Penalties for Late Filed Forms 3520, 3520-A, 5471, and 5472

In episode 58 of How Tax Works, Matt Foreman discusses  Zhang v. IRS, No. 4:24-cv-08210 (N.D. Cal. 2026), which held that the IRS does not need to file a civil lawsuit to impose penalties for a late-filed Form 3520.  Zhang is a related case to Farhy, and applies the same principles to penalties for late- or non-filed Forms 3520-A, 5471, and 5472

How Tax Works, hosted by Falcon Rappaport & Berkman LLP Partner Matthew E. Foreman, Esq., LL.M., delves into the intricacies of taxation, breaking down complex concepts for a clearer understanding of how tax laws impact your financial decisions.

Follow us on Bluesky:
@howtaxworks.bsky.social

This podcast may be considered attorney advertising. This podcast is not presented for purposes of legal advice or for providing a legal opinion. Before any of the presenting attorneys can provide legal advice to any person or entity, and before an attorney-client relationship is formed, that attorney must have a signed fee agreement with a client setting forth the firm’s scope of representation and the fees that will be charged. 

This Podcast is Hosted by:
Falcon Rappaport & Berkman LLP
1185 Avenue of the Americas, Suite 1415
New York, NY 10036
(212) 203 -3255
info@frblaw.com

Transcript

Matthew Foreman [00:00:12]:
Hello and welcome to the 58th episode of How Tax Works. I'm Matt Foreman. In this episode, I'll discuss the imposition of penalties under Section 6039 for late or non-filed 3520s and how it extends to 3520s, 5471s, and 5472s. I promise you, if you don't know what those are, you will, you'll learn it fairly quickly. How Tax Works is meant for informational and entertainment purposes only. This is not legal advice and it may be attorney advertising. Please hire your own attorney. How Tax Works is intended to help listeners navigate the intricacies and complexities of tax law, regulations, case law, and guidance to demystify how taxes shape the financial and business decisions that we all make.

Matthew Foreman [00:00:57]:
New episodes every 2 weeks. The next episode's about partnership allocations and the need for substantial economic effect. If you have any questions, comments, or constructive criticism, you can email me or post against me, I guess, on LinkedIn. Upcoming webinars. I actually have some. Hey, how about that? It should be, it should be up by now, I believe, on the FRB webpage. If not, you can email me or connect on LinkedIn, and I, I'm sure I've posted it by now. Obviously I record these in advance, so I, I don't know what I'm doing in advance and exactly when, but November 3rd, pass— then these are all, hold on, these are all credits for CLE, CPE for accountants, for CPAs, CE for EAs, and CPE for CFPs.

Matthew Foreman [00:01:37]:
November 3rd, pass after loss limitations. November 10th, selling a business, tax and non-tax considerations. November 17th, payroll taxes, SORBON, Sirius, and S corps. December, skipping a week, December 1st, Opportunity Zones 2.0, hopefully with the updated regulations, recently released regulations. December 8th, QSBS update, hopefully again with updated and new regulations. And December 15th, granting equity to employees. And now let's talk about tax here. Here we are.

Matthew Foreman [00:02:05]:
So Zhang. Zhang is an interesting, interesting, interesting case. Yeah. It is a penalty case for a late-filed Form 3520. It is the same concept as Farhi, which was D.C. Circuit. This is the Northern District of California. Double-check this one.

Matthew Foreman [00:02:24]:
For those who don't know what a 3520 is for, I will give you the extremely short update. When a U.S. person, whether citizen, resident, certain visas, etc., receives a gift, they're required— exceeding an amount, I believe it's $10,000, they're required to disclose it on Form 3520. There is no tax whatsoever, but a disclosure is required by statute. In this situation, there are wedding gifts totaling $287,108. Okay, again, I, I, it is $10,000. You must file a Form 3520 if you receive a single gift exceeding $10,000. So if 32 people send you gifts and the total is over $10,000, that's fine as long as none of the specific ones are over $10,000.

Matthew Foreman [00:03:21]:
And the gifts are coming from non-residents. That I probably should have said that more clearly. If it's from a resident, then you probably have a gift tax requirement, filing requirement, because the gift tax Right. In this, you know, the taxpayer Zhang filed a 2017 income tax return with TurboTax, no gift tax return. For those who don't know TurboTax, I don't know if they actually do ask, but at one point they didn't. They may now. An assessment will happen in 2020. The penalty is 5% penalty per month late, maximum of 5 months.

Matthew Foreman [00:03:53]:
So effectively a 25% penalty. Or on the gift amount, it ended up being roughly $70,000. The taxpayer filed the 3520 late in October of 2018, so it wasn't even that late, and basically said, hi, I didn't know, it's a weird one, and requested penalty abatement. I'm going to make a comment here, and this is my entire policy thing. I— the IRS historically has not been great about abating these. I think this is a mistake. Given especially this taxpayer's fact pattern. And the reason that I believe that is a very simple one.

Matthew Foreman [00:04:29]:
The goal of this return— there's no tax. There is no tax. The government missed no tax. This is information. If you want to incentivize people to come forward and disclose, you don't want to then say, well, but if you, you disclose late before we catch you, we're gonna hit you with the same penalty. As if you didn't disclose at all. That doesn't really make sense. There's no incentive to comply at all.

Matthew Foreman [00:04:55]:
Again, and also this taxpayer, unlike Farhi— Farhi was a bad dude. This taxpayer just got wedding gifts, really not a whole lot going on, no active concealment, nothing like that. So I just, I don't know, I don't get it. I don't understand. This is a weird— it's not even a tax, and that's what's important. It's just a weird information reporting requirement that's largely out of lockstep with any other reporting requirement that exists. So I think it catches a lot of people unaware and unexpected. And I just, I don't know, I think they should be much more general on this.

Matthew Foreman [00:05:29]:
So anyway, filed the 3520 late, requested penalty abatement, and then appealed to Independent Office of Appeals. The Independent Office of Appeals lowered the penalty from 25% to 20%. 20%. So I mean, awesome. It's like, you know, $10,000, $12,000, $14,000. Great. And then Taxpayer Paid filed a refund claim, said there was reasonable cause, said that this violates the excessive fines clause of the Eighth Amendment. It then said the IRS lacked authority to assess the 6039 Cap F penalty and some other arguments that I'm just going to ignore because I don't really think they're that interesting.

Matthew Foreman [00:06:03]:
They weren't successful, and I think the other ones are much better arguments. So we'll, we'll, we'll stick with those. Before I get there, let's get some music in a little early on this one, but I think this is one where before we really dig into it, it would make sense to take a quick break. So we'll be back in just a moment. So, so bad. So let's talk about reasonable cause. As I said, you know, previously, I think reasonable cause should be granted more often with these. The IRS would never ever find these.

Matthew Foreman [00:06:51]:
A lot of these, you know, I've seen ones where non-resident aliens are doing, you know, transferring this and the money is coming from bank accounts for banks that are located in, you know, G20 countries. They're located in the U.S. bank accounts. They just happen to be held by non-residents. And they're just— the information's there. They theoretically could find them. They are never going to find them. And I think that if your goal is compliance, then you should be abating this penalty.

Matthew Foreman [00:07:23]:
If your goal is punishing people, which I don't think it ever should be in this context, then yeah, do what you're doing. But if you're— you want to encourage compliance, that's it. Aggressively, you know, quite as simple, aggressively imposing penalties creates an incentive to continue non-compliance. And especially with 3520 and 3520-A, because there's no tax due, nor there can be tax due. 3520-A is when a US person holds an interest in a foreign trust. I've seen those a lot. A lot of them are grantor trusts. So they already paid the tax, or the trust made a distribution.

Matthew Foreman [00:07:58]:
So again, they already paid the tax. So I don't know what's going on. 5471, 5472, you know, there could be tax due, there could be, there could be stuff like that. So there's sort of some incentive to be like, hey, like, you know, you should know about this. But they're quirky, and I think that that's a really, really important one. Generally, the 6039 F, and it's capital F, not parenthesis F, penalty. The taxpayers' argument is that if no recovery mechanism is in the statute, the IRS must use civil action under Title 28 of the United States Code, Section 2461. This is the same argument— I'll read what it says in a second— as what Farhi did.

Matthew Foreman [00:08:36]:
Okay, and I'll get to Farhi in a second. The language is, whenever a civil fine, penalty, or pecuniary forfeiture is prescribed for the violation of an act of Congress, Without specifying the mode of recovery or enforcement thereof, it may be recovered in a civil action. This is the same again, like I said, in Farhi. Farhi was Tax Court and then DC Circuit overturned. In Farhi, he, the taxpayer there, had, I believe it was Panamanian corporations and didn't file 5471s. You have to file 5471 if you own more than a certain amount of foreign corporation. It's by CFC, so it's more than 50%. It's more than 50%, I believe, or it's 50 or more percent.

Matthew Foreman [00:09:15]:
I always mix that up. And I make a point never to own it, never to learn it, because I always have the question, and what is ownership and how is it ownership and how does the waterfall work and things like that? It can depend, right? So it was a non-file penalty. It was under 6038. The Tax Court said you can only impose it for a civil action. The D.C. Circuit on appeal overturned, said Congress renders penalties assessable in more ways than through explicit reference alone, and penalties can be rendered assessable by implication, which I thought was kind of a heck of a reading. If a reasonable cause defense is explicitly permitted, surely penalties must be assessable under the same statute. Okay, Section 6201 of the Internal Revenue Code, the Treasury Secretary, which means the IRS, may assess all taxes, including interest, additional amounts, additions to the tax, and assessable penalties imposed by the Internal Revenue Code.

Matthew Foreman [00:10:13]:
While tax and penalties are different things, they're assessed in the same manner and they're collected in the same manner. So what they're basically saying— this is what FARHEE said, and we'll get to what's going on here in a second— is that even though it doesn't say you have to collect in X manner. What they're basically saying is the statute itself, 6201, views this, um, as a— views this penalty imposed, okay, as an addition to tax. And because the addition to tax can be imposed or assessed by the IRS, by Treasury Secretary, but the IRS has the authority under that Treasury Secretary delegate, that you don't actually need to file a lawsuit in order to assess and collect. You can assess and collect without it. That's what it says. And the implication— I thought this was a— penalties can be rendered assessable by implication. And this leads to a really tough situation for tax lawyers, any tax professional, right? Yeah.

Matthew Foreman [00:11:28]:
Tax professionals will always say, you know, what does Congress say? What is it intending to say? But also, what does it actually say? What, what are the words there? The idea that you can assess a penalty by implication is kind of squirrely, that even if Congress's drafting was not very good, it doesn't mean they messed up. And I think I understand what the courts are saying here. But I do not understand what they're trying to do here because I think they're exceeding the statutory authority there. So there's really 2 arguments that are going: the IRS's argument, which is what the DC Circuit and the Northern District of California now have, or the taxpayers' argument, which is what everyone else has because of how the Tax Court said it in, in Farhi. And what it essentially says is that the, the IRS's view is that no, no, no, no, no, they just intended to be a penalty, to be an addition to tax. Therefore, it's assessed in the same way as a tax. Therefore, you don't need special authority. You don't need a lawsuit.

Matthew Foreman [00:12:40]:
The argument that Farhi made and the taxpayer here is making is that, look, if Congress does not specifically prescribe a way to collect it, then the only way to recover it is a civil action. What the IRS points to, and it is a really good argument in doing it, oh, this is— no, I think it's a really good argument, I really do, is the statute in 60— in 28 USC 2461 says may be recovered in civil action. And the question becomes, may be recovered in civil action, Does that mean that the IRS may recover it through other means than a civil action, or does it mean that the IRS, if it also has the opportunity to do it otherwise, may still use a civil action even if, you know, Congress says you can do it X way? And courts, both again the D.C. Circuit and the Northern District of California, that, that means that if there is another way to read the statute, to keep the statute, which means that penalty becomes the tax as an addition to tax, and then it's assessed through normal mechanism, 6201 of the Internal Revenue Code, then that's it. You're done. Stop reading. No more. I don't know.

Matthew Foreman [00:14:07]:
I don't know if I believe that. I don't know if I agree to that, but they're both fairly viable ones. I tend to be a little more literal when thinking about, you know, the IRS and Congress, because Congress writes the laws. And I say this fairly often, taxpayers, especially when it comes to like state residency rules, the legislature writes the law. And therefore, because they have the authority and the ability to write the law, that they can write it in a very one-sided manner. But if they don't run it, write it the way they want, they should not be saved by court saying, well, this is what they meant to say. They have to actually say what they meant to say or something that otherwise works. And I'm not sure it does.

Matthew Foreman [00:14:51]:
One other thing, you know, that they talk about in this is the Eighth Amendment. They just kind of— they just kind of wave their hand, but they cite a lot of cases. They said the penalty is not a fine, so it's not a problem. Penalty or any payment can only be a fine if it is a punishment for some offense. They cite Austin, 509 U.S. 602. Spot cite is 609, 610. It's a 1993 Supreme Court case, and it defines what a fine is or what a penalty— what a fine is.

Matthew Foreman [00:15:19]:
And so therefore, to be a fine, the purpose of the penalty must be primarily retribution or a deterrent rather than remedial. Also signing Austin. I think that, you know, I've sort of said this is that the penalty itself is not a deterrent, right? Penalty is, is, I think it's kind of punitive. So I appreciate what the definition is, and we're sort of stuck by the definitions of courts. I struggle with it, you know, but it is what it is. This is the answer. I'm not gonna do music again. Let's just kind of close this one out.

Matthew Foreman [00:15:54]:
I think this will be a shorter one, such as life. life, right? So open questions. One, is there reasonable cause to abate? I am of the opinion that for things like these penalties, especially 3520 and 3520-A, where it's only information reporting and no tax is possible from it— 5471, 5472 involve business entities that are earning income, so there is theoretically tax from them, although neither form actually imposes a tax of any sort. Right. Those ones is different, but I, I think as long as you file this before the IRS finds you, I think they should abate it every time. And I think conversely, if you don't file this and the IRS finds you, I think there should be a full penalty with no abatement every time. It should be completely binary. I think the simple act of filing late is sufficient under one extreme exception.

Matthew Foreman [00:16:49]:
If you've done this for 10 years and then you miss a year, I think penalties will see what will go into the normal reasonable cause abatement. Conversely, I didn't know about this one. Look, I've written penalty abatement requests on this post-Farhi, all post-Farhi, a couple before. And what I said is this is a quirky tax. I was a little more technical than that. It doesn't exist elsewhere. It doesn't really make sense elsewhere. Therefore, not knowing about it is reasonable.

Matthew Foreman [00:17:15]:
Yeah. And therefore should be it. So that's it. They also, you know, in it talked about managerial approval for the imposition of the penalty. For those who have not been following, IRS got dinged a bunch because they have to be able to produce proof that there was managerial approval for the imposition of a penalty. I mean, it can mean literally click a box on your computer, click yes. It's not like we need, you know, 30 forms. There's no DTF-9s or something.

Matthew Foreman [00:17:37]:
So I think that the really important kind of comment there Is that as long as they can show they can do it, the IRS has also been abating penalties pretty aggressively where they may not be able to show managerial approval. So I think it's really important to make sure that exists there. And again, look, Congress makes the rules. They don't like that rule, they can change it. Keep their feet to the fire. So what's the solution? What's the final answer to this, right? Tax court, you need a civil action everywhere except for the DC in DC or the Northern District of California. Those 2, you do not need a civil action. The IRS disagrees with what I just said.

Matthew Foreman [00:18:14]:
They think Farhi was wrong and should just get overturned generally, but it's unlikely to do so. And without a couple more cases, I don't think it's gonna. Fortunately/unfortunately, there's a couple cases involving 4 forms, multiple statutes, so this is likely to keep coming up. So that's the question. I don't think the IRS is going to go for civil action. I think they're going to keep, to the extent they don't abate penalties, and they've actually been very gentle and have abated a lot of penalties. They, each time they didn't actually say why, they just said, oh, we've decided to. Both times I went through, appealed to the independent, or multiple, like 4 or 5, appealed to the Independent Office of Appeals.

Matthew Foreman [00:18:49]:
And before there was even a hearing, penalties got abated. That was the letter. Like, congratulations, you were done. So I think it's really important to do it. Look, if you need to get one of these abated for any of those forms, 3520, 3520-A, 5520, 5471, 5472, and it's just that I didn't know I had to do it. Just cite Farhi, say you don't have to, even if you're in DC or Northern District of California, and say, look, like, there really is reasonable cause, but also there's a question you might get overturned. Farhi, Farhi, Farhi, and hope for the best. I've actually found it to be pretty successful.

Matthew Foreman [00:19:22]:
It's a pretty good argument. All right, well, thank you. That was the 58th episode of How Tax Works. I hope you learned something. We'll be back in 2 weeks, 59th episode, which will be about partnership allocations. And the need for substantial economic effect. And now for the very best song of all time.