Understanding Form 3520: Reporting Transactions with Foreign Trusts and Receipt of Foreign Gifts

Form 3520 is a critical IRS compliance document required for U.S. taxpayers who engage in certain transactions with foreign trusts or receive significant gifts or inheritances from foreign persons or entities. While it is an informational return (not a tax return itself), failure to file can result in steep penalties. Understanding when and how to file is essential for staying compliant with U.S. tax law and avoiding unnecessary IRS scrutiny.

What Is Form 3520?

Form 3520, officially titled “Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts”, serves as the IRS’s mechanism to track the flow of money and assets between U.S. taxpayers and foreign individuals, entities, or trusts.

It is used to report:

1. Transactions with Foreign Trusts
   • Direct or indirect transfers to foreign trusts.
   • The creation of a foreign trust.
   • Ownership of foreign trusts under U.S. “grantor trust” rules.
   • Receipt of distributions from a foreign trust.
2. Receipt of Foreign Gifts or Bequests
   • Large gifts or inheritances from non-U.S. individuals.
   • Transfers from foreign corporations or partnerships that may function as disguised gifts.

Why Does the IRS Require This Form?

The IRS uses Form 3520 to ensure that:

• U.S. taxpayers are not using foreign trusts or entities to hide income or avoid U.S. tax.
• Significant foreign gifts and bequests are transparent and not disguised transfers of income.
• Proper reporting aligns with global anti-money laundering and anti-tax evasion initiatives (e.g., FATCA).

Who Must File Form 3520?

You must file Form 3520 if you are a U.S. person (U.S. citizen, resident alien, or certain domestic entities) and any of the following applies:

1. Receipt of Foreign Gifts or Bequests

• Baseline Rule: Under current law (IRS Notice 97-34), you must file Form 3520 if you receive gifts or inheritances from foreign individuals or estates exceeding $100,000 in aggregate during the tax year.
• Proposed Regulations (2024): In 2024, the IRS issued proposed regulations that reduce this threshold to $19,570 (indexed annually for inflation).
  • Taxpayers may elect to rely on these proposed regulations for tax years ending after May 8, 2024, but only if they and all related persons apply the proposed regulations in their entirety and consistently for all relevant years.
  • If you do not elect to rely on the proposed regulations, the $100,000 threshold remains in effect until the proposed regulations are finalized.
• Gifts from Foreign Corporations or Partnerships: The reporting threshold is $19,570 for 2024 (indexed annually).
• Aggregation Rule: Multiple gifts from related parties are aggregated to determine whether thresholds are exceeded.

Example: If you receive $70,000 from your foreign father and $50,000 from your foreign mother in the same year, the total is $120,000 — triggering a Form 3520 filing requirement under the $100,000 rule..

2. Engagement with Foreign Trusts

1. 1. You create or transfer property to a foreign trust.
   2. You are treated as the “owner” of a foreign trust under grantor trust rules.
   3. You receive money or assets from a foreign trust.

Example: If a foreign relative establishes a trust abroad and names you as a beneficiary, you must report distributions received on Form 3520.

How to File Form 3520

1. Obtain the Form
   Download it directly from the IRS Website: https://www.irs.gov/pub/irs-pdf/3520.pdf
2. Complete the Form
   • Enter taxpayer details (name, address, SSN/ITIN).
   • Report gifts, bequests, or trust transactions, including amounts, dates, and donor details.
   • For trusts, identify the trust, trustee, and describe the transaction.
3. Attach Supporting Documents
   • Bank statements, legal documents, or trust agreements that substantiate the reported activity.
   • Translation of documents if not in English.
4. Submit the Form
   • Unlike Form 1040, Form 3520 is filed separately.
   • Mail to the IRS address provided in the form instructions (Ogden, Utah).

When to File Form 3520?

• Due Date: The 15th day of the 4th month after the end of your tax year (generally April 15 for calendar-year taxpayers).
• Extensions: If you file Form 4868 for an extension of your income tax return, the extension also applies to Form 3520 (new due date usually October 15).
• Important Note: The deadline for Form 3520 is not automatically the same as Form 1040 unless you extend both.

Penalties for Non-Compliance

The IRS enforces harsh penalties to deter non-filing or late filing:

1. Monetary Penalties
   • $10,000 minimum penalty or:
     • 35% of the gross value of property transferred to or received from a foreign trust.
     • 5% per month (up to 25%) of the value of unreported foreign gifts or bequests.
     • 5% of foreign trust assets treated as owned by a U.S. person under grantor rules.
2. Continued Failures
   • Penalties accrue monthly if the taxpayer continues to withhold information.
   • The IRS may disallow reasonable cause defenses if it determines “willful neglect.”
3. Increased Scrutiny
   • Late or inaccurate filings can trigger further IRS audits or requests for foreign account information.

Common Pitfalls

• Assuming gifts from family don’t count: Even inheritances from parents abroad can require filing if thresholds are met.
• Confusing Form 3520 with Form 8938 or FBAR: These forms cover foreign accounts and assets, not foreign gifts. In many cases, taxpayers must file multiple forms.
• Missing aggregation rules: Gifts from related parties must be combined to see if thresholds are exceeded.
• Failure to extend properly: Taxpayers often extend their Form 1040 but forget Form 3520 must also be extended.

Conclusion

Form 3520 is not a tax return, but an informational reporting requirement with teeth. Its purpose is transparency: to notify the IRS of significant foreign gifts, inheritances, and trust activity that could otherwise go unreported.

By understanding the filing requirements, thresholds, deadlines, and penalties, U.S. taxpayers can avoid unnecessary exposure to severe fines. Because foreign trust and gift reporting can quickly become complex — especially where multiple jurisdictions, trusts, or large sums are involved — consulting with a tax professional experienced in international compliance is strongly advised.

Practical Example: Reporting a Foreign Inheritance

Scenario:
In 2024, Ms. Hughes, a U.S. taxpayer, inherits $700,000 from her late father’s estate in UK. On January 2, 2024, the estate distributes the full $700,000 to her. Of this amount:

• $80,000 is wired to her U.S. bank account.
• $620,000 remains in a UK investment account that she now controls.

Step 1 – Identify the Filing Requirement

• Because Ms. Hughes is a U.S. person, she must determine if her inheritance triggers Form 3520.
• Since the total inheritance from a foreign person exceeds $100,000, she must file Form 3520, Part IV (Receipt of Certain Foreign Gifts and Bequests).

Step 2 – Aggregate and Report the Full Value

• The reporting threshold is based on the entire amount received ($700,000), not just the portion transferred to the U.S.
• On Form 3520, she reports:
  • The donor’s information (her father’s estate, including address).
  • The total amount of the bequest ($700,000).
  • A description of the property (cash inheritance, partially transferred to the U.S., remainder left in foreign account).

Step 3 – Coordinate With Other Forms

• Form 3520: Reports the inheritance.
• FBAR (FinCEN 114): She must also report the foreign investment account because it is under her control and exceeds $10,000.
• Form 8938 (FATCA): If she meets the filing threshold, she must also disclose the foreign account and assets on her tax return.

Step 4 – Filing Timeline

• Since she is a calendar-year taxpayer, her 2024 Form 3520 is due April 15, 2025, unless she files Form 4868, which extends the due date to October 15, 2025.
• Form 3520 is not filed with her Form 1040 but mailed separately to the IRS in Ogden, Utah.

Step 5 – Potential Pitfalls to Avoid

• Ms. Hughes must report the entire $700,000 — not just the $80,000 transferred to the U.S.
• If she fails to file, she could face penalties of 5% per month (up to 25%) of the $700,000, which could be as much as $175,000.
• Providing supporting documents (estate letter, bank transfer records) helps substantiate the filing.

👉 This example illustrates how even a straightforward foreign inheritance requires careful reporting across multiple forms. The key lesson is: the IRS looks at the total gift or bequest, not just the portion that crosses into the U.S.

Example: Ms. Hughes’s Form 3520 Entry (Foreign Inheritance)

Part I – General Information

• Line 1a (Name of U.S. Person): Hughes, Rachel (SSN: XXX-XX-1234)
• Line 1b (Address): 123 Main Street, Philadelphia, PA 19103

Part IV – U.S. Recipients of Gifts or Bequests Received During the Current Tax Year from Foreign Persons

• Line 54a (Date of Gift or Bequest): 01/02/2024
• Line 54b (Description of Property Received): Cash inheritance from estate of father, Hughes, Adam, deceased 12/01/2023 (Estate located in London, UK).
• Line 54c (Fair Market Value of Property on Date of Receipt): $700,000
• Line 54d (Donor’s Name and Address): Estate of Adam Hughes (UK address)

Accompanying Statement (Attached to Form 3520)

On January 2, 2024, taxpayer received $700,000 from the estate of her father, Adam Hughes, located in London, UK. Of this amount, $80,000 was transferred to a U.S. bank account at ABC Bank (Philadelphia, PA) on January 5, 2024. The remaining $620,000 remains in a UK investment account under taxpayer’s control. The reported value reflects the total bequest received, not just the portion transferred to the United States.

Other Forms Required in Coordination

• FBAR (FinCEN 114): Report the UK investment account (since balance > $10,000).
• Form 8938 (FATCA): Disclose foreign investment account and assets if thresholds are met.

Why This Format Matters

• The main Form 3520 entry provides the required details: date, description, amount, and donor information.
• The accompanying statement clarifies the movement of funds ($80k U.S. transfer vs. $620k held abroad). This prevents IRS confusion and shows proactive transparency.
• Coordinating with FBAR and Form 8938 ensures full compliance.

Article Submitted by Allen S. Hsu, CPA