Form 3520 and Form 3520-A went largely unmonitored by the IRS for decades. They would only cast their gaze to someone’s 3520 or 3520-A when they were already under exam and they were seeking easier paths to the application of penalties. The period of IRS dormancy concerning these filings ended on May 21st, 2018 when the IRS added 3520 and 3520-A to their “compliance campaigns” (yes, unfortunately, “compliance campaigns” are a real thing:https://www.irs.gov/businesses/large-business-and-international-compliance-campaigns)

The IRS then updated their systems to generate notices to taxpayers imposing penalties based on how certain information was reported on Form 3520 and Form 3520-A. As you probably guessed, this was an enormous failure. The IRS improperly penalized lots and lots of people, to the point where their international helpline was overrun with individuals calling about these penalties. 

The IRS staff, now overwhelmed by the correspondence associated with these penalties (even pre-covid the IRS was taking over a year to respond to correspondence and reasonable cause letters relating to these penalties), needed an avenue to address a lot of these calls, offer taxpayers relief where it was convenient, but still preserve the ability to penalize individuals for 3520 and 3520-A issues whenever a case actually reached a revenue agent. 

Enter Revenue Procedure 2020-17. A close read of the requirements of this revenue procedure makes it pretty clear that most individuals are not going to be able to utilize this revenue procedure to avoid Form 3520 and Form 3520-A reporting, although there is little doubt that a lot of individuals, and even a lot of professionals, are going to incorrectly conclude that some of these protections extend to retirement accounts that are actually not covered.

Under 2020-17, to benefit from the ‘relief’ you need to have an “applicable trust” and you need to be an “eligible individual”.

For a trust to be an applicable trust, it must:

1. Be created under the laws of a foreign country to operate almost exclusively to provide retirement benefits and it must meet the following requirements:

1. It must be exempt from income tax or tax favored in the foreign country. 

2. Annual information reporting regarding the trust must be provided or available to the taxing authority in the foreign country.

3. All contributions need to be associated with the performance of personal services.

4. Contributions to the trust must be limited by a percentage of the earned income of the participant, the contributions subject to an annual limit of $50,000, or are subject to a lifetime limit of $1,000,000. 

5. Withdrawals, distributions, or payments from the trust must be conditioned upon reaching a specified retirement age, disability, or death, or penalties apply to withdrawals, distributions, or payments made before such conditions are met.

6. Trust must be nondiscriminatory for all company employees.

For an individual to be an eligible individual they must be a U.S. citizen or resident that is compliant with all U.S. tax obligations and an individual that “has reported as income any contributions to, earnings of, or distributions from, an applicable tax-favored foreign trust on the applicable return.”

We haven’t received any guidance on how these requirements are going to be enforced but it’s pretty clear that where an IRS agent wants to reach the conclusion that a trust isn’t an ‘applicable trust’ or an individual isn’t an ‘eligible individual’ it’s not going to be very difficult. Initially, these types of legal determinations are going to be left to the agents, but taxpayers will certainly be able to challenge these determinations and escalate the issue within the IRS, but, with the way this ‘relief’ has been written, I wouldn’t expect taxpayers to be winning too many of these battles.