You have received an IRS CP15 notice (regarding the Form 3520 penalty), now what? – Tax authorities

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IRS Notice CP15 Overview

As our previous firm Insights explains, there is a numbered notice for almost every communication the IRS provides to a taxpayer.
See, for example, CP518 and CP504. In some cases, the taxpayer can safely review a communication without taking further action. For example, the IRS routinely sends a summary of tax debts owed to taxpayers each year as a reminder of tax owed. Butin other cases, a taxpayer must act quickly to preserve certain procedural rights allowed under the Internal Revenue Code (the “Coded“) or existing IRS guidelines. Undoubtedly, IRS Notice CP15 (“CP15“) is one that falls squarely into the latter group, requiring prompt action on the part of the taxpayer.

As the name suggests, the IRS uses CP15 to notify taxpayers that it has imposed certain civil penalties against the taxpayer. Typically, CP15 will provide a short (or even very short) reason for the imposition of the civil penalty and will also provide the taxpayer with notice of the amount of the civil penalty imposed.

Although the IRS uses CP15 for various civil penalties, the remainder of this article focuses only on the IRS’ use of CP15 for assessing the civil penalty associated with a taxpayer’s failure to file on time. timely a correct and complete declaration. IRS Form 3520, Annual return to report transactions with foreign trusts and receipt of certain foreign donations(“Form 3520“). In addition, this article will postpone the discussion of the civil penalty for receipt of certain foreign giftsfocusing only on the reporting obligation applicable to foreign trusts.

What is Form 3520?

The reporting obligation of Form 3520 only exists in certain cases. First, there must be a foreign trust involved in the transaction. Second, only certain types of transactions trigger a reporting requirement on Form 3520. To further break down all of these requirements, taxpayers generally need to determine the following:

  • Is the entity in question a trust?

  • If the entity is a trust for federal tax purposes, whether foreign or domestic?

  • If it is a foreign trust, whether the transaction with the foreign trust must be reported.

Each of these is discussed in more detail below.

What is a Trust?

Unfortunately, much of the confusion associated with Form 3520 revolves around whether the entity in question is actually a trust for federal income tax purposes. The instruction is not clear. However, the “tick the box” regulation provides a starting point.
To see Treasures. Reg. § 301.7701-4(a).

Under these regulations, a trust is generally “an arrangement created either by will or by declaration inter vivos whereby the trustees take title to the property for the purpose of protecting it or preserving it for the beneficiaries under the rules ordinary courts applied in the courts of chancery or probate.”
Identifier. Thereby, “[g]Generally, an arrangement will be treated as a trust under the [Code] if it can be shown that the purpose of the arrangement is to confer on trustees the responsibility for the protection and preservation of the property of beneficiaries who cannot participate in the exercise of this responsibility and, therefore, cannot are not partners in a joint venture for the conduct of business for profit. » Identifier.

Under this broad definition, arrangements in which one person holds title to property or assets for the benefit of another person may qualify as trusts for federal income tax purposes. This is especially true if the person has certain fiduciary duties to the person (that is to say, the beneficiary). However, the IRS has also found that other arrangements – which are not generally considered standard trusts – may constitute trusts for federal income tax purposes, such as pension plans and trust funds. retirement. See, for example, PLR 200508004 (retired); PLR 200807003 (pension fund).

To the extent that the taxpayer is satisfied that the entity in question is do not a trust, the analysis of Form 3520 ends. However, even if this is the case, the taxpayer should keep in mind that other U.S. reporting obligations may apply (for example,form 5471, form 8938, etc.).

>Is the trust foreign or domestic?

If the taxpayer identifies the arrangement as a trust under federal income tax principles, the next question is whether the trust should be characterized as foreign or domestic. Foreign trusts give rise to Form 3520 reporting requirements; national trusts do not.

A trust is considered a domestic trust if it meets two requirements. First, a United States court (for these purposes only the States and the District of Columbia) must be able to exercise primary control over the administration of the trust. This is called the “Court test“. Second, if the Court’s test is satisfied, one or more United States Persons must have the power to control all material decisions of the trust. This is called the “control test“). The regulations bring much more color to these requirements and will not be repeated here. To see Treasures. Reg. § 301.7701-7.

To the extent that a trust fails the forensic test or the control test, the trust will be considered a foreign trust for federal income tax purposes. Applicable law and the language of the trust agreement itself are important in making these decisions.

Is the transaction reportable?

If a foreign trust is involved, taxpayers with certain interactions with the foreign trust may have certain reporting obligations for federal income tax purposes. The legislative text of section 6048 provides most of the guidance in these cases.

Generally, under Section 6048, a U.S. person or estate representative must file a Form 3520 in three instances. First, a Form 3520 is required if there is a US person or US estate with a “reportable event”.
To see IRC § 6048(a)(3). For these purposes, a “reportable event” means: (i) the creation of a foreign trust by a US Person; (ii) the transfer of money or property (directly or indirectly) to a foreign trust by a US Person (including upon death); and (iii) the death of a U.S. citizen or resident if the deceased was deemed to be the owner of a portion of the foreign trust under the grantor trust provisions of the Code or if a portion of the trust was included in the gross income of the deceased. domain. Exceptions may apply to the extent that a transfer was for fair market value (with special valuation rules applicable) or if the transfer of ownership went to certain deferred compensation and/or charitable trusts. Reporting persons include either a settlor of the foreign trust (if the settlor has established a foreign inter vivos trust); the transferor of property or cash to a trust (unless the transfer was due to death); or in any other case, the executor. To seeIRC § 6048(a)(4). To see IRC § 6048(a)(4). As a result, unsuspecting executors who are unaware of the worldwide assets of the deceased should take extra care to ensure that they timely file an accurate Form 3520 with the IRS.

A Form 3520 is also required in two other cases besides “Reportable Events” above. Specifically, a person from the United States (for examplebeneficiary of a foreign trust) must file a Form 3520 if the person receives a distribution from a foreign trust in a tax year. To see IRC § 6048(c). In addition, and per IRS guidelines and Form 3520 instructions, a U.S. person must file Form 3520 to the extent that they are considered to own a portion of a foreign trust during a taxation year.

While the above transactions cover the gauntlet of transactions that must be reported on a Form 3520, taxpayers should also be aware that an IRS Form 3520-A, Annual Information Return of a Foreign Trust with a US Ownermust be filed in certain cases where a foreign trust fails to file Form 3520-A with the IRS.

Return to CP15.

To the extent a taxpayer fails to file a Form 3520 when otherwise required to do so, the taxpayer may receive CP15. Generally, CP15 states that the taxpayer may submit a statement of reasonable cause disputing the civil penalty within 30 days from the date of CP15. And, if the taxpayer has already submitted a Statement of Reasonable Cause to the IRS, CP15 will tell the taxpayer that they can file a protest with the IRS Independent Appeals Office. Taxpayers with the resources and desire to pay the civil penalty also have the option of paying the full civil penalty assessment and filing a refund claim with the IRS. Regardless, it is generally advisable to file a petition with the IRS to challenge the civil penalty, although in some cases there may be strategic reasons to wait for collection proceedings (“CDP“) notification that will follow in case of non-payment of the civil penalty.

Defenses to Form 3520 Civil Penalty.

There can be a litany of valid defenses against the civil penalty assessment of Form 3520. For example, the standard reasonable cause defense applicable to other civil penalties also applies in this context. To see IRC § 6677(d). Generally, taxpayers will want to be careful about the reasonable cause defenses they choose to use, paying particular attention to those that the IRS tends to accept more than others. In addition, the taxpayer may consider raising certain procedural defenses, such as whether the IRS complied with Code section 6751(b). For example, see here. Other defenses may also apply, which must be timely, concisely, and properly raised before the IRS.

Conclusion.

Taxpayers who file a Form 3520 late should be aware that the IRS generally imposes the Form 3520 late-filing penalty on a routine basis. That is, IRS computers usually flag late-filed Form 3520 and automatically issue a CP15 notice. While the actions of the IRS are automatic in this regard, the taxpayer’s next moves are not. Taxpayers who receive a CP15 in these cases should at least consider consulting with a tax advisor to determine the best course of action for responding to CP15.

The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.

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