer should not be liable for any two penalties if their combined assessment would add up to more than the gross reportable amount for any one violation.” (JA185.) In the court's view, this provision supported the conclusion that the maximum penalty here was zero, because the gross reportable amount applicable to taxpayer's violation of § 6048(b) was zero. The court found further support for its interpretation of § 6677 in the instructions to Form 3520, which it read as implying that a foreign trust owner who receives distributions from his own trust need not report those distributions. (JA186.)

The District Court therefore concluded that taxpayer was only subject to the 5-percent penalty applicable to foreign trust owners, and that here, because the trust's assets at the end of the year were zero, the applicable penalty was also zero. (JA186-87, JA192.)

SUMMARY OF ARGUMENT

The plain text of I.R.C. §§ 6048 and 6677 establishes that separate penalties apply for each violation of the foreign trust reporting requirements. Because taxpayer violated two of § 6048's reporting requirements for the 2007 tax year, he was subject to two separate penalties under § 6677, and the District Court erred in holding as a matter of law that he could not be liable for the penalty applicable to the failure to report a distribution.

Section 6048 requires that U.S. grantors file returns reporting all transfers to foreign trusts, § 6048(a), that U.S. owners ensure that the foreign trust files an annual return reporting the trust's activities, §6048(b), and that U.S. persons who receive a distribution from a foreign trust file a return reporting that distribution, § 6048(c). In 2007, because taxpayer owned the Trust and received a distribution from the Trust, he was required to ensure that the Trust filed an annual return under § 6048(b) and to file a return reporting his receipt of the $9.2 million distribution under § 6048(c).

Section 6677 provides for separate penalties for each violation of §6048: (1) grantors must pay 35 percent of the amount transferred to the trust, (2) owners must pay 5 percent of the trust's assets at the end of the year, and (3) beneficiaries must pay 35 percent of the distribution they received. I.R.C. § 6677. Here, taxpayer both owned the Trust and received a distribution from the Trust, and he failed to comply with the distinct reporting requirements that the statute imposed on him in each of these two roles. Because of his failure to meet these two separate reporting requirements, taxpayer was, under the plain terms of the statute, liable for two distinct penalties: taxpayer was liable (1) as an owner for a penalty in the amount of 5 percent of the trust's assets at the end of the year — which happens to be zero here — and (2) as a recipient of a distribution for a penalty in the amount of 35 percent of the $9.2 million distribution — which is $3.2 million.

The history and purpose of the statutes at issue are consistent with the application of separate penalties. The foreign trust reporting requirements are part of a broader scheme to ensure that U.S. taxpayers report their foreign assets and interests, and Congress expanded the foreign trust reporting requirements and increased the applicable penalties due to concerns that U.S. taxpayers were using foreign trusts to avoid their tax responsibilities.

The District Court erred in holding as a matter of law that the 5-percent penalty was the only penalty that could apply here. The statutory text provides for separate penalties for each violation of the §6048 reporting requirements. Contrary to the District Court's interpretation of § 6677, nothing in the statutory text suggests that an owner cannot also be liable for penalties for violating § 6048(a) or (c). The District Court's reading of the statute improperly nullifies the requirements that taxpayers report transfers to or distributions from a foreign trust and eliminates the penalties for those violations in any case in which the taxpayer also failed to ensure the filing of the annual trust return. The District Court's decision also leads to the absurd result that a U.S. owner of a foreign trust who violates multiple reporting requirements may owe less in penalties than a taxpayer who violates a single reporting requirement. In addition, the District Court erred in finding that the instructions to Form 3520 excused taxpayer's failure to report receipt of the $9.2 million distribution.

The estate's anticipated argument that taxpayer was exempt from reporting the distribution because the distribution was not taxable to him — which the estate asserted below but the District Court did not reach — is not a reason to affirm. This argument fails because the text of the statute does not create such an exception, and because the § 6677 penalties are not conditioned on the occurrence of a taxable event. Rather, the penalties are designed to enforce the § 6048 reporting requirements.

ARGUMENT
The District Court erred in holding that taxpayer could not be subject to a penalty for his failure to report the $9.2 million distribution he received from his foreign trust in 2007

Standard of review

This Court reviews a district court's grant of summary judgment de novo. Gudmundsson v. United States, 634 F.3d 212, 216 (2d Cir. 2011). Similarly, this Court reviews questions of statutory interpretation de novo. See Trusted Media Brands, Inc. v. United States, 899 F.3d 175, 179 (2d Cir. 2018).

A. The plain text of the statutes requires the imposition of a penalty for taxpayer's failure to report the 2007 distribution

This Court's interpretation of a statute must begin with the statutory text. See Kidd v. Thomson Reuters Corp., 925 F.3d 99, 103 (2d Cir. 2019) (quoting Life Techs. Corp. v. Promega Corp., 137 S. Ct. 734, 741 (2017)). “If the statutory language is unambiguous and the statutory scheme is coherent and consistent,” the inquiry is at an end. Kingdomware Techs., Inc. v. United States, 136 S. Ct. 1969, 1976 (2016) (quoting Barnhart v. Sigmon Coal Co., 534 U.S. 438, 450 (2002) (internal quotation marks omitted)).

Whether the statutory text is plain or ambiguous “is determined by reference to the language itself, the specific context in which that language is used, and the broader context of the statute as a whole.” Robinson v. Shell Oil Co., 519 U.S. 337, 341 (1997). In making this determination, “courts must presume that a legislature says in a statute what it means and means in a statute what it says there.” Connecticut Nat'l Bank v. Germain, 503 U.S. 249, 253-54 (1992).

This Court's task is to give effect to every word, phrase and clause in a statute, United States v. Menasche, 348 U.S. 528, 538 (1955), and not to treat any part of it as inoperative, void or superfluous, United States v. Corley, 556 U.S. 303, 314 (2009). As the Supreme Court has cautioned, the Court's “task is to apply the text, not to improve upon it.” Pavelic & LeFlore v. Marvel Entm't Grp., 4793 U.S. 120, 126 (1989).

The plain text of §§ 6048 and 6677 subjected taxpayer to the 35-percent penalty for failing to report his receipt of the $9.2 million distribution. Section 6048 imposes three distinct reporting requirements, and § 6677 imposes a separate penalty for each failure to comply with those reporting requirements. Thus, taxpayer's failure to comply with two of § 6048's reporting requirements subjected him to two separate penalties under § 6677.

Beginning with the reporting requirements, § 6048(a) requires the filing of a return whenever a transfer is made to a foreign trust.11 Section 6048(b) imposes a reporting requirement on the U.S. owner of a foreign trust, requiring them to ensure that “such trust makes a return for such year which sets forth a full and complete accounting of all trust activities and operations for the year, the name of the United States agent for such trust, and such other information as the Secretary may prescribe.” I.R.C. § 6048(b)(1). Section 6048(c)(1) provides that “any United States person” who receives a distribution from a foreign trust “shall make a return with respect to such trust for such year which includes” (A) the name of the trust, (B) the aggregate amount of distributions received, and (C) “such other information as the Secretary may prescribe.” I.R.C. § 6048(c)(1). And § 6048(d)(1) provides that, in determining whether a U.S. person receives a distribution from a foreign trust, “the fact that a portion of such trust is treated as owned by another person . . . shall be disregarded.” I.R.C. § 6048(d)(1).

As a U.S. citizen and resident, taxpayer was a “United States person.” See 26 U.S.C. § 7701(a)(30)(A). Because taxpayer was the sole owner and the sole beneficiary of the Trust, § 6048 required taxpayer both to ensure that the Trust filed an annual return and to file a return reporting the $9.2 million distribution he received from the Trust in 2007. See I.R.C. § 6048(b), (c). Nothing in § 6048 indicates that § 6048(c) does not apply if the recipient of the distribution is also the owner of the trust. To the contrary, § 6048(c)(1) explicitly requires “any United States person” to file a return reporting “any distribution” from a foreign trust (emphasis added), and § 6048(d)(1) suggests that the ownership of the trust “shall be disregarded” when determining whether a distribution has occurred.

When a violation of § 6048 has occurred, a 35-percent penalty generally applies. The statute as in effect in 2007 provided in that regard:

(a) Civil penalty. — In addition to any criminal penalty provided by law, if any notice or return required to be filed by section 6048 —

(1) is not filed on or before the time provided in such section, or

(2) does not include all the information required pursuant to such section or includes incorrect information,

the person required to file such notice or return shall pay a penalty equal to 35 percent of the gross reportable amount.12

I.R.C. § 6677(a).

Section 6677(b) provides for a different penalty rate if the taxpayer failed to comply with the reporting requirement included in §6048(b): 

(b) Special rules for returns under section 6048(b).–In the case of a return required under section 6048(b) — 

(1) the United States person referred to in such section shall be liable for the penalty imposed by subsection (a), and

(2) subsection (a) shall be applied by substituting “5 percent” for “35 percent”. 

I.R.C. § 6677(b).

And § 6677(c) defines the “[g]ross reportable amount” that is used for computing the § 6677 penalty, but provides three different definitions that correspond to the three § 6048 reporting requirements: 

(c) For purposes of subsection (a), the term “gross reportable amount” means — 

(1) the gross value of the property involved in the event (determined as of the date of the event) in the case of a failure relating to section 6048(a),

(2) the gross value of the portion of the trust's assets at the close of the year treated as owned by the United States person in the case of a failure relating to section 6048(b)(1), and

(3) the gross amount of the distributions in the case of a failure relating to section 6048(c). 

I.R.C. § 6677(c).

Because taxpayer violated two of § 6048's distinct reporting requirements, he was liable for two separate penalties under § 6677. Taxpayer's failure to ensure that the Trust timely filed the annual return required by § 6048(b) subjected him to a penalty equal to 5 percent of the trust's assets at the end of 2007, which in this case is zero. Taxpayer's separate failure to file a return reporting the $9.2 million distribution that he received from the Trust in 2007 subjected him to a penalty equal to 35 percent of the distribution, and the IRS properly assessed a penalty of $3.2 million.

The statute provides for separate penalties for each violation of §6048's reporting requirements, and there is nothing in the statutory language to suggest that a taxpayer who is both an owner and a beneficiary of a foreign trust cannot be liable for the penalty that applies when a beneficiary fails to report a distribution. Section 6677 explicitly states that it applies to a failure to file “any notice or return required to be filed by 6048.” I.R.C. § 6677(a) (emphasis added). This wording, particularly when considered with § 6048's three distinct reporting requirements, indicates that each failure to report under the distinct sections of § 6048 gives rise to a separate penalty. That Congress provided different definitions of “gross reportable amount” in § 6677(c) — depending on the section of 6048 to which the failure to report relates — reinforces the conclusion that the separate subparagraphs of § 6048 impose separate reporting obligations subject to separate penalties.

There is limited authority interpreting I.R.C. § 6677, but the one case to address whether multiple violations of § 6048 can result in multiple penalties under § 6677 accords with the plain text of the statute. In In re Wyly, 552 B.R. 338 (Bankr. N.D. Tex. 2016), the taxpayers were owners of foreign trusts and had received payments from the foreign trust. Consistent with the text of the statute, the Wyly court interpreted § 6677 as imposing more than one penalty if the taxpayers had violated the reporting requirements of both § 6048(b) and § 6048(c). Id. at 552, 556-57. While the Wyly court ultimately found that the taxpayers had not violated § 6048(c), the court's analysis, in which it separately considered whether the debtors were subject to penalties for violating each of § 6048(b) and § 6048(c), makes clear that separate penalties apply to each violation of § 6048. Id.

And while the IRS has not promulgated regulations under either § 6048 or § 6677, the existing IRS guidance provides that a separate penalty applies to each violation of § 6048. See IRS Chief Counsel Advisory 201208028, available at 2012 WL 595486 (advising that separate penalties applied under § 6677(a) and (b) when taxpayer failed to timely file Forms 3520 and 3520-A).

B. The history and purpose of the statutes at issue demonstrate that separate penalties apply to each violation of § 6048's reporting requirements

While it is not necessary for this Court to look beyond the plain and unambiguous text of I.R.C. §§ 6048 and 6677, doing so lends additional support to the Government's position. These statutes are part of Congress's broader efforts to require taxpayers to report foreign transactions and assets, and Congress's amendments to the statutes demonstrate an intent to expand reporting requirements and to increase penalties for a failure to comply with those reporting requirements.

U.S. citizens and residents are generally required to pay federal income tax on “all income from whatever source derived,” I.R.C. §61(a)(4); see I.R.C. §§ 1, 63(a), including income from sources outside the United States. Filler v. Commissioner, 74 T.C. 406, 410 (1980). The United States relies on “a system of self-reporting,” United States v. Bisceglia, 420 U.S. 141, 145 (1975), but U.S. taxpayers do not always comply with their self-reporting obligations, especially with regard to foreign entities.

To address concerns about taxpayers using foreign entities and bank accounts to conceal their income and assets, Congress has enacted a number of provisions that require taxpayers to report their foreign interests and assets. See, e.g., California Bankers Ass'n v. Shultz, 416 U.S. 21, 27 (1974) (describing how the Bank Secrecy Act reflected Congress's concern about “a serious and widespread use of foreign financial institutions, located in jurisdictions with strict laws of secrecy as to bank activity, for the purpose of violating or evading domestic criminal, tax, and regulatory enactments”); “Tax Haven Banks and U.S. Tax Compliance,” S. Hrg. 110-614 at 1 (July 17 and 25, 2008) (“Each year, the U.S. Treasury loses up to $100 billion in tax revenues from offshore tax abuses.”) (statement of Senator Carl Levin).

These statutory provisions require U.S. taxpayers to report a variety of foreign interests, including interests in foreign business entities, I.R.C. §§ 6038, 6046, 6046A; foreign bank accounts, 31 U.S.C. §5314; and, as relevant here, interests in and transactions with foreign trusts, I.R.C. § 6048. A mosaic of penalties exists to encourage compliance with these reporting requirements. There are general accuracy-related and fraud penalties, I.R.C. §§ 6662, 6663; general failure-to-pay penalties, I.R.C. § 6651; failure-to-file penalties concerning foreign entities or transactions, e.g., I.R.C. §§ 6038, 6038A, 6038B, 6038C, 6046, 6046A, 6048, 6679; a non-tax penalty for failing to file a Report of Foreign Bank and Foreign Accounts, or “FBAR,” 31 U.S.C. §§ 5314, 5321, and the foreign trust penalties at issue in this case, I.R.C. § 6677.

Before 1996, Congress had required U.S. grantors to report transfers to foreign trusts and had required U.S. owners of foreign trusts to file annual trust returns. See Revenue Act of 1962, Pub. L. No. 87-834, § 7, 76 Stat. 960, 985, 988; Tax Reform Act of 1976, Pub. L. No. 94-455, sec. 1013, § 6048, 90 Stat. 1520. The penalties for failure to comply with the prior reporting requirements were 5 percent of the amount transferred to the trust (for grantors) or 5 percent of the value of the trust's account at year end, but total penalties were capped at $1,000. Id.

In 1996, Congress expanded reporting requirements to include U.S. beneficiaries of foreign trusts and increased the penalties applicable to violations of § 6048's reporting requirements. See Small Business Job Protection Act of 1996, Pub. L. No. 104-188, § 1901, 110 Stat 1755. The 1996 amendments modified Section 6048(c) to expressly provide that “any United States person” who receives a distribution from a foreign trust must file a return reporting that distribution. Id. Congress also amended Section 6667 to do away with the $1,000 cap on penalties and to provide that the penalty for the failure to file a return required by § 6048(a) or (c) was equal to 35 percent of either the amount transferred to the trust or the amount distributed to the U.S. recipient. I.R.C. § 6677(a), (c). The 1996 amendments retained the 5-percent penalty for trust owners who failed to ensure the filing of the annual trust return. I.R.C. § 6677(b).

Congress's choice to establish a new penalty for a beneficiary's failure to report a distribution demonstrates that the beneficiary's transactional reporting requirement in § 6048(c) is distinct from the owner's annual reporting requirement in § 6048(b): Congress maintained the penalty for an owner's failure to meet annual reporting requirements at the pre-existing 5 percent, while creating a new 35-percent penalty for a beneficiary's failure to report a distribution. See Small Business Job Protection Act of 1996, Pub. L. No. 104-188, § 1901, 110 Stat 1755.13

Congress expanded the foreign trust reporting requirements because it recognized that taxpayers' use of foreign trusts in tax haven jurisdictions facilitated “noncompliance” with tax requirements. (JA165); Joint Comm. on Taxation, General Explanation of Tax Legislation Enacted in the 104th Congress at 270 (Dec. 18, 1996). Congress further recognized that “prior-law civil penalties for failure to comply with the reporting requirements applicable to foreign trusts established by U.S. persons had proven to be ineffective.” Id. This expansion of reporting requirements and penalties was necessary because “some of the jurisdictions in which U.S. settlors established foreign trusts have strict secrecy laws” that “may effectively preclude the Treasury Department from obtaining information necessary to determine the tax liabilities of the U.S. grantors or U.S. beneficiaries with respect to items related to such foreign trusts.” Id.

Sections 6048 and 6677 form a key part of Congress's efforts to ensure that U.S. taxpayers are complying with their obligations to report their foreign interests. This purpose is reflected in the text of §6677, which imposes separate penalties for each violation of § 6048's reporting requirements, and which requires the application of the 35-percent penalty to taxpayer's failure to report his receipt of the $9.2 million distribution.14

C. The District Court erred in holding, as a matter of law, that taxpayer was not liable for a penalty for his failure to report his receipt of the 2007 distribution

As discussed above, the plain text of I.R.C. § 6677 provides for separate penalties for each violation of § 6048's foreign trust reporting requirements. The District Court nonetheless held that, despite the fact that taxpayer violated § 6048(c)'s requirement that a beneficiary report receipt of a distribution, taxpayer could only be liable for the penalty applicable to § 6048(b)'s requirement that an owner ensure the filing of an annual trust return. The District Court's decision to grant partial summary judgment to the estate on this ground was based on an erroneous reading of the applicable statutes and a misinterpretation of the instructions for Forms 3520 and 3520-A.

1. Section 6677 does not provide that only one penalty can apply when a taxpayer violates multiple reporting requirements

The District Court's decision here was based in part on the court's conclusion that § 6677(b) provided that a 5-percent penalty was the only penalty that could apply to the owner of a foreign trust. (JA184-85.) The court read § 6677(b)'s instruction to substitute 5 percent for 35 percent in cases involving a failure to comply with § 6048(b) as mandating that the 5-percent penalty was the only penalty that could apply here. But § 6677(b) makes clear that the substitution of 5 percent only applies to violations of § 6048(b), i.e. an owner's failure to ensure the filing of the annual foreign trust return. As discussed above, § 6048 imposes separate reporting requirements on grantors, owners, and beneficiaries, and § 6677(b) does not bar the application of a 35-percent penalty if a grantor or a beneficiary fails to report a transfer to or a distribution from a foreign trust in violation of § 6048(a) or (c). Nothing in § 6677(b)'s special rule substituting 5 percent for 35 percent “[i]n the case of a return required under section 6048(b),” suggests that the 35-percent penalty would not still apply if the same person, in the same year, also was responsible for filing a return under the separate requirements of § 6048(a) or (c), yet failed to do so.

The District Court effectively rewrote § 6677 to provide a penalty coordination rule, i.e. a provision that prohibits the application of multiple penalties in certain instances. But Congress knows how to include coordination rules in the penalty statutes and chose not to include one here. For example, I.R.C. § 6662, the underpayment penalty statute, specifically provides that the penalty “shall not apply to any portion of an underpayment on which a penalty is imposed under section 6663,” and, with some exceptions, “shall not apply to the portion of any underpayment which is attributable to a reportable transaction understatement on which a penalty is imposed under section 6662A.” I.R.C. § 6662(b) (flush language). Similarly, § 6662A(e)(2)(A) provides, “This section shall not apply to any portion of an understatement on which a penalty is imposed under section 6663.” Congress deliberately chose not to include such a provision in § 6677, and the District Court erred when it interpreted the statute as prohibiting the imposition of multiple penalties.

The District Court's interpretation of § 6677 is not only contrary to the text of the statute, it effectively nullifies subparagraphs (a) and (c) of § 6048 and the penalties associated with those provisions whenever reporting under § 6048(b) is also at issue. This approach violates the rule against superfluities, which directs that “'[a] statute should be construed so that effect is given to all its provisions,'” and “'no part will be inoperative or superfluous, void or insignificant.'” Hibbs v. Winn, 542 U.S. 88, 102 (2004) (quoting 2A Norman J. Singer, Statutes and Statutory Construction § 46.06, at 181, 186 (6th rev. ed. 2000)).

Here, under the District Court's view, the § 6677 penalties that apply to a failure to report under subparagraph § 6048(a) or (c) would have no application in any year in which the taxpayer also violates §6048(b), because then the only applicable penalty would be § 6677(b)'s 5-percent penalty for a failure to report under § 6048(b). Because the District Court's construction essentially eliminates § 6677(a)'s 35-percent penalties for failing to report under § 6048(a) or (c) — at least for any year where a penalty might apply to a U.S. owner for a violation of § 6048(b) — the court's construction improperly renders § 6677(a) largely superfluous, while making the reporting requirements in §6048(a) and (c) unenforceable against an owner who is subject to a penalty for a failure to report under § 6048(b). In addition, because owners are in fact frequently named beneficiaries under trust instruments, thereby causing the trusts to be treated as grantor trusts under the grantor trust rules, the statute's application would be significantly limited if it only applied to U.S. beneficiaries who are not also owners of the foreign trust. See, e.g., I.R.C. §§ 674, 677-679.

Moreover, the District Court's interpretation of § 6677 leads to an absurd result, thereby violating another principle of statutory construction. See, e.g., Rowland v. California Men's Colony, Unit II Men's Advisory Council, 506 U.S. 194, 200 (1993) (“[T]he common mandate of statutory construction [is] to avoid absurd results.”); New York v. Mountain Tobacco Co., 942 F.3d 536, 547 (2d Cir. 2019) (recognizing that “a statute should be interpreted in a way that avoids absurd results” (quoting United States v. Dauray, 215 F.3d 257, 264 (2d Cir. 2000))). Under the District Court's interpretation, a taxpayer who violates two or three of § 6048's reporting requirements could be subject to lower penalties than he would face if he only violated a single reporting requirement. Here, the fact that taxpayer violated both the owner and beneficiary reporting requirements resulted in a lower penalty than would have been the case if taxpayer solely violated the beneficiary reporting requirement.

According to the court, if someone other than taxpayer had owned the Trust, taxpayer would properly be subject to the $3.2 million penalty for failing to report his receipt of the $9.2 million distribution. But because taxpayer is both the owner and the beneficiary, the court's approach leads to a total penalty of zero. The District Court's interpretation of the statute means that a taxpayer will face no tax consequences if he fully liquidates a foreign trust and distributes it to himself without any reporting, because the year-end balance of the trust will be zero and that will be the only relevant “gross reportable amount.” This approach would permit U.S. owners of foreign trusts to secretly repatriate the entire corpus of a foreign trust without facing a single penalty under § 6677. That cannot be what Congress intended, and this absurd result emphasizes the errors in the District Court's textual analysis. Cf. Fid. Int'l Currency Advisor A Fund, LLC ex rel. Tax Matters Partner v. United States, 661 F.3d 667, 673 (1st Cir. 2011) (“Indeed, one might think that it would be perverse to allow the taxpayer to avoid a penalty otherwise applicable to his conduct on the ground that the taxpayer had also engaged in additional violations that would support disallowance of the claimed losses.”) (citing Gilman v. Commissioner, 933 F.2d 143, 150 (2d Cir. 1991)).

In addition to misinterpreting the penalty scheme laid out in §6677, the District Court erred in suggesting that the statute was ambiguous and that any ambiguity should be construed against the Government. (JA185 (citing Gould, 245 U.S. at 153).) While it is true that penalty statutes are strictly construed in favor of taxpayers, that simply means that a taxpayer “is not to be subjected to a penalty unless the words of the statute plainly impose it.” Commissioner v. Acker, 361 U.S. 87, 91 (1959) (citation omitted). Here, the statute plainly imposes a separate penalty for each violation of § 6048's reporting requirements. The clear language of the statute reveals that the District Court erred in relying on Gould.15 (JA185.)

2. The District Court misinterpreted § 6677(a)

The District Court relied on flush language in § 6677(a) to support its conclusion that the maximum penalty in this case was zero. But the text of that provision does not support the District Court's reading. After § 6677(a) provides for a 35-percent penalty for any failure to comply with § 6048, it goes on to provide for late fees if a taxpayer fails to comply with reporting obligations after receiving notice from the IRS of the failure, while limiting the total aggregate penalty:

If any failure described in the preceding sentence continues for more than 90 days after the day on which the Secretary mails notice of such failure to the person required to pay such penalty, such person shall pay a penalty (in addition to the amount determined under the preceding sentence) of $10,000 for each 30-day period (or fraction thereof) during which such failure continues after the expiration of such 90-day period. In no event shall the penalty under this subsection with respect to any failure exceed the gross reportable amount.

I.R.C. § 6677(a). The clear import of this language is that if a taxpayer continues to ignore his reporting violations, the penalty for each failure under either § 6048(a), (b), or (c) may not exceed the “gross reportable” amount attributable to each failure.16 Here, for example, the $3.2 million penalty imposed for taxpayer's failure to report his $9.2 million distribution under § 6048(c), plus any additional late fees, can never exceed $9.2 million, which is the “gross reportable amount” under § 6677(c).

The District Court, however, construed this language to mean that the total penalties imposed on one person who fails to comply with §6048 cannot exceed the gross reportable amount applicable for any one violation. (JA185.) According to the District Court, the penalties applicable to taxpayer could not exceed zero, since the gross reportable amount under § 6677(c)(2) was zero. The District Court's interpretation is in tension with the three different definitions of “gross reportable amount” included in § 6677(c) and fails to give effect to the court's recognition that the language capping the aggregate penalty “is primarily concerned with subsequent late fees.” (JA185.)

3. The District Court's analysis of the required forms was erroneous

The District Court's analysis of the statute also relied on a factual error: the court incorrectly stated that it was “imperative to understand that a person in Wilson's situation — i.e. a sole grantor/owner and sole beneficiary of a foreign trust — would have only been required to file a single Form 3520 for fiscal year 2007.” As an initial matter, the District Court placed undue weight on whether a single form was required. A single form can encompass multiple reporting requirements, and the court's suggestion that only a single penalty can apply to a failure to file a single form that encompasses multiple reporting requirements is wholly misconceived.17

But, in any event, the court's statement about the required forms was incorrect. Here, taxpayer was responsible for filing two separate forms in 2007. As the owner of the Trust, he was required to ensure that the Trust filed Form 3520-A, the annual return for a foreign trust.18 See I.R.C. § 6048(b); IRS Notice 97-34, § IV, 1997-1 C.B. 422; (JA128). And as the recipient of a distribution from the Trust, taxpayer was required to file Form 3520, the return for reporting distributions from a foreign trust. See I.R.C. § 6048(c); IRS Notice 97-34, § V, 1997-1 C.B. 422; (JA109).

Relatedly, the District Court erred in its interpretation of the instructions for Forms 3520 and 3520-A. Form 3520-A — the annual trust return — requires, consistent with the statute, that the trust report all activities for the year at issue, including any distributions to U.S. persons, and furnish a statement to both the trust's owners and beneficiaries. (JA128, JA131, JA133-36); see also I.R.C. § 6048(b). Form 3520 features three parts: Part I is for the reporting of transfers to a trust, Part II is for the reporting of ownership of a trust, and Part III is for the reporting of a distribution from a trust. (JA113-15, JA122-26.) The 2007 instructions for Part III of Form 3520 indicate that a trust owner who has ensured that the trust has reported all distributions need not complete Part III:

If you received an amount from a portion of a foreign trust of which you are treated as the owner and you have correctly reported any information required on Part II and the trust has filed a Form 3520-A with the IRS, do not separately disclose distributions again in Part III.

(JA114.) The District Court interpreted this instruction to mean that Form 3520 “disregards the beneficiary status of the trust owner” and relied on this instruction to support the court's conclusion that taxpayer could be liable only for the penalty applicable to trust owners. (JA186.)

The District Court's interpretation is incorrect for several reasons. First, in this case, the instructions plainly required taxpayer to complete Part III of the Form 3520 because it is undisputed that the Trust did not file a timely Form 3520-A.19 (JA8, JA155, JA159.) The form instructions thus do not excuse taxpayer's failure to file Form 3520, and his non-filing of Form 3520 remains subject to the 35-percent penalty.

Second, the Form 3520 instructions do not ignore a trust owner's obligation to report distributions. The instructions simply provide that, if the foreign trust at issue filed a Form 3520-A that properly reported all distributions as part of the trust's annual reporting (which did not occur here), the trust owner can simply direct the IRS to the 3520-A already filed (by checking the appropriate box on Part II of Form 3520 and attaching his ownership statement) and need not report that information again on Part III of the Form 3520.20 The instructions in no way suggest that the obligation under § 6048(c) to report distributions is eliminated when the distributions are to a trust owner.

At all events, the instructions to an IRS form cannot override the plain text of the relevant statutes. See, e.g., Adler v. Commissioner, 330 F.2d 91, 93 (9th Cir. 1964) (recognizing that taxpayer's interpretation of IRS instructions cannot “change the meaning of taxing statutes”); Montgomery v. Commissioner, 127 T.C. 43, 65 (2006) (“It is settled law that taxpayers cannot rely on Internal Revenue Service instructions to justify a reporting position otherwise inconsistent with controlling statutory provisions.” (citing Johnson v. Commissioner, 620 F.2d 153, 155 (7th Cir. 1980))). Regardless of the instructions for the Form 3520, I.R.C. § 6048(c) required taxpayer to report the $9.2 million distribution he received in 2007. By failing to file any timely form whatsoever reporting that distribution, taxpayer here clearly failed in his reporting obligation.

D. A beneficiary's duty to report a distribution from a foreign trust does not depend on the tax consequences of the distribution

The Government anticipates that the estate will defend this appeal by repeating arguments it made below, but that the District Court did not address: that taxpayer could not be subject to a penalty for failure to report the $9.2 million distribution because he did not owe any tax on that distribution, and that, because the distribution was not taxable to him, § 6048(c)(2) created an implicit exception to the reporting requirements for distributions. These arguments fail because the penalties that apply to a failure to report foreign trust transactions do not depend on the tax consequences of the transaction at issue and because § 6048(c)(2) does not create an exception to the distribution reporting requirement in § 6048(c)(1).

1. Section 6048(c)(1) does not require that the distribution at issue be a taxable event

The estate contended below that, because the 2007 distribution did not have any tax consequences for taxpayer, he was not required to report the distribution. (Doc. 17 at 13-16.) This argument ignores the text of §§ 6048 and 6677 and focuses on statutory provisions that are not at issue in this case.

The estate argued below that, because the trust income was taxable to taxpayer as the owner of the trust, he had no obligation to report the 2007 distribution and should not have been subject to a penalty for failing to do so. As a general matter, under the “grantor trust” rules of I.R.C. §§ 671-679, if a grantor retains control over trust property, the trust is disregarded for income-tax purposes and the grantor is required to treat the trust's income as his own. See 10 Mertens Law of Federal Income Taxation § 37:1 (2020). Here, the Trust was a grantor trust (JA188), and thus taxpayer was required to report the trust's income on his individual returns (even though he failed to timely do so in 2005, 2006, and 2007 (JA159)).

But the estate's argument that the distribution's lack of tax consequences exempts him from reporting the distribution fails because, even if the 2007 distribution was not taxable, § 6048(c)(1) does not condition the reporting requirement on the tax consequences of the distribution. The statute provides that “any United States person” who receives “any distribution from a foreign trust” must file a return reporting that distribution. I.R.C. § 6048(c)(1). The estate's effort to read an exception into the broad language of § 6048(c)(1) fails; there is no suggestion in that provision that a distribution must have tax consequences in order to be reportable. “Only when a literal construction of a statute yields results so manifestly unreasonable that they could not fairly be attributed to congressional design will an exception to statutory language be judicially implied.” United States v. Rutherford, 442 U.S. 544, 555 (1979). The estate cannot meet this standard.

The estate's attempt to highlight the tax consequences of the distribution fundamentally misinterprets the nature of the § 6677 penalties. Those penalties are not based on the existence of a tax deficiency or on a failure to pay a tax. Instead, they solely penalize a failure to report the information required by § 6048. The § 6677 penalties are similar to other statutory provisions that penalize a failure to report, irrespective of whether there is a tax deficiency related to the reporting failure. See, e.g., I.R.C. §§ 6038(b) (penalty for failing to report interest in foreign corporation); 6038B(c) (penalty for failing to report transfers to certain foreign entities and persons); 31 U.S.C. §5321 (penalty for failing to report foreign bank account on FBAR). In contrast, other penalties are aimed at the understatement of tax or a failure to pay tax due and owing. See, e.g., I.R.C. §§ 6651(a)(2) (failure-to-pay penalty); 6662 (underpayment penalty). This contrast reveals that Congress made a deliberate choice when it did not condition the §6677 penalties on the existence of a tax deficiency or the tax consequences of the transaction at issue.21

In addition, § 6048(d)(1) provides that the grantor trust rules should not be considered in determining whether a transfer to or a distribution from a foreign trust has occurred:

Determination of whether United States person makes transfer or receives distribution. — For purposes of this section, in determining whether a United States person makes a transfer to, or receives a distribution from, a foreign trust, the fact that a portion of such trust is treated as owned by another person under the rules of subpart E of part I of subchapter J of chapter 1 shall be disregarded.

I.R.C. § 6048(d)(1). Subpart E refers to the grantor trust rules that are codified at I.R.C. §§ 671-679, and thus § 6048(d)(1) directly contradicts the estate's argument that the grantor trust rules should determine whether a distribution triggering § 6048(c)(1)'s reporting requirement has occurred. That taxpayer owned the Trust was thus irrelevant to determining whether he was required to report the 2007 distribution.

Finally, the estate's argument assumes that trust owners will report income from the trust on their individual tax return. But as discussed above, Congress expanded the § 6048 reporting requirements and increased the applicable penalties for violating § 6048 because of a concern that many taxpayers were using foreign trusts to avoid their tax obligations. Here, the record establishes that taxpayer failed to report the Trust's income on his individual tax returns for 2005, 2006, and 2007. (JA159.) The facts of this case thus undermine the estate's argument that it was unnecessary for taxpayer to report the $9.2 million distribution because he was required to report the Trust's income on his individual return: in this case, taxpayer timely reported neither.

2. Section 6048(c)(2) did not excuse taxpayer's failure to report the distribution he received in 2007

The estate also argued below (Doc. 17 at 10-11) that § 6048(c)(2) creates an implied exception to § 6048(c)(1)'s requirement that beneficiaries report any distribution received from a foreign trust. Again, the estate cannot demonstrate that an exception to the plain text of the statute should apply here. See Rutherford, 442 U.S. at 555.

Section 6048(c)(2) addresses the tax treatment of distributions in the absence of adequate records:

If adequate records are not provided to the Secretary to determine the proper treatment of any distribution from a foreign trust, such distribution shall be treated as an accumulation distribution includible in the gross income of the distributee under chapter 1.

I.R.C. § 6048(c)(2)(A). The estate contended below that, because a distribution to the trust owner should not be treated as an “accumulation distribution,” that provision demonstrated Congress's intent to exempt trust owners from § 6048(c)(1)'s reporting requirement.

Nothing in § 6048(c)(2) exempts taxpayer from § 6048(c)(1)'s reporting requirement or otherwise modifies the reporting requirement. Section 6048(c)(2) simply provides that, in the absence of records showing otherwise, a distribution shall be treated as an accumulation distribution that is taxable to the beneficiary. If a distribution to a trust owner is not taxable as an accumulation distribution, then the owner simply needs to provide adequate documentation to the IRS to establish this fact. Section 6048(c)(2) actually reinforces the reporting requirement in § 6048(c)(1) because it incentivizes the disclosure of information to the IRS.

In sum, § 6048(c)(1) required taxpayer to report the $9.2 million distribution he received in 2007, and § 6677 made him liable for a 35-percent penalty on the amount of the distribution because he failed to fulfill his reporting requirement under § 6048(c). The IRS properly assessed the penalty at issue here.

CONCLUSION

The judgment of the District Court should be reversed, and the case should be remanded for further proceedings to determine whether I.R.C. § 6677(d)'s reasonable cause exception applies.

Respectfully submitted,

RICHARD E. ZUCKERMAN
Principal Deputy Assistant Attorney General

JOSHUA WU
Deputy Assistant Attorney General

ELLEN PAGE DELSOLE (202) 514-8128
ELISSA HART-MAHAN (202) 305-7397
California Bar No. 241678
Attorneys
Tax Division
Department of Justice
Post Office Box 502
Washington, D.C. 20044

Of Counsel:
RICHARD P. DONOGHUE
United States Attorney

JUNE 2020

FOOTNOTES

1“JA” references are to the Joint Appendix filed with the Government's opening brief. “Doc.” references are to record items not included in the Joint Appendix, as numbered by the District Court Clerk on that court's docket sheet.

2Unless otherwise indicated, our references to §§ 6048 and 6677 are to those provisions as in effect in 2007, the year at issue. As discussed in Section B of the Argument, infra, those provisions have been amended, both before and after 2007. But the relevant structure of the statute has continually imposed distinct reporting requirements with distinct penalties.

3As discussed infra, § 6677 includes a reasonable cause exception for the imposition of penalties if a taxpayer violates § 6048's reporting requirements.

4In 2010, § 6677(a) was amended to provide, inter alia, that “the person required to file such notice or return shall pay a penalty equal to the greater of $10,000 or 35 percent of the gross reportable amount.” Hiring Incentives to Restore Employment Act, Pub. L. 111-147, March 18, 2010, 124 Stat 71. Both the version of the statute in effect in 2007 and the current version (as amended in 2010) are included in the statutory appendix attached to this brief.

5The estate asserted below (JA8) that the Trust's annual returns for the 2003 and 2004 tax years were timely filed, but there is no evidence in the record supporting this assertion.

6 The IRS also assessed penalties for taxpayer's failure to meet §6048's reporting requirements in earlier years, but those other penalties were all settled in IRS Appeals. (JA8.)

7Taxpayer also filed an administrative claim for refund in 2017, but that claim was not signed by taxpayer. (JA9, JA94.) Taxpayer filed a refund suit based on his 2017 refund claim in the Court of Federal Claims, but that court dismissed the suit, finding that it lacked subject matter jurisdiction because taxpayer had not signed the administrative claim. (JA9-10, JA94-104.)

8The Government does not appeal the District Court’s denial of the partial motion to dismiss in which the Government asserted that taxpayer’s administrative refund claim did not adequately assert the claims made in the complaint.

9In fact, taxpayer was required to file two different returns in 2007: as the owner of the Trust, he was responsible for ensuring that the trust filed Form 3520-A, and as the recipient of a distribution from the trust, he was required to file Form 3520. See Notice 97-34, 1997-1 C.B. 422, §§ IV, V.

10We note that the District Court quoted from the version of the statute that was enacted in 2010, rather than the provision that was applicable in 2007. (JA185); compare Small Business Job Protection Act of 1996, P.L. 104-188, August 20, 1996, 110 Stat. 1755, with Hiring Incentives to Restore Employment Act, Pub. L. No. 111-147, March 18, 2010, 124 Stat. 71.

11More specifically, § 6048(a) requires the filing of a return by the “responsible party” — defined as a grantor, transferor, or executor of an estate, see § 6048(a)(4) — for any “reportable event” — defined as the creation of a trust, a transfer to a trust, or the death of a U.S. person when the decedent owned a foreign trust or a foreign trust is part of the estate, see § 6048(a)(3).

12As noted above, Congress amended § 6677(a) in 2010 to call for a penalty of $10,000 or 35 percent of the gross reportable amount, whichever is greater.

13Congress subsequently increased the penalties applicable under §6677 again in 2010, when it amended § 6677(a) to provide that the penalty shall be equal to “the greater of $10,000” or “35 percent” of the “gross reportable amount.” Hiring Incentives to Restore Employment Act, Pub. L. No. 111-147, March 18, 2010, 124 Stat. 71, 115. While that amendment is not at issue in this case, it demonstrates Congress's continuing concern that taxpayers are not complying with the foreign trust reporting requirements.

14The estate argued below (Doc. 17 at 11-12) that the legislative history indicated that the 35-percent penalty applicable to violations of §6048(c) did not apply to the owners of foreign trusts, but that argument focused on the amendments to the grantor trust rules, codified at I.R.C. §§ 671-679, rather than the amendments to §§ 6048 and 6677. Whatever reasons Congress may have had for amending the grantor trust rules, the legislative history of the amendments to §§ 6048 and 6677 demonstrate a clear intent to expand reporting requirements and to increase penalties to encourage compliance with those reporting requirements. This purpose is reflected in the plain text of these statutes and requires the application of the 35-percent penalty here.

15Nor does Gould apply to I.R.C. § 6048's reporting requirements. Section 6048(c) plainly requires each U.S. person who has received a distribution from a foreign trust to report the gross amount of that distribution. The statute makes no distinction between U.S. persons who are owners of the trust or U.S. persons who are beneficiaries of the trust, it just refers to “any United States person.” The lack of ambiguity in § 6048(c) further demonstrates that the District Court improperly relied upon Gould.

16The statute's reference to “any failure described in the preceding sentence” refers back to a failure to timely file “any notice or return required to be filed by section 6048,” indicating that any failure can trigger a penalty. Accordingly, this language further supports the conclusion that a separate penalty applies to each violation of I.R.C. §6048.

17For example, Form 3520 is the form designated for reporting foreign gifts pursuant to I.R.C. § 6039F, in addition to being used to report transactions with a foreign trust pursuant to § 6048. (JA109, JA117.) If a taxpayer was required to report a transaction with a foreign trust under § 6048 and receipt of a foreign gift under § 6039F, two different penalties would apply if taxpayer failed to timely file a single Form 3520 reporting those transactions. See I.R.C. §§ 6039F(c), 6677.

18If a foreign trustee fails to file Form 3520-A on behalf of the trust, the trust owner may complete Part II of Form 3520 and attach a substitute Form 3520-A to the Form 3520 in order to avoid a penalty for violating I.R.C. § 6048(b). (JA114, JA125); IRS Notice 97-34, 1997-1 C.B. 422, § VII. Thus, a Form 3520-A is still required even if the trust fails to file it.

19Nor did taxpayer timely complete Part II of Form 3520, which, if the trust had not filed a Form 3520-A, would have required him to attach a substitute Form 3520-A. (JA125.) Although the Trust prepared a “pro forma” Form 3520 to which it attached a “substitute Form 3520-A” (JA138-48), the record is clear that neither the Form 3520 nor the attached “substitute Form 3520-A” were in fact timely filed with the IRS, but rather were prepared for purposes of this litigation. (JA105, ¶ 4.)

20The same is true even if the foreign trustee fails to file a Form 3520-A on behalf of the trust and the owner attaches a substitute Form 3520-A to the Form 3520. The substitute Form 3520-A must report all distributions, and if that information has been included in the substitute Form 3520-A, then the taxpayer need not report that information a second time in Part III of Form 3520.

21The information that I.R.C. § 6048 requires has significance independent of the tax consequences of a given transaction. For example, the § 6048(b) reporting requirement notifies the IRS of the existence of the foreign trust and therefore allows the IRS to ensure that the trust owner is reporting the trust's income on his personal returns. See, e.g., I.R.C. § 671. As noted above, taxpayer failed to report the trust's income on his personal returns. (JA159.) In addition, the value of a foreign trust's corpus at the end of the year is necessary to determine the tax consequences of distributions to a U.S. beneficiary in future years if the foreign trust later becomes a complex trust (for example, when the grantor dies). See, e.g., subparts C and D of part I of subchapter J.

END FOOTNOTES

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