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What’s Reasonable for Late-Filed Foreign Information Returns?

Posted on June 21, 2021
[Editor's Note:

This article originally appeared in the June 7, 2021, issue of Tax Notes International.


Taxpayers filing late international information returns continue to encounter difficulties with the IRS’s recent practice of apparently disregarding reasonable cause statements initially and automatically assessing penalties. In particular, late filers of Form 3520, “Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts,” have found it challenging to persuade the IRS to even look at reasonable cause statements upon submission and frequently seem to wind up in a probably unnecessary Appeals process.

The problems stem from an apparent change in the IRS’s intake procedures for delinquent international information returns several years ago. Despite encouraging taxpayers who believe they have reasonable cause for late submissions of the information reporting forms to submit requests for reasonable cause abatement and suggesting that the requests would be reviewed, the IRS evidently began immediately assessing penalties. The result is that taxpayers who owe no taxes and who might be eligible for relief from penalties for late filing of information returns because of reasonable cause for failure to file either are forced into a lengthy Appeals process or simply don’t remediate their filing errors when they realize them. The situation poses a problem for voluntary compliance that the IRS could fix through a reasonable amount of leniency.

“It’s incredibly frustrating,” said Megan L. Brackney of Kostelanetz & Fink LLP. By applying a high standard for reasonable cause, the IRS has been assessing the highest possible penalty even on taxpayers who filed a foreign information return for the first time, quickly corrected the missed filing, had no tax due, and missed the filing deadline only because they relied on a professional preparer, she said. The process has also increased the length of time it takes, and the associated expenses, for taxpayers to reach a resolution with the IRS.

After an assessment of a penalty, taxpayers request abatement, which sometimes takes the IRS up to a year to deny. Then taxpayers generally file an appeal. The time involved is causing a backlog of cases, Brackney said. Taxpayers who would otherwise come into compliance now often reconsider and instead choose not to file missing information returns. “The IRS is losing out on an opportunity to get returns and voluntary compliance,” Brackney said. Plenty of other tax practitioners agree.

For taxpayers with unfiled international information returns, the best approach is to carefully evaluate the options for coming into compliance, said Eli Noff of Frost Law. For instance, in light of the IRS approach to reasonable cause regarding international information reporting penalties, the streamlined filing compliance procedures, when available to non-willful taxpayers who have both unreported foreign-source income and delinquent Forms 3520, might provide the best option for coming into compliance.

Before the change in IRS practice for late international information reporting processing and penalty assessments, the same taxpayer who might choose the streamlined procedures today might have instead filed their late international information reports using the delinquent international information return procedures as previously outlined on the IRS’s website until it was changed in 2020. “Each case should be evaluated for strategy based on its own unique set of facts and circumstances,” Noff said.

A Change in Approach

One example of a situation in which a taxpayer fails to file a Form 3520 and probably should have a solid reasonable cause argument is this: The taxpayer receives a gift of over $10,000 from a foreign relative and informs their return preparer, and the preparer knows that the receipt of the gift isn’t subject to federal income tax, but doesn’t know that the taxpayer must still file Form 3520 to report it.

That taxpayer doesn’t owe any taxes but is on the hook for 5 percent of the amount of the gift for each month the information return isn’t filed, up to 25 percent of the total gift. Section 6039F explains that the penalties shall not apply to any failure to report a foreign gift if the taxpayer shows that the failure is attributable to reasonable cause and not willful neglect.

The IRS’s website includes an explanation for taxpayers who need to file late international information returns. From at least March 2018 through late October 2020, the webpage explained that taxpayers with delinquent information returns who don’t “need to use the [offshore voluntary disclosure program] or the Streamlined Filing Compliance Procedures to file delinquent or amended returns to report and pay additional tax,” and who have reasonable cause for not timely filing the information returns, should “file the delinquent information returns with a statement of all facts establishing reasonable cause for the failure to file.”

The March 2018 version, which said it was last reviewed or updated on August 3, 2017, further stated that “if a reasonable cause statement is not attached to each delinquent information return filed, penalties may be assessed in accordance with existing procedures.” 

This webpage was updated or reviewed on November 5, 2020, according to the note at the bottom. Taxpayers are now invited to attach a reasonable cause statement to the return, but there’s a warning that “during processing of the delinquent information return, penalties may be assessed without considering the attached reasonable cause statement.” The explanation also notes that “it may be necessary for taxpayers to respond to specific correspondence and submit or resubmit reasonable cause information.” 

The notable difference is the IRS’s statement that it won’t necessarily consider the reasonable cause statement. The change confirmed what taxpayers and practitioners had been experiencing for the past several years.

Both the March 2018 version of the information for filers of delinquent international information returns and the current version explain that “information returns filed with amended returns will not be automatically subject to audit but may be selected for audit through the existing audit selection processes that are in place for any tax or information returns.”

The IRS appears to have reviewed or updated the webpage for delinquent filers on June 18, 2018, and March 13, 2020, but left intact the language telling taxpayers to file a reasonable cause statement.

Taxpayers and their advisers submitting late returns under the pre-November 2020 instructions expected a meaningful review of their reasonable cause statements, but instead received seemingly automated penalty notices sending them directly to IRS Appeals. The absence of an opportunity to discuss taxpayers’ claims of reasonable cause at the examination level has added to the pressure on Appeals to resolve these cases. 

“Changing rules retroactively and issuing penalties without meaningful review of submitted statements undermines the confidence of taxpayers and advisers,” said Matthew F. Kadish of Frantz Ward LLP. He said that while computerized processing of delinquent international information returns might initially save IRS time, the result might be taxpayers who simply choose not to come forward, or instead simply file outside of the delinquent international information return submission procedures, which it now appears effectively ensure a penalty will be asserted. 

A ‘Most Serious Problem’

Taxpayers aren’t the only ones who are dismayed by this change in IRS practice. The national taxpayer advocate identified the IRS’s assessment of international penalties under sections 6038 and 6038A as one of the most serious problems facing tax administration in her December 2020 report to Congress. The report recommended that instead of automatically assessing penalties under chapter 61, the IRS send soft notices to taxpayers to encourage voluntary compliance and minimize the number of penalties asserted. The report also recommended extending eligibility for first-time abatement to all penalties under chapter 61.

Origins in UBS Prosecution

The IRS and Justice Department’s pursuit of willful nonfilers in the wake of the UBS scandal and John Doe summons of 2008 brought the issue of nonfiling, particularly in the international context, to national attention. The IRS ever since has been seeking voluntary compliance from taxpayers who are willing and criminal convictions or penalties for those who aren’t.

Taxpayers who aren’t willfully noncompliant have several ways to get into compliance. The streamlined OVDP includes both domestic and foreign branches, and there are delinquency procedures for late FBARs and another set of procedures for foreign information returns, including Form 3520. For taxpayers who owe no tax because they only failed to file Form 3520 and report a gift, the streamlined program isn’t an option. For those taxpayers, the delinquency procedures outlined on the IRS’s website are the only option. The change in approach that appears to have begun several years ago and was confirmed in November 2020 complicated the decision to go in and remediate for those taxpayers.

It’s unclear why the IRS changed its approach. One possibility is that it lacks enough agents to handle reviews of reasonable cause statements, so the decision was made to halt reviews at the intake stage and defer them until the taxpayer moves on to Appeals. Another possibility is an IRS belief that taxpayers who should file Form 3520 are high-net-worth individuals who are sophisticated enough to know what they ought to do regarding foreign information returns. That’s not the case in many situations, however, Brackney said.

Even when taxpayers reach the point of the IRS considering their reasonable cause statements, it has become harder to prevail in their pursuit of penalty abatement. Phillip Colasanto of Agostino & Associates PC said everyone with a college degree seems to be considered a sophisticated taxpayer who should know of the requirement to file a Form 3520, a difficult position to overcome. “Reasonable cause is becoming a unicorn,” he said.

Taxpayers rarely have independent knowledge of the required forms and schedules that need to be filed for foreign gifts, so they turn to professional preparers, Colasanto said. “You can have a return preparer who says the taxpayer answered all their questions and provided everything they asked for and the IRS will still not abate penalties,” he said.

Part of the difficulty that taxpayers encounter in seeking abatement for reasonable cause is the lack of favorable case law on reasonable cause in the international information reporting penalty arena, Noff said. “Of the few cases out there, some had egregious facts compared to the typical non-filer of [Form 3520],” he said. The result is that Appeals is less likely to tip the hazards of litigation scale in the taxpayer’s direction and tends to take a harsh approach to reasonable cause, Noff said.


A first-time abatement policy for late filers of Form 3520 who owe no tax is probably the ideal way to encourage voluntary compliance in the long run. The IRS could also issue soft notices for noncompliant taxpayers. A letter that explains the potential penalty — likely 25 percent of the gift — and grants one-time relief, but notes that the IRS will impose the maximum penalty on any future late-filed Forms 3520, would likely suit the goal of long-term voluntary compliance. That approach would also largely avoid the added legal expenses and frustration of the current process.

Another option for the IRS would be to create a program for late-filed foreign information returns that taxpayers could enter if they aren’t already under audit and have no tax due, Brackney suggested. The prior procedures for delinquent returns required reasonable cause for penalty abatement, but that wasn’t much of an inducement to taxpayers to come into compliance because the IRS can’t impose penalties when a taxpayer shows reasonable cause for failure to file anyhow. A program that would allow taxpayers to catch up on filing foreign information returns without penalties, or at least give them an opportunity to engage with the IRS on their reasonable cause arguments before the assessment of penalties, would be a big improvement, Brackney said.

Brackney said the streamlined procedures for reporting and paying both offshore and domestic taxes owed are an excellent example of how the IRS has enhanced voluntary compliance reasonably. “I would encourage the IRS to think about how well the streamlined procedures have worked and how many people who never filed before are filing,” she said.

The current IRS approach to late-filed Forms 3520 discourages voluntary compliance through significant penalty assessments, including when there’s no unreported income. As more taxpayers therefore choose not to remediate by filing late forms, that approach could threaten to undo some of the beneficial effects on compliance and confidence in the tax system of the past 12 years of offshore compliance efforts. “It’s pushing people into hiding, and that’s not what any of us practitioners and the IRS want to see,” Noff said. Returning to the process in which taxpayers had a pre-assessment opportunity to be heard on their reasonable cause assertions would be a welcome step toward improving compliance.

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