As global financial activity becomes more common, the Internal Revenue Service (IRS) continues to increase its focus on international transparency. For U.S. citizens, resident aliens, and residents for tax purposes, the cost of non-compliance with foreign disclosure requirements can be steep. To monitor cross-border wealth transfers and foreign trust activity, the IRS requires specific disclosures through Form 3520 and Form 3520-A.
Failing to file these informational returns properly can lead to substantial penalties, even when no U.S. tax is owed.
What Is a Foreign Trust for U.S. Tax Purposes?
Determining whether a trust is "foreign" or "domestic" is the first step in identifying reporting obligations. Under Section 7701 of the Internal Revenue Code, a trust is classified as a foreign trust unless it meets both the "Court Test" and the "Control Test":
- The Court Test: A U.S. court must be able to exercise primary supervision over the administration of the trust.
- The Control Test: One or more U.S. persons must have the authority to control all substantial decisions of the trust.
If a trust fails either test — for example, if a foreign person has the power to veto trust distributions — it is treated as a foreign trust. It is important to distinguish this from a domestic trust that is simply owned by a non-U.S. person. While a foreign-owned domestic disregarded entity may have separate reporting requirements (such as Form 5472), the specific requirements for Form 3520 and Form 3520-A generally apply to trusts that meet the technical definition of a “foreign trust.”
Form 3520: Reporting Foreign Trust Transactions and Foreign Gifts
Form 3520 is used by U.S. persons to disclose transactions with foreign trusts, including the creation of the trust, the transfer of assets, and the receipt of distributions. It is also the vehicle for reporting the receipt of large gifts or inheritances from foreign sources.
The penalty structure for Form 3520 is significant and varies by the type of transaction:
- Foreign Trust Transactions (Parts I-III): For failure to report transfers to or distributions from a foreign trust, the penalty is generally the greater of $10,000 or 35% of the “gross reportable amount” (the value of the property transferred or distributed).
- Foreign Gifts and Bequests (Part IV): If a U.S. person fails to report foreign gifts that exceed the applicable threshold, the penalty is 5% of the gift amount for each month the failure continues, capped at 25%.
Form 3520 is typically due on the same date as the taxpayer’s income tax return (April 15 for individuals), including extensions. However, it must be filed separately from Form 1040.
Form 3520-A: Annual Reporting for Foreign Trusts with U.S. Owners
Form 3520-A is the annual information return of a foreign trust with at least one U.S. owner. This form provides information about the trust’s income, assets, and distributions. While the foreign trust is technically responsible for filing Form 3520-A, the U.S. owner is ultimately responsible for ensuring the return is filed. If the trust fails to file, the U.S. owner must submit a “substitute” Form 3520-A with their own Form 3520 to avoid penalties.
The penalty for failing to ensure the filing of Form 3520-A is the greater of $10,000 or 5% of the gross value of the trust assets treated as owned by the U.S. person.
Does a Foreign Trust File Form 1041 or Form 1040-NR?
A common misconception is that a foreign trust with U.S. beneficiaries must file Form 1041. However, for federal tax purposes, a foreign trust is treated as a non-resident alien individual. Consequently, if a foreign trust has U.S.-source income that is not effectively connected with a U.S. trade or business, it reports that income on Form 1040-NR, not Form 1041. Form 1041 is reserved for domestic trusts.
Why Compliance Matters: Reasonable Cause and Procedural Shifts
The IRS has historically been aggressive in systemically assessing penalties for late-filed Forms 3520. However, in 2024 and 2025, there has been a notable procedural shift. The IRS now frequently reviews “reasonable cause” statements before the automatic assessment of penalties, particularly regarding foreign gift reporting in Part IV.
To qualify for relief, taxpayers must provide a written statement demonstrating that the failure to file was due to reasonable cause and not willful neglect. Common factors include unexpected illness or death in the immediate family, though “oversight” by a professional advisor is rarely sufficient on its own.
Section 2801 and the Tax on Foreign Bequests
Taxpayers should also be aware of Section 2801, which applies to U.S. citizens or residents who receive “covered gifts” or “covered bequests” from individuals who have expatriated from the United States. Following guidance issued in 2025, taxpayers must be prepared to report these amounts on Form 708 (once finalized). Unlike standard U.S. gift tax, which is paid by the donor, the tax under Section 2801 is the responsibility of the recipient.
Work with an Advisor
Navigating Forms 3520 and 3520-A can be complicated because of the detailed filing rules and IRS instructions involved. Beyond completing the forms correctly, thoughtful planning is needed around how foreign trusts, gifts, and cross-border assets are structured from the start. With the right approach, taxpayers may be able to reduce complexity, avoid unnecessary reporting obligations, and limit long-term tax exposure.
An experienced tax advisor can help evaluate your current structure, identify risks, and develop strategies that align compliance with your broader financial and estate planning goals, especially if you have international interests.