Penalty for failure to report distribution from foreign trust not reduced.

• Author: Beavers, James A.

The Sec. 6677(a) 35% penalty for the failure by a beneficiary to timely file an information return for a distribution from a foreign trust is not reduced to a 5% penalty when the beneficiary is also the owner of the trust.

Background

In 2003, when Joseph Wilson's wife was planning to divorce him, Wilson established an overseas trust for the sole purpose of putting his assets outside the reach of his wife. Wilson was the sole owner and beneficiary of the trust. He named himself its grantor and funded the trust with approximately $9 million in U.S. Treasury bills, accruing annual interest of 5% or less. In 2007, upon conclusion of the divorce proceedings, Wilson terminated the trust and transferred the assets, which were worth approximately $9.2 million, back to his U.S. bank accounts.

Sec. 6048 imposes disclosure requirements related to foreign trusts. Sec. 6048(b) requires a foreign trust's owner to file a return reporting the trust's activities and operations for the year and any other information specified by the IRS. The trust reports this information on Form 3520-A, Annual Information Return of Foreign Trust With a U.S. Owner. Sec. 6048(c) requires a beneficiary of a foreign trust that receives a distribution from the trust in a year to file a return reporting the distributions received from the trust. A beneficiary reports this information on Form 3520, Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts.

To ensure that trusts and their owners and beneficiaries comply with these information reporting requirements, Sec. 6677 provides penalties for the failure to meet them. Under Sec. 6677(a), if a person required to file a return under Sec. 6048 does not file the return on time or files an incomplete return, the person generally is subject to a penalty of 35% of the amount of the reportable distribution. However, Sec. 6677(b) provides that in the case of a return required under Sec. 6048(b), the penalty in Sec. 6677(a) is applied by substituting "5 percent" for "35 percent."

For 2007, Wilson failed to timely file a Form 3520 disclosing the approximately $9.2 million he received from the trust, and the trust failed to timely file a Form 3520-A reporting the information required under Sec. 6048(b). The IRS, applying Sec. 6677(a), assessed a penalty of $3,221,183 (35% of the distribution from the trust) for Wilson's failure to report the distribution to himself.

Wilson initially paid the penalty...