A U.S. grantor of a foreign trust that is a grantor trust that receives a distribution from the trust as a beneficiary has two U.S. filing requirements attributable to the foreign trust status:
- Code Section 6048(b) requires U.S. owners of any portion of a foreign trust to ensure that the trust files a return for the tax year. A 5% penalty applies for noncompliance under Code Section 6677(b).
- Code section 6048(c) requires U.S. beneficiaries of a foreign trust that receive a distribution from the trust to report the distributions. A 35% penalty applies for noncompliance under Code Section 6677(a).
Forms 3520 and 3520-A are used for these reportings.
Before his death, Joseph A. Wilson received a $9.2 million distribution from a foreign grantor trust of which he was 100% owner. No filings were made under the above two provisions. The IRS imposed a 35% penalty of $3,221,183.
Wilson (and after his death) his estate claimed that when he was the owner of the trust, then only the 5% penalty should apply. The District Court ruled in favor of the estate.
On appeal, the 2nd Circuit Court of Appeals reversed and held that both penalties could apply (although technically the 5% penalty did not apply because that penalty is measured against the assets remaining in the trust at the end of the year and that amount was $0).
The taxpayer made numerous technical arguments based on various arguments that parsed the language of the various provisions. But in the end, the appellate court determined that the two reporting requirements were separate reporting requirements and the penalty provisions were also separate, with each applicable to its one particular reporting requirement to which it relates. No language in the statute supported an argument that only one of these penalties could be assessed when there are reporting failures under the two separate reporting requirements.
Estate of Wilson v. U.S., 2nd CA, Case No. 20-603 (July 28, 2021)
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