As many readers may know, Joseph Wilson (“Mr. Wilson”) was the settlor, tax owner, and beneficiary of a foreign trust. By virtue thereof, Mr. Wilson, as a U.S. citizen, had the requirement to file IRS Form 3520 and IRS Form 3520-A annual returns. As we see all too often, Mr. Wilson filed his Forms 3520 and 3520-A late and the Internal Revenue Service (the “IRS”) assessed a 35% penalty. Making the otherwise long background story short, Mr. Wilson paid the penalty, and (after Mr. Wilson’’s passing) Mr. Wilson’s estate sued for a refund. The fundamental argument being that the IRS should have only imposed a 5% penalty that applies to owners of foreign trusts. The District Court agreed, concluding “[t]he IRS can . . . assess only the 5% penalty under . . . § 6677 — not both or either the 5% and/or 35% penalty — for Wilson’s untimely filing of his 2007 Form 3520.” Wilson v. United States, No. 19-CV-5037 (BMC), 2019 WL 6118013, at *8 (E.D.N.Y. Nov.. 18, 2019). On July 28, 2021, The United States Court Of Appeals for the Second Circuit (remember that we, in Florida, are in the Eleventh Circuit) disagreed, indicating that both the 35% and the 5% penalties can apply, and vacated the judgment of the District Court and remanded it for further proceedings. See Emily S. Wilson et al. v. United States; No. 20-603 (the “Opinion”).
The Opinion is certainly a difficult loss for U.S. taxpayers. This is particularly true when one considers the current Form 3520 and Form 3520-A penalty environment in which taxpayers and their U.S. tax professionals must operate. This said, the Opinion certainly reloads the turrets of the IRS penalty Battleship. Of course, any well-built Battleship has more than one set of turrets, so the logical question that arises is: to what extent can the logic expressed by the Opinion load other turrets?
Making matters possibly worse, consider that President Biden’s administration has proposed giving significant funds (at one point, it was $7 billion) to the IRS for “program integrity activities” over the next decade. The intention of this funding is to improve the effectiveness of the IRS’s tax enforcement program. Although this has not yet happened, there is some bipartisan support for this due to it being a revenue-generating proposition that does not involve an income tax increase. Sadly, the penalties mentioned herein are some of the easiest to apply to taxpayers that, oftentimes, may have facts that indicate that penalties are not warranted.
Taking all of the above into consideration, one can see how easily a taxpayer who does not timely file Form 3520 or 3520-A may have the following conversation with the IRS:
IRS: F3520 (Part I or III).
IRS: F3520 (Part II).
IRS: F3520 (Part IV).
Taxpayer: Hit! You sank my Battleship!
The practical takeaway for a U.S. taxpayer reading this, is that timely and proper U.S. tax compliance remains essential, as the related failure to do so may result in the IRS imposing significant, possibly duplicative, penalties. Similarly, if you think you might have a problem, call an experienced, knowledgeable U.S. tax professional for assistance with coming into compliance before the IRS Battleship targets you! Either way, expect that this may be a lengthy process and might require the involvement of the Office of Appeals or the use of an approved IRS program or procedure.
The practical takeaway for our U.S. accounting professional friends may be more in the nature of reminders:
a) any tax non-compliance exists;
b) there may be reasonable cause;
c) using a version of the Streamlined Filing Procedure may be applicable; or
d) there may be an aspect of willfulness (again, caution to our accounting professional friends in making this last determination, as this is a legal concept).
As a bottom line, U.S. taxpayers and their U.S. professional accounting advisors should take the Opinion very seriously in the context of Form 3520 and Form 3520-A penalties. Similarly, taxpayers and their advisors should consider the Opinion and the extent to which the IRS may impose multiple, or possibly duplicative, penalties on taxpayers in other contexts.
We would be glad to discuss our views on the Opinion and the related issues raised above if you have, may have, or are otherwise in need of assistance with, similar U.S. tax compliance issues.