Foreign trust reporting is one of the most heavily penalised areas of US tax compliance. Even when no US tax is due, failure to file the correct forms, or filing them incorrectly, can result in significant penalties.
This guide explains the main penalties US taxpayers face when foreign trust reporting goes wrong, focusing on Forms 3520 and 3520-A.
Why Foreign Trust Penalties Are So Severe
US tax law requires extensive information reporting for foreign trusts so the IRS can determine whether income or distributions should be taxed to a US grantor or beneficiary. When required information is missing, incomplete, or late, penalties can apply automatically.
Importantly, penalties are based on values of contributions, distributions, or trust assets, not on unpaid tax.
Form 3520: Penalties by Section
Form 3520 is filed by US persons, including grantors and beneficiaries, to report transactions with foreign trusts and certain foreign gifts. Different parts of the form carry different penalties.
Form 3520 – Part I
Failure to Report Contributions to a Foreign Trust
If you fail to report contributions to a foreign trust:
- Initial penalty is the greater of $10,000 or 35% of the total unreported contributions.
- If the IRS sends a notice and the form is not filed within 90 days, an additional penalty of $10,000 for each 30-day period may apply.
- Total penalties cannot exceed the total unreported contributions.
Form 3520 – Part II
Failure to Report Ownership of a Foreign Trust
If you fail to report ownership of a foreign trust under the grantor trust rules:
- Initial penalty is the greater of $10,000 or 5% of the total unreported trust assets.
- Additional penalties of $10,000 per 30-day period may apply after 90 days.
- Total penalties are capped at the value of the unreported trust assets.
Form 3520 – Part III
Failure to Report Distributions From a Foreign Trust
If you fail to report distributions or benefits received from a foreign trust:
- Initial penalty is the greater of $10,000 or 35% of the total unreported distributions.
- Additional continuation penalties may apply after 90 days.
- Total penalties are capped at the value of the unreported distributions.
This applies to distributions from both foreign grantor trusts and foreign non-grantor trusts, including non-cash benefits treated as distributions.
Form 3520 – Part IV
Failure to Report Certain Foreign Gifts
If you fail to report qualifying foreign gifts:
- Penalty is 5% of the value of the unreported gift per month.
- The total penalty is capped at 25% of the value of the unreported gift.
Form 3520-A: Penalties for Foreign Trusts With a US Owner
Form 3520-A is filed by the trustees of a foreign trust that has a US owner under the grantor trust rules. However, if the trustees fail to file it, the US owner becomes responsible.
Penalty for Failure to File Form 3520-A
If Form 3520-A (or a substitute form) is not filed:
- Initial penalty is the greater of $10,000 or 5% of the gross value of the portion of trust assets treated as owned by the US person at year-end.
- If the IRS sends a notice and the form is not filed within 90 days, an additional penalty of $10,000 for each 30-day period may apply.
- Total penalties cannot exceed the value of the US owner’s trust assets.
This means a US grantor can be penalised even though the filing obligation technically belongs to the trustees.
Common Situations That Trigger Penalties
Penalties often arise when:
- A US beneficiary receives a distribution but does not file Form 3520
- Trustees fail to file Form 3520-A for a foreign grantor trust
- Required trust statements are missing or incomplete
- A US person assumes no filing is required because no tax is due
- Reporting deadlines are missed
In some cases, if proper reporting information is not provided, the IRS may determine taxable income unilaterally, increasing tax exposure in addition to penalties.
Key Takeaways
- Foreign trust penalties apply even when no US tax is owed.
- Form 3520 penalties can reach 35% of unreported contributions or distributions.
- Form 3520-A penalties are tied to the value of trust assets, not income.
- Additional penalties apply if failures continue after IRS notice.
- US grantors may be penalised for trustee failures.
Final Thoughts
Foreign trust reporting errors are among the most expensive compliance mistakes US taxpayers can make. Understanding the penalty framework is essential for anyone involved with foreign trusts, whether as a grantor, trustee, or a beneficiary.
The information in this blog post is for general informational purposes only and does not constitute professional tax advice. We strongly recommend consulting a qualified tax professional before making any decisions. US Expat Tax Advisor is not liable for any actions taken based on this content.
