Source: http://www.capdale.com/Information-Reporting-and-Civil-Penalties-In-a-Nutshell-12-22-2008
Timestamp: 2019-04-25 00:07:49+00:00

Document:
In addition to income tax filings, U.S. persons and certain foreign persons may be subject to certain information reporting requirements. For example, the Code requires a foreign grantor trust with a U.S. owner to furnish to the IRS certain information regarding its identification, income and assets.7 Reporting of such information is generally required on Form 3520-A, “Annual Information Return of Foreign Trust With a U.S. Owner.” As discussed below in Section II, the failure to file such information can result in significant civil penalties imposed on the U.S. owner of the foreign grantor trust.
Contrary to foreign grantor trusts, foreign nongrantor trusts generally do not have an information reporting requirement. However, U.S. persons who maintain or engage in certain transactions with foreign grantor or nongrantor trusts during the year are generally required report such transactions to the IRS on a Form 3520, “Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts.” Such reportable transactions include: (1) ownership of a foreign grantor trust; (2) transfer of property to a foreign trust (i.e., the U.S. transferor must notify the IRS of the transfer and provide the IRS with the identity of the trustees and beneficiaries); and, (3) receipt of property or distribution from a foreign trust.8 Reporting is also required for any testamentary transfer of property, as well as the death of a U.S. citizen or resident who was considered to own any portion of a foreign trust or in whose estate are included a foreign trust’s assets.9 In the case of testamentary transfers and the death of a U.S. owner of a foreign trust, notice must be furnished by the decedent’s executor.10 As discussed below in Section II, the failure to timely file a Form 3520, or filing an incorrect or incomplete form, can result in significant civil penalties.
Information reporting on Form 3520 is also required where a U.S. person receives, in the aggregate, gifts or bequests in excess of $100,000 from a nonresident alien or a foreign estate during the year.11 While a foreign person is not subject to the U.S. gift tax on gratuitous transfers of foreign property, as discussed below in Section II, the failure on the part of the U.S. recipient to disclose such gift to the IRS can result in significant monetary penalties.
Additionally, if, during the year, a U.S. person, either directly or indirectly, (1) transfers property to a foreign corporation, (2) owns at least 10% of the vote or value of a foreign corporation which is owned, in the aggregate, more than 50% (by vote) by U.S. persons, or (3) acquires or disposes of certain amounts of ownership interests in a foreign corporation, such U.S. person must generally file an information return on a Form 5471, "Information Return of U.S. Persons With Respect to Certain Foreign Corporations,” and, in the case of a transfer to a foreign corporation, also on Form 926, “Return by a U.S. Transferor of Property to a Foreign Corporation.”12 For purposes of Form 5471, certain beneficiaries of foreign trusts can be treated as indirectly engaging in the transaction with the foreign corporation.
The following is a general discussion of certain information reporting requirements imposed on U.S. persons to disclose certain relationships and transactions with foreign trusts, foreign corporations and foreign financial accounts. A general discussion of the potential civil penalties which can apply for the failure to disclose such information is provided at the end thereof.
The Form 1040NR is due on June 15th of the year following the calendar year when the nonresident alien individual, estate or trust received the taxable income. The form must be signed by the trustee or executor, if it is for a trust or estate, or by the individual taxpayer on the return showing his beneficial share of the income.
The Code generally imposes an information reporting requirement on U.S. persons that engage in certain transactions with foreign trusts. In addition, U.S. persons who receive certain foreign gifts or bequests must disclose such gifts or bequests.
Form 3520 is filed separately from the personal income tax return of the U.S. settlor, transferor or recipient and is due on the date of such personal income tax return, including extensions. Generally, Part 1 covers transfers to a foreign trust by a U.S. person; Part II provides information on the owner of a foreign trust settled by a U.S. person; Part III covers distributions received by a U.S. person from a foreign nongrantor trust; and, Part IV is used to report large foreign gifts. Note that a trust distribution will not constitute a foreign gift and should be reported on Part III rather than Part IV.
Whenever a U.S. beneficiary receives a distribution, either directly or indirectly, from a foreign trust, the Code requires such U.S. beneficiary to file a Form 3520.30 For this purpose, a distribution from a foreign trust includes: (i) any gratuitous transfer of money or property from a foreign trust, whether or not the trust is deemed to be owned by another U.S. person; (ii) the receipt of trust corpus and the receipt of a gift or bequest that is not otherwise subject to income tax; and (iii) a direct or indirect loan of cash or marketable securities to a U.S. grantor or U.S. beneficiary by a foreign trust. Note that a distribution is reportable whether is it actually or constructively received.
The Form TD F 90-22.1 was recently revised in October 2008. The revised form is effective for tax years starting on January 1, 2009. The revised form provides additional definitions and clarifications. It also generally expands the class of individuals and companies required to make annual reports, including certain foreign persons in and doing business in the United States (including a branch of a foreign entity) and certain trusts with U.S. settlors. There are also more detailed rules regarding consolidated reports for corporate parents and subsidiary corporations. The revised form confirms that there is no extension of time for filing the form.
Any of the financial accounts described above is considered to be a foreign financial account for purposes of FBAR, if it is located outside the United States, Guam, Puerto Rico, and the Virgin Islands.43 However, an account maintained with a military banking facility44 is not considered to be a foreign financial account for purposes of FBAR, even if the military banking facility is located in a foreign country.45 The geographical location of the account, not the nationality of the financial entity institution in which the account is founds determines whether it is in an account in a foreign country.46 That is, the situs of a financial account is determined by the location where the branch is, not the location of the institution’s home office. Thus, for example, an account maintained at a German branch of a U.S. bank is a foreign financial account, but an account maintained at a U.S. branch of a German bank is not a foreign financial account.
For purposes of Form TD F 90.22-1, a U.S. person is considered to have signature authority over a foreign financial account if such person can control the disposition of money or other property in the account by delivering his or her signature (or his or her signature and that of one or more other persons) to the bank or other person maintaining the account. In addition, a U.S. person has “other authority” subject to FBAR reporting if such person can exercise comparable power over an account by direct communication to the bank or other person maintaining the account, either orally or by some other means.
2. An officer or employee of a domestic corporation whose equity securities are listed upon U.S. national securities exchanges or which has assets exceeding $10 million and 500 or more shareholders of record need not file such a report concerning the other signature authority over a foreign financial account of the corporation, if he has NO personal financial interest in the account and he has been advised in writing by the chief financial officer of the corporation that the corporation has filed a current report, which includes that account.51 There are additional exceptions for domestic and foreign subsidiaries.
Form 5471 is generally used by certain U.S. citizens and residents who are officers, directors, or shareholders in certain foreign corporations to satisfy the reporting requirements of sections 6038 (reporting with respect to certain foreign corporations) and 6046 (returns relating to organizations and reorganizations of foreign corporations). A separate Form 5471 and applicable schedules for each foreign corporation must be attached to the U.S. Federal income tax return of the U.S. person obligated make the information return.
• Category 1 Filer: This filing requirement has been repealed by the “American Jobs Creation Act of 2004.” Prior to this repeal, U.S. citizens or residents who were officers, directors, or 10 percent shareholders of a foreign personal holding company were required to file a Form 5471 as Category 1 Filers.
The failure to file the required tax returns and information returns may result in civil and criminal penalties, as discussed below.
In addition to the tax due, if a taxpayer fails to file a return, there may be imposed a penalty of 5% per month of the amount of tax required to be shown on a tax return. The amount of the penalty is not to exceed 25% of the amount of tax in the aggregate. There is an exception if the failure was due to reasonable cause, not willful neglect.
In addition to the tax due and the penalty imposed under section 6651, a taxpayer could be subject to a penalty of 20% of the amount of the underpayment. This penalty is imposed on both (a) negligence or disregard of rules or regulations, and (b) any substantial underpayment of tax (understatement of greater than 10% or $5,000).
a. EXCEPTION 1: There is a reasonable cause exception whereby the substantial underpayment of tax penalty may be alleviated if there was a reasonable cause for the underpayment (i.e., there is "substantial authority" for or adequate disclosure of the position and the position is not a tax shelter) and the taxpayer acted in good faith with respect to the underpayment.
b. EXCEPTION 2: If the taxpayer is subject to the (worse) fraud penalty under section 6663, then the substantial underpayment penalty does not apply. Generally, pursuant to section 6663, if the underpayment is based on fraud, in addition to the tax due, taxpayer could be subject to a penalty of 75% of the portion of the underpayment attributable to fraud. However, the Code provides an exception for reasonable cause.
(iii) Finally, if a U.S. donee fails to timely file a Form 3520 to report the receipt of a large foreign gifts, or files the form incorrectly or incompletely, such donee may be subject to a penalty equal to 5%, not to exceed 25%, of the value of the gift or bequest received in the relevant year.
The IRS may impose a penalty of $10,000 for each failure to timely file a Form 5471, or filing a Form 5471 which does not show the information required under section 6038. If the information is not filed within 90 days after the IRS has mailed a notice of the failure to the U.S. person, an additional $10,000 penalty (per foreign corporation) can be imposed for each 30-day period, or fraction thereof, during which the failure continues after the 90-day period has expired. The additional penalty is limited to $50,000. There is no reasonable cause exception for either the initial or additional penalty.
If a U.S. person fails to timely provide information regarding certain transfers to foreign corporations as required under section 6038B, the IRS may impose a penalty equal to 10% of the fair market value of the property transferred at the time of the exchange. There is a reasonable cause exception. Additionally, the amount of the penalty imposed under this section is limited to $100,000, unless the failure was due to intentional disregard.
There may be imposed an additional penalty of $50 for each return (not to exceed $250,000 per year) which fails to include all of the required information or includes incorrect information. There is an exception to this penalty if the failure is corrected within 30 days after the required filing date. However, if the failure is based on intentional disregard, then no exception applies (including the $250,000 cap) and the amount of the penalty is the greater of $100 or 10% of the aggregate amount of the items required to be reported. There is no reasonable cause exception.
There may be imposed an additional penalty of $50 for each failure to comply with a required information reporting (not to exceed $100,000 per year). There is no exception, including a reasonable cause exception.
In addition to the above, criminal penalties under sections 7203 (monetary and penal penalties for willful failure to file supply information), 7206 (monetary and penal penalties for fraud and false statements) and 7207 (monetary and penal penalties for fraudulent statements) may apply.
This article is designed to give general information on the developments covered, not to serve as legal advice related to specific situations or as a legal opinion. Counsel should be consulted for legal advice.
1. Unless otherwise noted, all section references herein are to the Internal Revenue Code of 1986, as amended, and the regulations thereunder.
4. The "substantial presence test" measures the weighted average of days an alien is physically present in the United States over a three calendar year period. Specifically, if an individual is present in the U.S. for at least 31 days in the current year and the weighted average for the three year period totals 183 days or more, he generally will be treated as a resident alien of the United States as of the first day in the current year he is physically present in the United States. I.R.C. § 7701(b)(2)(A)(iii); Treas. Reg. § 301.7701(b)-4(a). The formula counts days present in the current year at full value, days present in the immediately preceding year at 1/3 value, and days present in the second preceding year at 1/6 value.
5. I.R.C. § 6012(a); Treas. Reg. § 1.6012-1(a)(1); see also Instructions to Form 1040. I.R.C. § 6012 contains the exceptions for when an individual is not required to file a Form 1040.
6. I.R.C. § 6012(a); Treas. Reg. § 1.6012-1(b)(1); see also Instructions to Form 1040NR.
8. I.R.C. § 6048(a). In Notice 97-34, 1997-25 I.R.B. 22, the IRS clarified section 6048(a)’s notice requirements. The Form 3520, used to report transfers to foreign trusts, is filed with a U.S. transferor’s annual income tax return.
12. I.R.C. §§ 6038, 6038B; 6046.
13. A foreign corporation is treated as a PFIC for a taxable year if it satisfies one of two tests: (1) at least 75% of the corporation's gross income for the year is passive or investment-type income; or (2) at least 50% of the average fair market value of its assets during the year are assets that produce or are held for the production of passive income. I.R.C. § 1297(a). If a foreign corporation satisfies either test, the corporation is a PFIC and any U.S. person owning an interest (directly or indirectly) in the corporation generally is subject to the PFIC rules, regardless of how large an ownership interest the person has in the foreign company. Unless the shareholder makes a special election to be taxed on a current basis, a distribution or sale of the shares may result in additional tax and interest charges. That is, the portion of a distribution from a PFIC that exceeds 125% of the average distributions made to the shareholder within the three preceding years included in the shareholder's holding period, or if the holding period is less than three years, the actual holding period itself. I.R.C. § 1291(b)(2).
14. Prop. Treas. Reg. § 1.1291-1(i).
15. See Instructions for Form TD F 90-22.1 (revised October 2008).
16. In addition to other applicable rules, where a U.S. person transfers property to a foreign trust, such U.S. transferor may be treated as the owner of the trust’s assets for U.S. federal tax purposes if the foreign trust that has or could have one or more U.S. beneficiaries. I.R.C. § 679.
20. See Instructions for Form 3520-A; see also Rev. Proc. 2002-23, 2002-15 I.R.B. 744, section 3, for other eligible Canadian plans.
21. See Instructions for Form 3520-A.
22. Cf. A foreign nongrantor trust is treated as its own taxpayer, separate from the grantor or settlor. I.R.C. § 641(b). It is taxed as a foreign individual and therefore must file a Form 1040NR to report certain types of income from U.S.-source FDAP income, if not fully withheld at source, and effectively connected income. Treas. Reg. § 1.6012-1. The Form 1040NR is generally due on June 15th of the year following the calendar year when the foreign nongrantor trust received the taxable income. The form must be signed by the trustee.
23. I.R.C. § 6048(a); Notice 97-34, 1997-25 I.R.B. 1.
24. Form 3520 is filed separately from Form 1040, but the Form is due on the date the individual’s U.S. income tax return (Form 1040) is due (including extensions). Form 3520 must be filed timely to avoid penalties for failing to timely report. See Instructions for Form 3520.
25. Treas. Reg. § 1.671-2(e)(2)(ii).
26. Treas. Reg. § 1.671-2(e)(2)(i).
27. Treas. Reg. § 1.684-3(d).
28. I.R.C. § 679 provides for exceptions to the exception for transfers at fair market value to a foreign trust that is a related party (for transfers occurring after February 5, 1995.
29. Notice 97-34. To be treated as a “qualified obligation,” an obligation must: (i) be reduced to writing by an express written agreement; (ii) have a term not exceeding five years including options to renew and rollovers; (iii) be denominated in U.S. dollars; (iv) have a yield to maturity of between 100% and 130% of the applicable AFR on the date the obligation was issued; (v)have a U.S. person willing to extend the statute of limitations for assessment of any income or transfer tax changes attributable to the transfer to three years beyond the maturity date of the obligation; and (vi) have a U.S. person report on the status of the obligation and the interest and principal payments on Form 3520.
31. I.R.C. § 6039F(a); see also Instructions for Form 3520.
32. Notice 97-34; Instructions for Form 3520.
33. I.R.C. § 6048(a)(3)(B)(ii); Notice 97-34.
34. See Instructions for Form TD F 90-22.1 (revised October 2008).
35. 31 CFR § 103.24. Such persons will be required to provide detailed information concerning each account when so requested by the Secretary or his delegate. Id.
44. Such facilities are generally known as a “United States military banking facility” or a “United States military finance facility” that are operated by a U.S. financial institution designated by the U.S. government to serve U.S. government installations abroad.
60. IRC §§ 958(a)(1) and 318(a)(2)(B)(i); Treas. Reg. §1.958-2(c)(ii)(a).
61. See also Instructions for Form 3520.
68. The instructions for Form TD F 90.22-1 specifically provide that criminal penalties for failing to comply with FBAR are provided in 31 U.S.C. § 5322(a) and (b), and 18 U.S.C. § 1001. In addition, civil penalties for failure to comply with the BSA or regulations issued under the authority of the BSA are generally provided in 31 U.S.C. § 5321.
69. 31 U.S.C. § 5321. Section 5321 generally provides that if a U.S. person willfully violates a provision of the BSA or a regulation issued under the BSA, such person may be liable for a civil penalty of not more than the greater of the amount (not to exceed $100,000) involved in the transaction (if any) or $25,000. With respect to reporting on Form TD F 90.22-1, a U.S. person is not reporting a transaction but, rather, reporting his interest or signature authority over a foreign financial account. Thus, the maximum amount of potential civil penalty is $25,000.
70. 31 U.S.C. § 5322(a).
71. 31 U.S.C. § 5322(b).
72. 18 U.S.C. § 1001.

References: § 7701
 § 301
 § 6012
 § 1
 § 6012
 § 6012
 § 1
 § 6048
 § 1297
 § 1291
 § 1
 § 679
 § 641
 § 1
 § 6048
 § 1
 § 1
 § 1
 § 679
 § 6039
 § 6048
 § 103
 §1
 § 5322
 § 1001
 § 5321
 § 5321
 § 5322
 § 5322
 § 1001