Problems Facing Taxpayers with Foreign Information Return Penalties and Recommendations for Improving the System (Part 3 of 3)

By Megan L. Brackney
Procedurally Taxing
January 8, 2020

The Gifts That Keep on Giving

Two young people moved to the U.S. as students.  They met in graduate school and married.  After graduation, they were offered jobs and were sponsored by their employers so that they could stay in the U.S.  While they were students, their parents from their home country sent them money to help pay for their expenses in the U.S.  After they became U.S. taxpayers, they received a few more gifts, totaling more than $100,000.  They told their CPA about these gifts, and even showed him copies of their bank statements so that he could see the wire transfers from their parents’ non-U.S. accounts.  The CPA told them that because these were gifts and not subject to taxation, they did not need to be reported.  The CPA did not advise them of the Form 3520 filing requirement for gifts from foreign persons that exceed $100,000 in the aggregate during the tax year.  Neither of the taxpayers had any knowledge of the Form 3520, and genuinely believed that they were filing their returns correctly.

A few years later, the taxpayers switched to a new CPA and again mentioned the gift issue, and she told them that they should have been filing Forms 3520 after they became U.S. taxpayers.  She prepared three Forms 3520 with statements explaining their reasonable cause, and the taxpayers filed them.  There was no audit or inquiry by the IRS and no tax due as a result of the error, and other than this understandable omission, they have a perfect compliance history.  The CPA was not aware of the Delinquent International Information Return Submission Procedures, but the taxpayers’ submission nevertheless substantially complied with the requirements for that procedure. 

Soon after their good faith attempt to self-correct, the IRS assessed the maximum amount of penalties on both taxpayers pursuant to I.R.C. § 6039F – 25% of the amount of the gifts they had received.  The IRS issued separate notices for the three years so that there were three different deadlines for the appeals, and thus three separate appeals.       

These notices were entitled “Notice of Penalty Charge.”  The Notices stated merely that “you have been charged a penalty under Section 6039F of the Internal Revenue Code for Failure to File Form 3520 to Report Receipt of Certain Gifts” and did not provide any other information or explanation.  As the word “charge” does not appear in the Code or Regulations, a lay person would not know from this notice whether there has actually been an assessment of the penalty. 

The only information provided about how to challenge the penalty was to state that the taxpayer could submit a written request for appeal within 30 days from the date of the notice which, “should reflect all facts that you contend are reasonable cause for not asserting this penalty.” 

The notice does not contain any information about collection while the appeal is pending but contains the following statement: “If you do not wish to appeal this penalty, there is nothing you need to do at this time.  You may later dispute the penalty by paying the penalty and then filing a claim.”  A reasonable layperson could interpret this to mean that the taxpayer does not have to pay the penalty until after his or her appeal.  And, indeed, as noted in the previous column, Internal Revenue Manual 8.11.5.1 states that taxpayers are afforded pre-payment appeals.  The notice does not explain any of this, however, and yet the IRS will only suspend collection activity if the taxpayer separately notifies Collections that he or she has filed an appeal (and frequently not even then).

Moreover, from the notice, there is no indication that the IRS obtained managerial approval of the penalty, as is required by I.R.C. § 6751(b), and no indication that the IRS considered the reasonable cause defense submitted along with the Forms 3520. 

The taxpayers timely submitted an appeal to each penalty, explaining again that they had reasonable cause for failure to file foreign information returns, i.e., that that they retained a competent CPA to prepare their returns, that they gave him full and complete information, and they reasonably relied on his advice that nothing needed to be done to report the gifts from their parents.

Despite the timely appeals, the IRS has continued sending collection notices.  In response to Notice CP504, the taxpayers requested that the IRS place a hold on collection pending the appeal.  The IRS did not respond, but moved forward with issuing the notice of intent to levy on one tax year.  The taxpayers were forced to file a CDP request to prevent enforced collection while Appeals considers their reasonable cause defense.  The taxpayers are frightened that the IRS will file a notice of federal tax lien, which would be devastating as they are trying to buy a house right now.  

In the meantime, for one of the tax years, the IRS sent the taxpayers a notice stating that it was rerouting the taxpayers’ correspondence (the timely filed appeal) to the Frivolous Correspondence Department.  The taxpayers promptly responded with a letter explaining that their appeal was not frivolous, and that they had a right to Appeals review, and that the IRS cannot refuse to forward their protest to Appeals.  They have received no further communications regarding the appeal. 

For another tax year, the taxpayers received a cryptic letter from the Service Center, responding to their correspondence (with the same date as the appeal for that year), by stating “We reviewed the information you provided and determined that no action is necessary on your account.”      

The taxpayers have not received any further communications from Appeals.  We have tried to find someone at the IRS who has this file, but have had no luck.  Although the Service Center told me that their case is assigned to the field, no one at that office has specific responsibility over it.  As of the date of publication of this column, the taxpayers have been waiting for over a year for an Appeals conference.  Meanwhile, the IRS collection machinery rolls on, without regard to the fact that the taxpayers have never had any Appeals review of the assessments. 

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Click here for Part Two