Emily S. Wilson et al. v. United States: Playing Battleship with the Internal Revenue Service | Bilzin Sumberg

As many readers may know, Joseph Wilson (“Mr. Wilson”) was the settler, tax owner, and beneficiary of a foreign trust. As a result, as a US citizen, Mr. Wilson was required to file IRS Form 3520 and IRS Form 3520-A annual returns. As we see all too often, Mr. Wilson filed his Forms 3520 and 3520-A late and the Internal Revenue Service (the “IRS”) fined 35%. To make the otherwise long backstory short, Mr. Wilson paid the fine, and (after Mr. Wilson’s death) sued Mr. Wilson’s estate for a refund. The basic argument is that the IRS should only have imposed a 5% penalty that applies to owners of foreign trusts. The district court agreed and came to the conclusion “[t]he can IRS. . . underestimate only the 5% penalty. . . Section 6677 – neither or neither the 5% nor the 35% penalty – for Wilson’s early filing of his 2007 Form 3520. ” Wilson v United States, No. 19-CV-5037 (BMC), 2019 WL 6118013, * 8 (EDNY November 18, 2019). On July 28, 2021, the United States Appeals Court for the Second District (remember, we’re in Florida in the Eleventh District), advising that both 35% and 5% penalties could be applied , and overturned the judgment of the district court and remitted her for further hearing. See Emily S. Wilson et al. v. United States; No. 20-603 (the “opinion“).

That opinion is certainly a heavy loss for US taxpayers. This is especially true when looking at the current Forms 3520 and 3520-A penalties that taxpayers and their U.S. tax professionals are required to attend to. This said that opinion certainly reloads the turrets of the IRS punitive battleship. Of course, every well-built battleship has more than one set of towers, so the logical question arises: To what extent can the logic of the opinion load other guns?

To make matters worse, President Biden’s administration has proposed that substantial funds (at one point US $ 7 billion) be allocated to the IRS for “program integrity activities” over the next decade. The intent of this funding is to improve the effectiveness of the IRS’s tax enforcement program. Although it has not yet done so, there is bipartisan support for it as it is a revenue generating proposal that does not include an income tax hike. Unfortunately, the penalties mentioned here are some of the simplest for taxpayers, who often have facts that suggest penalties are not justified.

With all of the above in mind, one can see how easily a taxpayer who fails to submit Form 3520 or 3520-A on time can have the following conversation with the IRS:

IRS: F3520 (part I or III).
taxpayer: Blow!
IRS: F3520 (part II).
taxpayer: Blow!
IRS: F3520 (part IV).
taxpayer: Blow!
IRS: F8938.
taxpayer: Blow! You sunk my battleship!

The practical takeaway for a U.S. taxpayer reading this is that timely and proper compliance with U.S. tax laws remains imperative, as the associated failure to do so can result in the IRS imposing significant, potentially duplicate, penalties. If you think you have a problem, call a knowledgeable U.S. tax professional for help with regulatory compliance before the IRS battleship targets you! Either way, expect that this can be a lengthy process and may require the involvement of the Complaints Office or the use of an approved IRS program or process.

The practical souvenir for our friends from the US accounting industry might be more memorable:

• Involve U.S. legal advisors early in the tenant admission process to maintain legal confidentiality as much as possible.
• while under legal privilege, coordinate with legal counsel and taxpayer to conduct the proper screening of the client to verify that:

on) there is a tax non-compliance;

B) there can be a reasonable reason;

C) use of a version of the optimized filing process may be applicable; or

D) there may be an aspect of intent (again, beware of our accountant friends with this final decision, as it is a legal concept).

• Make sure you file all relevant tax and information returns. Include responses to all applicable sections and schedules as this may lead the IRS to claim the form is “incomplete” and treat it as not submitted. However, overwrite your control programs and force the entry of a “0” instead of leaving sections blank.
• Pay particular attention to due dates in connection with Form 3520 and Form 3520-A. We often see these forms (specifically Form 3520-A) being late in filing due to a misunderstanding of the due date and a lack of a request to extend the filing deadline.

The bottom line is that US taxpayers and their US professional accountants should take the opinion regarding the Form 3520 and Form 3520-A penalties very seriously. Likewise, taxpayers and their advisors should consider the opinion and the extent to which the IRS may impose multiple, or potentially duplicate, penalties on taxpayers in other contexts.