CCA 1208028: IRS advises on an estate's foreign trust filing penalties

Plain-English summary

Chief Counsel advised that an estate generally assumes a decedent's liability for initial penalties tied to missing Forms 3520 and 3520-A for a foreign trust. The estate also remains responsible for additional penalties accruing after the Service mailed notice, unless the executor establishes reasonable cause for the late filing. For short tax years after the decedent's death, the estate's liability depends on whether the Forms 3520 were timely, complete, and correct, while the Form 3520-A for the short year ending at death was late unless reasonable cause applies. The advice treated the estate as stepping into the decedent's role for the outstanding liabilities and distinguished the initial penalties from the additional penalties. It did not decide the final penalty amounts or unrelated tax consequences.

Ruling snapshot

• Question: Is an estate responsible for foreign trust information-return penalties assessed after the decedent's death?
• Outcome: Advice given, with liability depending on the filing facts and reasonable-cause exception
• Key authorities: IRC §§ 6048, 6677, 679, 6903, and 7701; Treas. Reg. §§ 1.684-2 and 301.6903-1; Notice 97-34

Full text (IRS public release)

       Office of Chief Counsel
       Internal Revenue Service
       Memorandum
       Number: 201208028
       Release Date: 2/24/2012
       CC:PA:02: TWCurteman                     Third Party Communication: None
       POSTS-135602-11                          Date of Communication: Not Applicable

UILC: 6048.00-00, 6677.00-00, 6677.01-01, 6677.03-00

date: November 02, 2011

 to:   Samuel Berman
       Special Counsel
       (Small Business/Self-Employed)

from: Ashton P. Trice
Branch Chief
(Procedure & Administration)

subject: Applicability of Section 6677(a) and (b) Penalties

       This Chief Counsel Advice responds to your request for assistance. This advice may
       not be used or cited as precedent.


       LEGEND

       A = ------------------
       B = --------------------------
       C = ----------------
       D = ----------------------
       E = --------------------
       Location F = ---------------
       Location G = ------------------
       Location H = -------------
       Location I = --------------
       $W = $-------------
       $X = $-------------
       $Y = $---------
       $Z = $---------
       Date 1 = ----------------------
       Date 2 = -------------------
       Date 3 = -------------------

POSTS-135602-11 2

Date 4 = -------------------
Date 5 = -----------------------
Date 6 = --------------------------
Date 7 = --------------------------
Date 8 = --------------------------
Date 9 = --------------------------
Date 10 = ------------------
Date 11 = -----------------
Date 12 = -------------------
Date 13 = -------------------
Date 14 = ------------------
Date 15 = ---------------------------
Date 16 = ------------------------
Date 17 = ------------------------
Date 18 = ---------------------
Date 19 = ---------------------
Date 20 = -----------------
Date 21 = -------------------
Year 1 = -------
Year 2 = -------
Year 3 = -------
Year 4 = -------
Year 5 = -------
Year 6 = -------
Year 7 = -------
Year 8 = -------

ISSUES

(1)     Whether the Estate is responsible for the section 6677(a) and (b) “initial”
        penalties for the applicable tax years (Year 3 through Year 6) ending prior to
        the Decedent’s death.

(2)     Whether the Estate is responsible for the section 6677(a) and (b) “additional”
        penalties for the applicable tax years (Year 3 through Year 6) ending prior to
        the Decedent’s death.

(3)     Whether the Estate is responsible for the section 6677(a) and (b) “initial”
        penalties for the two short tax years within Year 7.

CONCLUSIONS

POSTS-135602-11 3

(1)     The Estate is responsible for the section 6677(a) and (b) “initial” penalties
        asserted against the Decedent for the applicable tax years (Year 3 through
        Year 6) ending prior to the Decedent’s death because the Forms 3250 and
        3250-A were not filed timely.

(2)     The Estate is responsible for the section 6677(a) and (b) “additional” penalties
        asserted against the Decedent for the applicable years (Year 3 through Year
        6) ending prior to the Decedent’s death, unless the Executor has a
        reasonable cause for filing the required section 6048 returns more than 90
        days after the Service mailed notice that these returns were never filed.

(3)     The Estate may be responsible for the section 6677(a) “initial” penalty for the
        two short tax years within Year 7, if the two Forms 3520 filed were untimely,
        incomplete, or incorrect. The Estate is responsible for the section 6677(b)
        “initial” penalty for the short tax year ending Date 2 because the Form 3520-A
        for the short tax year ending Date 2 was filed untimely, unless the Executor
        has a reasonable cause for filing the Form 3520-A nearly one and a half
        years after its due date.

FACTS

We understand the following facts based upon the Executor’s counsel’s letter dated
Date 21 (the “Executor’s Letter”), the Letter 3946 dated Date 12, and the subsequent
Letter 3946 dated Date 12:

A (“A” or the “Decedent”) established a foreign grantor trust called the B sometime in
Year 1, from which he would receive distributions during that and each subsequent
year. The B’s bank accounts were located in Location F and Location G. Sometime at
the end of Year 6, A instructed his accountant (“Preparer”) to prepare amended returns
for tax years Year 4 through Year 5. None of these returns were completed or filed
before A died.

A died on Date 2. C (“Executor”) and D were appointed as executors of A’s Estate.1
On Date 5, the Preparer filed the Decedent’s Year 6 Form 1040. Between Date 6 and
Date 13, Preparer filed the Decedent’s Forms 1040X for tax years Year 4 through Year
5, as previously instructed by the Decedent. The submission of these amended returns

1
The Executor’s Letter claims that C and E were appointed as executors of the A Estate. However, Line
6a of the A Estate’s Form 706 (United States Estate (and Generation-Skipping Transfer) Tax Return)
identifies C as an executor, and the Form 706 is signed by D as an executor. Accordingly, it appears
likely that D was also appointed as an executor of the Estate before her death on Date 20. It is unclear
whether E was actually appointed as an executor to the A Estate, but his name and signature do not
appear on the Form 706. Thus it appears that C became the sole executor of the Estate sometime after
Date 20. Regardless of E’s and D’s actual role as co-executors, there appears to be no dispute that C
served as an executor during the Year 8 examination and remains the Executor of the A Estate to date.

POSTS-135602-11 4

prompted an examination of the Decedent’s liabilities for these tax years. The Revenue
Agent began the examination in Year 8. 2

On Date 7, the Executor caused the B to provide a check for $W. On Date 8, the
Executor paid $W in estimated estate taxes, and simultaneously requested an
extension to file Form 706 (United States Estate (and Generation-Skipping Transfer)
Tax Return) on Date 17. The Service granted this extension request.

On Date 11,3 the Executor filed Form 706, which reflected a total estate tax liability of
$X. The facts are unclear as to whether the Executor paid over the remaining net
liability of $Y upon filing the Form 706.

On Date 12, the Revenue Agent mailed the Decedent (c/o the Executor) a Letter 3946
advising him that no Forms 3520 or 3520-A had been filed with respect to the foreign
trust for tax years Year 2 through Year 5, and no Form 3520-A had been filed for tax
year Year 6. The letter also notified the Decedent and the Executor that the person
responsible for filing these forms may be subject to the initial penalties under section
6677(a) and (b) for failing to file these forms, and may be subject to the respective
“additional” penalties of $10,000 per month if the forms were not filed within 90 days of
the letter’s date. The letter did not provide notice of potential penalties under section
6677(a) or (b) for tax year Year 7.

On Date 16, the Executor filed Forms 3520 and 3520-A for tax years Year 3 through
Year 5, Form 3520-A for tax year Year 6, and Forms 3520 and 3520-A for the short tax
year from Date 1 through Date 2. It is unclear when the Executor filed the Form 3520
for the short tax year from Date 3 through Date 9. The Executor filed these forms more
than 90 days after the Service mailed its Date 12 notice of failure to file the forms for
years Year 2 through Year 6.4

On Date 18, the Service proposed assessing the following section 6677 penalties
against the Estate: section 6677(a) “initial” penalties for tax years Year 3 through Year
5, and Year 7; section 6677(a) “additional” penalties for tax years Year 3 through Year

2
The Executor’s Letter claims that the Service began an examination of the Decedent’s Year 6 tax year
on Date 10. Ostensibly, the examinations for the other tax years at issue began on or after this date as
well.
3
The Executor’s Letter claims that the Form 706 was filed on Date 14, although IDRS reflects the Service
received the Form 706 on Date 11. For the issues discussed in this memorandum, the difference in dates
is immaterial.
4
It is unclear from the facts whether any Forms 3520 or 3520-A were filed for tax year Year 2 as initially
indicated by the Date 12, Letter 3946. However, no penalties were asserted by the Service for this tax
year, therefore they are outside the scope of this memorandum.

POSTS-135602-11 5

5; section 6677(b) “initial” penalties for tax years Year 3 through Year 7; and section
6677(b) “additional” penalties for tax years Year 3 through Year 6.5

The Estate, through the Executor, has requested that Appeals review the applicability of
the section 6677(a) and (b) penalties to the Estate.

LAW AND ANALYSIS

(1)         The Estate is responsible for the section 6677(a) and (b) “initial” penalties
            asserted against the decedent for the applicable tax years (Year 3 through
            Year 6) ending prior to the Decedent’s death because the Forms 3250 and
            3250-A were not filed timely.

The Executor does not dispute that for the applicable tax years prior to the Decedent’s
death (tax years Year 3 through Year 6), the Decedent was responsible for filing Form
3520 (Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain
Foreign Gifts). Furthermore, where the foreign trust failed to file Form 3520-A (Annual
Information Return of Foreign Trust with a U.S. Owner), the Decedent, as the U.S.
owner of the trust, was responsible for completing and attaching a substitute Form
3520-A for the foreign trust. The Executor does dispute, however, that the related
section 6677(a) and (b) penalties are applicable against the Estate.

            (a)      The Decedent’s Requirement to File Form 3520 under Section
                     6048(a) or (c).

Section 6048(a)(1) generally requires a “responsible party” to provide written notice of a
“reportable event” to the Secretary. This written notice is provided on Form 3520, as
discussed below.

Section 6048(a)(4) defines “responsible party” for purposes of section 6048(a) as:

      (A)   the grantor in the case of the creation of an inter vivos trust,
      (B)   the transferor in the case of a reportable event described in section
            6048(a)(3)(A)(ii) other than a transfer by reason of death, and

5
A confirmation of the calculation of the penalties is outside the scope of this memorandum. For the tax
years at issue, the section 6677(a) “initial” penalty is a one time penalty per required section 6048 return
equal to 35% of the gross reportable amount as defined in section 6677(c). The “initial” penalty under
section 6677(b) is a modification of the section 6677(a) “initial” penalty where the penalty amount is
reduced from 35% of the gross reportable amount to 5% of the gross reportable amount. For the sake of
convenience we will call this a “section 6677(b) ‘initial’ penalty.” The “additional” penalty tacks on an
additional $10,000 for each 30-day period (or fraction thereof) during which the failure to file the required
return continues for more than 90 days after the day on which the Service mails notice of the failure to file
the required section 6048 return.

POSTS-135602-11 6

    (C)     the executor of the decedent’s estate in any other case.

The Decedent is both the grantor and transferor under section 6048(a)(4)(A) and (B) of
the reportable events that occurred before his death (i.e., creation of the trust and
transfers of money or property to the trust under section 6048(a)(3)(A)(i)-(ii)). Thus, the
Decedent is a “responsible party” under section 6048(a) for reportable events that
occurred prior to death. The Decedent created the trust prior to the tax years at issue,
and we cannot confirm whether the Decedent transferred money or property to the trust
during the tax years at issue.

We understand, however, that the Decedent received approximately $Z per year in
distributions from the trust. Section 6048(c)(1) generally provides that if any U.S.
person receives (directly or indirectly) any distribution from a foreign trust during any
taxable year of such person, such person shall make a return with respect to such trust
for such year which includes certain information. This person should report those
distributions on Part III of Form 3520 for each tax year. 6

Section 6677(a) generally imposes an “initial” penalty where the person required to file a
notice or return under section 6048 does not timely file such notice or return or files an
incomplete or incorrect return. Section 6677(a) provides that these “initial” penalties are
assessed against “the person required to file such notice or return.” This phrase refers
back to the “responsible party” under section 6048(a), or the U.S. person who receives
distributions under section 6048(c), as described above. Because there is no dispute
that the Decedent was the “responsible party” under section 6048(a) and/or the U.S.
person who received distributions from the trust under section 6048(c), the Decedent
should have filed Forms 3520 for tax years Year 3 through Year 6, and is therefore “the
person required to file such notice or return” for the purposes of the “initial” penalty
under sections 6677(a).

            (b)     The Decedent’s Requirement to File Form 3520-A under Section
                    6048(b).

Section 6048(b)(1) generally requires that if, at any time during any taxable year of a
U.S. person, such person is treated as the owner of any portion of a foreign trust under
the rules of sections 671-79, such person shall complete Part II of Form 3520 and be
responsible to ensure that the trust files an annual return (i.e., Form 3520-A). Part II of
Form 3520 tells the U.S. owner that if the foreign trust did not file Form 3520-A for the
current year, the U.S. owner must, to the best of his or her ability, complete and attach a
substitute Form 3520-A for the foreign trust. If the trust failed to file Form 3520-A and
the U.S. owner failed to provide a substitute Form 3520-A, section 6677(a) imposes a
penalty on the U.S. owner as modified by section 6677(b).

6
There does not appear to be a dispute that reportable events occurred as defined in section 6048(a)(3),
or the Decedent received a distribution provided for in section 6048(c)(1), during tax years Year 3 through
Year 6.

POSTS-135602-11 7

Section 679(a)(1) generally provides that a U.S. person who directly or indirectly
transfers property to a foreign trust (except by reason of death or for FMV
consideration) shall be treated as the owner for his taxable year of the portion of such
trust attributable to such property if for such year there is a U.S. beneficiary of any
portion of such trust.

The Decedent established the trust by depositing money to the trust’s Location F and
Location G bank accounts beginning in Year 1. The Decedent was the primary
beneficiary during all years of the trust’s existence prior to his death on Date 2. The
Decedent is a U.S. person, thus he is treated as an owner of the trust under section
679(a)(1). Under section 6048(b), the Decedent was responsible to ensure that the
trust filed Form 3520-A during each of the years of the trust’s existence. As noted
above, Part II of Form 3520 tells U.S. owners of foreign trusts that did not file Form
3520-A to complete and attach substitute Forms 3520-A for the foreign trust.

Section 6677(b) reduces the amount of the penalty under section 6677(a) on the foreign
trust’s U.S. owner in the case of a return required under section 6048(b) (i.e., Form
3520-A) that is not timely filed or is incomplete or incorrect. Because there is no dispute
that the Decedent was the U.S. owner of the foreign trust under section 679, he is “the
United States person referred to in [section 6048(b)]” for purposes of the initial penalty
under section 6677(b).

            (c)     The Estate’s Assumption of the Decedent’s Liabilities.

Based on the correspondence between the Executor and the Revenue Agent, we
understand that the Executor had notified the Service of his role as the Estate’s
executor and fiduciary in a timely manner after the Decedent’s death. As a fiduciary,
the Executor assumes the “rights, duties, and privileges of such other person in respect
of a tax imposed by this title.” I.R.C. § 6903(a). This means that the Executor assumes
the responsibility of administering the Decedent’s Estate, including paying any
outstanding liabilities of the Decedent. Id.; see also IRS Pub. 559 (Survivors, Executors
and Administrators).

The Executor’s responsibility to resolve the Estate’s liabilities is a common aspect of
state probate law. Indeed, it is well-established in Location H,7 as it is elsewhere, that
an unpaid tax liability of a deceased taxpayer is collectible from that taxpayer’s estate.
See ----------------------------------------------------------------. Federal law mirrors this state law
requirement. Treas. Reg. § 301.6903-1(a) (“The amount of the tax or liability is
ordinarily not collectible from the personal estate of the fiduciary but is collectible from
the estate of the taxpayer[.]”). Federal penalties assessable and assessed against a
decedent, including the civil fraud penalty, are also collectible from the estate. See,

7
Because the Decedent was a resident of Location I, Location H when he died, it is most likely that
Location H probate law will be applied to the Estate.

POSTS-135602-11 8

e.g., Estate of Rau v. Commissioner, 301 F.2d 51 (9th Cir. 1962) (civil fraud penalty for
decedent’s wrongful actions prior to death, yet assessed after his death, upheld as
valid). The Estate assumes the role of the Decedent upon his death, and the Estate is
administered by the Executor. Because the Decedent was a “person required to file [a
Section 6048] notice or return” under the penalty provisions of section 6677(a) and (b),
the Estate, as administered by the Executor, assumes the role of the Decedent with
respect to any outstanding liabilities and also satisfies the same role under sections
6677(a) and (b). Accordingly, the Estate assumes the liability for Decedent’s “initial”
section 6677(a) and (b) penalties for the Forms 3520 and 3520-A not filed by the
Decedent during his lifetime.

(2)        The Estate is responsible for the section 6677(a) and (b) “additional”
           penalties asserted against the Decedent for the applicable years (Year 3
           through Year 6) ending prior to the Decedent’s death, unless the Executor
           has a reasonable cause for filing the required section 6048 returns more
           than 90 days after the Service mailed notice of the failure to file.

The “initial” penalty for failing to file the section 6048 returns or notices timely or
correctly is not the only assessable penalty under section 6677. Section 6677(a) and
(b) also provide for an “additional” penalty until the proper section 6048 return is filed.
For the “additional” penalty to apply, the Service must first “mail[] notice of such failure
to the person required to pay such penalty[.]” I.R.C. § 6677(a). If the person required to
pay the “initial” penalty fails to properly submit the section 6048 return “more than 90
days after the day on which the Service mails” this notice, he must pay “$10,000 for
each 30-day period (or fraction thereof) during which such failure continues” after the
90th day. Id.

As explained above, the Executor – acting on behalf of the Estate – is required to pay
the section 6677(a) and (b) “initial” penalties for the Decedent’s failure to timely file the
Forms 3520 and 3520-A. On Date 12, the Service mailed a notice of failure to file
(Letter 3946) to “the person required to pay such penalty,” the Estate. This started the
90-day safe harbor period during which the “additional” penalties did not accrue. The
Executor did not submit the missing returns for tax years Year 3 through Year 6 on
behalf of the Estate until Date 16, more than 90 days after the Service mailed him the
Letter 3946.8 Accordingly, the “additional” penalties assessed against the Estate and
attributed to the untimely Forms 3520 and 3520-A were proper.

The Executor argues that the Executor could not be responsible for the section 6677(a)
and (b) “additional” penalties because he was not a “responsible person” required to file
any section 6048 return, and therefore not a “person required to file” under section
6677(a). This argument reflects the Executor’s confusion about the difference between

8
The 90th day after the Date 12 notice was Date 15. If the Executor filed the Forms 3520 and 3520-A on
Date 16, as he claims, then the forms were filed 72 days after the expiration of the 90-day safe harbor
period.

POSTS-135602-11 9

the “initial” and “additional” section 6677 penalties. Whereas the section 6677 “initial”
penalty is assessed against the “person required to file [the applicable section 6048
return],” the section 6677 “additional” penalty is assessed 90 days after the Service
mailes notice to the “person required to pay [the ‘initial’] penalty” if the applicable section
6048 returns are not filed. Section 6677(a) (emphasis added). As explained above, the
Decedent was the “person required to file” the applicable section 6048 returns during
his lifetime under section 6677. For the purposes of section 6677(a) and (b) “initial”
penalties, the Estate steps into the shoes of the Decedent and assumes the penalty
liability for the Decedent’s failure to file during his lifetime.9 The Service then notified
the Estate as the “person required to pay” the section 6677(a) and (b) “initial” penalties
that it had 90 days to file those section 6048 returns not filed by the Decedent during his
lifetime, or else the “additional” penalties would be assessed against it. Because the
Executor, acting on behalf of the Estate as its fiduciary, failed to file within 90 days of
the notice the applicable section 6048 returns that the Decedent should have filed
during his lifetime, the Estate was liable for the section 6677(a) and (b) “additional”
penalties as well as the section 6677(a) and (b) “initial” penalties.

This does not mean that imposing section 6677’s “additional” penalty is appropriate in
every circumstance. Section 6677(d) provides some flexibility by offering a reasonable
cause exception to any penalty identified in the section. Section 6677(d) does specify,
however, that the “fact that a foreign jurisdiction would impose a civil or criminal penalty
on the taxpayer” for disclosure of the required information is not reasonable cause.
Notice 97-34, 1997-25 I.R.B. 22, expands on this by providing that refusal of a foreign
trustee to provide the required information – including not doing so based upon
“difficulty in providing the required information” – is not reasonable cause. Nonetheless,
read in accordance with the discussion of reasonable cause for the accuracy-related
and fraud penalties under Treas. Reg. § 1.6664-4(b), such a determination is dependent
on the unique facts and circumstances of the case.

As opposed to the section 6677 “initial” penalties that carried over from the Decedent to
his Estate, removing the section 6677 “additional” penalties for reasonable cause may
be more understandable, for example, if the facts showed that the existence of the
foreign trust or accounts were only recently discovered by the Executor after the
Decedent’s death, and that a prompt filing of the Forms 3520 and 3520-A within 90 days
of the Service’s notice would require some sort of forensic accounting. Appeals should
consider all of the available facts to determine whether the reasonable cause exception
for the section 6677 “additional” penalties are appropriate in this case.10
9
The Internal Revenue Code not only defines an individual as a “person,” but an estate is a “person” as
well. Section 7701(a)(1) (“The term ‘person’ shall be construed to mean and include an individual, a trust,
estate, [etc.]”) (emphasis added).
10
By only referencing the reasonable cause exception in our discussion of the section 6677(a) and (b)
“additional” penalties, we do not intend to indicate that the exception is only available for the “additional”
penalties. The reasonable case exception to the section 6677 penalty applies for the “initial” and
“additional” penalties under sections 6677(a) and (b) as well, provided that the facts and circumstances
merit its invocation.

POSTS-135602-11 10

(3) The Estate may be responsible for the section 6677(a) “initial” penalty for
the two short tax years within Year 7 if the Forms 3520 were untimely,
incomplete, or incorrect. The Estate is responsible for the section 6677(b)
“initial” penalty for the short tax year ending Date 2 because the Form
3520-A for the short tax year ending Date 2 was filed untimely, unless the
Executor has a reasonable cause for filing the Form 3520-A nearly one
and a half years after its due date.

The section 6677(a) and (b) “initial” penalties asserted against the Estate for the
untimely filing of the Forms 3520 and 3520-A for Year 7 differ from those relating to
prior tax years because these Forms were due after the Decedent’s death. Also, unlike
the previous tax years, the Service did not provide the predicate notice for application of
the “additional” penalties under sections 6677(a) and (b). Because it provided no prior
notice under section 6677 the Service did not assert the “additional” penalties against
the Decedent’s Estate. Nonetheless, the Estate may be responsible for section 6677(a)
and (b) “initial” penalties for the Executor’s untimely, incomplete, or incorrect filing of the
required Form 3520 for short tax year ending Date 2 and for the short tax year Date 3
through Date 9. Furthermore, the Estate may be responsible for section 6677(a) and
(b) “initial” penalties for the Executor’s untimely, incomplete, or incorrect filing of the
Form 3520-A for the short tax year ending Date 2.

          (a)     The Estate may be responsible for the section 6677(a) “initial”
                  penalty for the two short tax years within Year 7, unless the Forms
                  3520 were untimely, incomplete, or incorrect.

As described above, section 6048(a)(1) generally requires the “responsible party” to
provide written notice of a “reportable event” to the Secretary, and the executor of a
decedent’s estate is one such “responsible party.” Under section 6048(a)(4)(C), the
Executor is the responsible party for reporting the death of the Decedent, which is a
reportable event under section 6048(a)(3)(A)(iii). Under Treas. Reg. § 1.684-2(e)(1),
because the Decedent was the owner of the foreign trust when he died, the Decedent is
treated as having transferred – on the date of death but immediately before his death –
the assets to a foreign trust. See Treas. Reg. § 1.684-2(e)(2), Example 2. Under the
plain language of section 6048(a)(4)(B) and (C), the Executor is also the responsible
party for reporting this transfer of money or property to the foreign trust by reason of
decedent’s death. Under the facts of this case, the Decedent’s death and related
transfer should be reported on both page 1 and Part I of Form 3520 for the tax year
beginning Date 1 and ending Date 2 (the date of death).

Although section 6048(a)(1) requires that the triggering event be reported “on or before
the 90th day (or such later day as the Secretary may prescribe) after any reportable
event,” the Service provided a more generous reporting requirement in its instructions

POSTS-135602-11 11

for Form 3520 with respect to the reporting triggered by a death under section
6048(a)(3)(iii). These instructions provide that in the case of a Form 3520 filed with
respect to a U.S. decedent, Form 3520 is due on the date that the estate tax return is
due (or would be due if the estate were required to file a return), including extensions.

Under the extension granted by the Service, the Estate had until Date 17 to file its Form
706, and accordingly, the Form 3520 for the short tax year ending Date 2. If the Form
3520 for the short tax year ending Date 2 were indeed filed on Date 16, as claimed by
the Executor, then it was filed timely.

This is not, however, the Estate’s only reporting requirement for Year 7 with respect to a
Form 3520. Section 6048(c)(1) generally provides that if any U.S. person receives
(directly or indirectly) during any taxable year of such person any distribution from a
foreign trust, such person shall make a return with respect to such trust for such year
which includes certain information. Section V of Notice 97-34 states that “a distribution
is reportable if it is either actually or constructively received. For example, if a U.S.
beneficiary uses a credit card, and charges on that credit card are paid or otherwise
satisfied by a foreign trust … the amount charged on that credit card will be treated as a
distribution to the U.S. beneficiary that must be reported under § 6048(c) for the year in
which the charge occurs.” 1997-25 I.R.B. 22.

On Date 7, Executor caused the Location G bank with which the foreign trust had an
account to make a payment to the U.S. Treasury for estimated estate taxes. This is
analogous to the credit card example in Notice 97-34 in that the foreign trust directly
paid off a debt of an estate. Likewise, the amount paid to the U.S. Treasury on behalf of
the Estate is treated as a distribution to the Estate. Thus, the Executor, on behalf of the
Estate, is required to report that distribution on Part III of Form 3520 for the tax year
beginning Date 3 and ending Date 9.

The instructions to Form 3520 also provide that the form is due on the date that your
income tax return is due, including extensions. In this case, the income tax return
referred to in the instructions is the Estate’s Year 7 Form 1041. This would apply to the
estate's Form 3520 for the short tax year beginning Date 3 and ending Date 9. Thus,
the estate's Form 3520 for the short tax year beginning Date 3 and ending Date 9 is due
on the date that its Form 1041 is due, including extensions. Because it is unclear from
the facts as to what the due date is for the Estate’s Form 1041, we cannot say whether
the Form 3520 for this period was filed timely.

Accordingly, the only basis for the Service’s section 6677(a) “initial” penalty against the
Estate would be if either Form 3520 were incomplete or incorrect, or additionally in the
case of the Form 3520 for the short tax year beginning Date 3 and ending Date 9, if the
Form 3520 were untimely. Furthermore, as with the Year 3 through Year 6 section
6677(a) and (b) “additional” penalties assessed for tax years Year 3 through Year 6,
Appeals should consider all of the available facts to determine whether the reasonable

POSTS-135602-11 12

cause exception for the Year 7 section 6677(a) “initial” penalty is appropriate in this
case.

          (b)    The Estate is responsible for the section 6677(b) “initial” penalty for
                 the short tax year Date 1 through Date 2 because Form 3520-A
                 was filed untimely, unless the Executor has a reasonable cause for
                 filing the Form 3520-A nearly one and a half years after its due
                 date.

Section 6048(b)(1) generally requires that if, at any time during any taxable year of a
U.S. person, such person is treated as the owner of any portion of a foreign trust under
the rules of sections 671-79, such person shall complete Part II of Form 3520 and be
responsible to ensure that the trust files an annual return (i.e., Form 3520-A). Part II of
Form 3520 tells the U.S. owner that if the foreign trust did not file Form 3520-A for the
current year, the U.S. owner must, to the best of his or her ability, complete and attach a
substitute Form 3520-A for the foreign trust. If the trust failed to file Form 3520-A and
the U.S. owner failed to provide a substitute Form 3520-A, section 6677(b) imposes a
penalty on the U.S. owner as the person required to file.

Section 679(a)(1) generally provides that a U.S. person who directly or indirectly
transfers property to a foreign trust (except by reason of death or for fair market value
consideration) shall be treated as the owner for his taxable year of the portion of such
trust attributable to such property if for such year there is a U.S. beneficiary of any
portion of such trust. Sections 671-79 and 6048(b) no longer apply as of the date of
death. Section 679(a)(2)(A) provides that section 679(a)(1) does not apply to a transfer
by reason of the death of the transferor. Treas. Reg. § 1.684-2(e)(1) provides that when
the decedent was the owner of the foreign trust at the time of death, decedent is treated
as having transferred, on the date of death but immediately before his death, the assets
to a foreign trust.

In this case, the Decedent established the foreign trust by depositing money to the
trust’s Location F and Location G bank accounts in Year 1. The Decedent was the
primary beneficiary during all years of the trust’s existence before he died on Date 2.
The Decedent is a U.S. person, thus he is treated as an owner of the trust under section
679(a)(1). Under section 6048(b), the Decedent was responsible to ensure that the
trust filed Form 3520-A during each of the years of the trust’s existence up until Date 2,
his date of death. As explained above, if the trust did not file Form 3520-A for the tax
year beginning Date 1 and ending Date 2 (the date of death), then the Executor, on
behalf of the Decedent, must provide a substitute Form 3520-A for this tax period to
avoid penalties under section 6677(b). However, upon the Decedent’s death on Date 2,
the grantor trust terminated and became a complex trust. See Year 8 Form 1041 for the
A Administrative Trust.

Although section 6048(a)(1) requires that the triggering event be reported “on or before
the 90th day (or such later day as the Secretary may prescribe) after any reportable

POSTS-135602-11 13

event,” the Service provided a more generous reporting requirement in its instructions
for Form 3520-A. These instructions provide that a Form 3520-A is due on the 15th day
of the third month after the end of the trust’s tax year. For Year 7, the end of the foreign
grantor trust’s tax year was Date 2, the date of the Decedent’s death. Therefore, the
Form 3520-A was due on Date 4. Because the foreign grantor trust terminated and
became a complex trust after the Decedent’s death, there was no longer a requirement
to file a Form 3520-A for any tax period after Date 2.

The Executor filed the 2007 Form 3520-A on Date 16, nearly a year and a half after its
Date 4 due date. Accordingly the Year 7 Form 3520-A was untimely. To the extent that
the Year 7 section 6677(b) “initial” penalty was assessed against the Estate on behalf of
the Decedent, the trust’s U.S. owner, for the tax year beginning Date 1 and ending Date
2 the Estate is responsible for the section 6677(b) “initial” penalty. Furthermore, as with
the section 6677(a) and (b) “additional” penalties assessed for tax years Year 3 through
Year 6, Appeals should consider all of the available facts to determine whether the
reasonable cause exception for the Year 7 section 6677(b) “initial” penalty is
appropriate in this case.

This writing may contain privileged information. Any unauthorized disclosure of this
writing may undermine our ability to protect the privileged information. If disclosure is
determined to be necessary, please contact this office for our views.

Please call (202) 622-4940 if you have any further questions.