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Estate Gets Back Millions of Dollars of Overcharged 6048 Penalty on Untimely Form 3520 international-tax-sm.png

11 / 24 / 2019

TAX FORM:   Form 3520

TAX FORM TROUBLES:  Joseph Wilson sets up overseas trust in 2003, naming himself grantor and its sole owner and beneficiary, to place assets beyond the reach of his then-wife, who he had reason to believe was preparing to file a divorce action against him.  She did, and Wilson funded the trust with approximately $9 million in US T-Bills, accruing 5% interest or less.  The principal had been previously taxed in US.  Wilson reported the existence of this trust in 2003-2007, and in 2007, after the divorce proceedings, Wilson terminated the trust and transferred $9.2 back to his US bank accounts.  He was late in filing the Form 3520 disclosing distributions from a foreign trust.  The IRS assessed a late penalty of 35% of the distributions from the trust during the 2007 tax year, and because he had transferred all of the funds back, the penalty amounted to 35% of the total trust assets.  Wilson pays it, and then sued to get it back, contending that instead of the 35% tax under 6048(c), which applies to trust beneficiaries, he should have been assessed a 5% tax under 6048(b) which applies to trust grantor/owner.

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Wilson  v. United States, 2019 U.S. Dist. LEXIS (11-19-2019)

Joseph Wilson sets up overseas trust in 2003, naming himself grantor and its sole owner and beneficiary, to place assets beyond the reach of his then-wife, who he had reason to believe was preparing to file a divorce action against him.  She did, and Wilson funded the trust with approximately $9 million in US T-Bills, accruing 5% interest or less.  The principal had been previously taxed in US.  Wilson reported the existence of this trust in 2003-2007, and in 2007, after the divorce proceedings, Wilson terminated the trust and transferred $9.2 back to his US bank accounts.  He was late in filing the Form 3520 disclosing distributions from a foreign trust.  The IRS assessed a late penalty of 35% of the distributions from the trust during the 2007 tax year, and because he had transferred all of the funds back, the penalty amounted to 35% of the total trust assets.  Wilson pays it, and then sued to get it back, contending that instead of the 35% tax under 6048(c), which applies to trust beneficiaries, he should have been assessed a 5% tax under 6048(b) which applies to trust grantor/owner.

The Government moved to dismiss, arguing that the plaintiffs had failed to supply in support of the refund claim the "exact basis" for the refund, because they failed to properly set forth and compute the penalty under Section 6677.  The Court rejected this variance claim, finding that plaintiffs certainly set forth facts sufficient to enablen an intelligent administrative review of the claim.  Wilson had supplied support to demonstrate that Wilson was the grantor/settlor/owner and sole owner/beneficiary of the trust, that the entire trust assets were transferred back to the US before year's end 2007, and he had filed IRS disclosure forms.  Confusion over whether the penalty was 5% of trust assets or 5% of that year's distributions was a nitpicky distinction that did not amount to a fatal variance.   The Government's argument on this point was not viewed as credible.

The Plaintiff (estate) "cross-moved" for summary judgment, asking that the court determine that a 5% penalty is applicable for the late filing of the Form 3520 for the 2007 year.  The government argued that he should have been subject to both the 35% and 5% penalties, because each can be applied independently.  

The court rejected this argument.  The court found that since Wilson was the sole owner of the foreign trust as well as its sole beneficiary, and therefore, only required to file one Form 3520.  That then did not permit a "trust owner" to be also be penalized as a beneficiary for violating 6048(b) under a plain reading of 26 USC Section 6677.  The statute was viewed as mandating that 5% replace the 35% whenever there is a case of a return required under section 6048(b).  The taxpayer's penalties should not exceed the "gross reportable amount" and it followed also that a taxpayer should not be liable for any two penalties if their combined assessment would add up to more than the gross reportable amount for any one violation.  As the court viewed it, the Government was improperly seeking $3,221,183 above the $0 of trust assets in the foreign trust at the end of 2007.

The court noted that the form itself indicates that the beneficiary status is disregarded in favor of trust owner status, at least for purposes of tracking distributions to the owner.