Form 3520 and 3520-A Tax Penalties
By Jason Kovan · May 16, 2023
How Form 3520 and Form 3520-A penalties arise, how the IRS calculates them, and what a taxpayer can do after receiving a notice.
Why the IRS assesses these penalties
Form 3520 and Form 3520-A are information returns. They help the IRS understand certain transactions involving foreign trusts, foreign gifts, inheritances, and related parties. A penalty may be assessed when a required form is filed late, not filed at all, incomplete, or materially incorrect.
The underlying transaction may not have produced taxable income. That does not necessarily eliminate the information-reporting obligation. A U.S. person who receives a substantial gift from a foreign person, reports a transaction with a foreign trust, or has a filing responsibility connected to a foreign trust should analyze the facts for the specific tax year and filing requirement.
The amount depends on the reporting failure
For certain unreported foreign gifts and inheritances, the penalty can be 5% of the amount that should have been reported for each month the failure continues, up to a 25% maximum. A delayed filing can therefore become expensive even when the recipient believed the transfer was private or non-taxable.
Certain unreported foreign trust transactions can carry an initial penalty equal to the greater of $10,000 or 35% of the reportable amount. Other failures involving a foreign trust or Form 3520-A may be governed by different calculations. The notice, the form involved, and the transaction details must be read together before the amount is evaluated.
A notice is the start of the review
An IRS penalty notice usually identifies the tax year, form, amount, and response instructions. Read the notice carefully and record the date it was issued, the deadline to respond, and the address or fax number the IRS provides. Preserve the envelope and every page, including attachments and payment instructions.
Next, compare the assessment with the actual filing history. Confirm whether a return was submitted, when it was received, what information it contained, and whether a corrected or amended filing was later sent. A penalty may reflect a missing attachment, a processing problem, or a misunderstanding of the transaction rather than the full factual record.
Reasonable cause may support relief
The IRS may consider abatement when a taxpayer can show reasonable cause and that the failure did not result from willful neglect. That showing is fact-specific. It may involve reliance on incomplete information, a serious event, the inability to obtain foreign trust records, a misunderstanding that was reasonable in the circumstances, or prompt corrective action once the issue became known.
Willful neglect is different from an honest mistake or a documented inability to comply. The response should explain what the taxpayer knew, what steps were taken, what information was available, and why the failure occurred. A conclusory statement that the taxpayer did not know about Form 3520 is rarely enough by itself.
Build a defensible response
A strong response begins with a timeline and supporting records: trust agreements, trustee correspondence, bank statements, transfer documents, appraisals, prior returns, proof of filing, and communications with advisers. The written explanation should connect those records to the specific penalty and request a clear outcome, such as withdrawal, correction, or abatement.
Because these matters often involve confidential financial and family information, it is worth considering who should lead the response. An attorney can evaluate the legal position and communicate with the IRS while protecting attorney-client communications within the limits of the engagement.