Dr. James formed an irrevocable trust in Nevis, West Indies for asset protection purposes. He properly reported the trust to the IRS on a Form 3520-A, but neglected to file a Form 3520. He is at risk for a penalty of the greater of $10,000 or 35% of the gross reportable amount – not an insignificant penalty (more than $578,000 in penalties for Dr. James). Code section 6677(a).
As is the case for many penalties, there is an exception if the failure to file was due to reasonable cause and not due to willful neglect. Dr. James claimed that he reasonably relied on his accountant to advise him on what returns should be filed, and that he had no personal knowledge of the Form 3520 filing requirements.
A taxpayer may reasonably rely on an expert’s advice as to tax filing obligations – this can constitute reasonable cause under the above penalty exception. In many cases, however, the facts do not support the exception. For example, the taxpayer may not have provided adequate information to the professional, or did not engage the professional to advise him on all required tax filings.
In the case of Dr. James, he had enough favorable facts to allow for a further review whether reasonable cause existed for his failure to file. These facts included:
a. Dr. James gave his accountant all the applicable trust documents;
b. Dr. James relied on the accountant to advise him on all required trust filings;
c. The accountant did advise him on some tax matters relating to the trust;
d. The accountant prepared Dr. James’ personal returns. On those returns he checked the box ‘no’ to the question whether Dr. James received a distribution from, or was the grantor of or transferor to, a foreign trust. This could be construed as advice to Dr. James that a Form 3520 was not needed.
e. Dr. James believed he filed all required returns, based on his discussions with his accountant.
Dr. James is not out of the woods yet – the case was simply a denial of the IRS’ motion for summary judgment that the exception to the penalty did not apply. Based on the court’s opinion, it would seem that the IRS has a difficult road ahead in convincing the court to apply the penalty.
The case is also representative of the zealousness with which the IRS is pursuing offshore accounts and trust nonreporting. It would seem that this was not a case of an intentional or egregious nonfiling, especially given the reliance on the taxpayer’s accountant and that other disclosure reporting was undertaken by the taxpayer of the trust to the IRS – instead, it looks more like a zero tolerance policy by the government. The case does not reveal whether Dr. James avoided reporting income from the trust – if he did that might provide additional justification for the IRS to throw the book at him.
James, 110 AFTR 2d ¶2012-5196 (2012, DC FL)