In November of 2019, we wrote[1] about the case of Wilson, et. al. v. United States, Case No. 2:19-cv-05037, US District Court, Eastern District of New York where a taxpayer prevailed in a case where he was the sole owner and beneficiary of a foreign trust. The owner/beneficiary was found to be liable for only the smaller 5% penalty under §6677(b) as the owner of a foreign trust that fails to file a report under IRC §6048.  He was able to escape the 35% penalty imposed on a beneficiary for failing to report the receipt of a distribution from that trust as required by the same section.

However, the Second Circuit Court of Appeals has now reversed the District Court after the IRS appealed the decision,[2] finding that the 35% penalty the IRS had originally imposed was due in this case, noting:

We vacate the court’s judgment and hold that when an individual is both the sole owner and beneficiary of a foreign trust and fails to timely report distributions she received from the trust, the government has the authority under the IRC to impose a 35% penalty.[3]

The appellate panel described IRC §6048’s reporting provisions as follows:

Section 6048 of the IRC imposes disclosure requirements related to foreign trusts. Subsection (c) instructs “any United States person [who] receives . . . during any taxable year . . . any distribution from a foreign trust” to “make a return with respect to such trust for such year” that includes, inter alia, “the aggregate amount of the distributions so received from such trust.” 26 U.S.C. § 6048(c). In other words, § 6048(c) requires beneficiaries of a foreign trust—such as Wilson—to disclose distributions they received from the trust in an annual filing. Subsection (b) orders U.S. owners “of any portion of a foreign trust” to “ensure that . . . such trust makes a return for such [taxable] year which sets forth a full and complete accounting of all trust activities and operations for the year” and “other information as the Secretary [of the Treasury] may prescribe.” Id. § 6048(b).[4]

In this case, the owner/beneficiary failed to timely file Form 3520 and Form 3520-A for 2007.

As a result, he did not timely disclose the $9.2 million distribution he received or report other information about his trust. The IRS assessed a late penalty of $3,221,183, 35% of the $9.2 million distribution. This penalty derives from § 6677(a) of the IRC, which provides “if any notice or return required to be filed by [§] 6048” is not filed on time or is incomplete, “the person required to file such notice or return shall pay a penalty equal to . . . 35 percent of the gross reportable amount.” 26 U.S.C. § 6677(a).[5]

The panel notes the trial court’s original holding in this matter:

Plaintiffs moved for partial summary judgment on their 5% penalty argument, which the district court granted, concluding that “[t]he IRS can . . . assess only the 5% penalty under . . . § 6677 – not both or either the 5% and/or 35% penalty – for Wilson’s untimely filing of his 2007 Form 3520.” Wilson v. United States, No. 19-CV-5037 (BMC), 2019 WL 6118013, at *8 (E.D.N.Y. Nov. 18, 2019).[6]

The panel found that the trial court had misread the plain meaning of IRC §§6048 and 6077:

The plain language of the IRC’s disclosure and penalty provisions, §§ 6048 and 6677, unambiguously demonstrates that when an owner of a foreign trust fails to timely disclose a distribution she received as a beneficiary of that trust, she violates § 6048(c) and thereby triggers the 35% penalty under § 6677(a). Section 6048(c) states in relevant part:

If any United States 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 . . . (B) the aggregate amount of the distributions so received from such trust during such taxable year.

26 U.S.C. § 6048(c)(1). Normally understood, “any United States person,” id., includes everyone, U.S. owners and beneficiaries of foreign trusts alike. The statute makes no exception for a beneficiary who is also the owner of a foreign trust. Wilson was therefore required under § 6048(c) to timely report the distribution he received from his trust.[7]

The panel goes on to describe the penalty provisions:

Under § 6677(a), “if any notice or return required to be filed by [§] 6048 . . . is not filed on . . . time . . . the person required to file such notice or return shall pay a penalty equal to . . . 35 percent of the gross reportable amount.” Id. § 6677(a). “[I]n the case of a failure relating to [§] 6048(c),” the “gross reportable amount” is “the gross amount of the distributions.” Id. § 6677(c). Because Wilson failed to timely report under § 6048(c), the IRS assessed––in accordance with § 6677(a) and (c)––a penalty of 35% of Wilson’s $9.2 million distribution.

Nothing in other parts of §§ 6048 and 6677 diminishes or eliminates the applicability of the 35% penalty to Wilson as a beneficiary of the trust. However, the district court relied on § 6677(b) to conclude that the 35% penalty cannot apply. See Wilson, 2019 WL 6118013, at *6. Section 6677(b) “substitut[es] ‘5 percent’ for ‘35 percent’ [of the gross reportable amount]” as the applicable penalty for the failure to timely file “a return required under [§] 6048(b),” which is the reporting requirement for owners of foreign trusts. 26 U.S.C. § 6677(b). According to the court, because Wilson violated § 6048(b) by failing to timely file as an owner, § 6677(b)’s “mandate[] that the 5% replace the 35%” applies. Wilson, 2019 WL 6118013, at *6 (emphasis omitted). [8]

The panel then deals with the specific flaw it identifies with the original reasoning that found that only the 5% penalty applies:

The problem with the district court’s analysis is that § 6677(b) leaves untouched the 35% penalty that applies to all other reporting requirements under § 6048, including to a return disclosing distributions required by § 6048(c). The district court and Plaintiffs do not identify any text in the statute that elides the requirement to disclose distributions received as a beneficiary under § 6048(c) when the beneficiary is also the owner of a foreign trust. Nor is there any textual support for the court and Plaintiffs’ view that when the owner and beneficiary are one, a failure to timely report the distribution received violates only § 6048(b) and not § 6048(c). Even if the information the owner must report under § 6048(b) covers the trust’s distributions, nothing in the statute indicates that as a result, § 6048(b) displaces or merges with the separate requirement to report distributions under § 6048(c). See id. at *6–7. Because Wilson’s failure to timely report the distribution he received violates § 6048(c) even if that same failure also violates his reporting requirements as an owner under § 6048(b), the 5% penalty under § 6677(b) does not supplant the 35% penalty.[9]

The panel also disagrees with the trial court finding that the provision in IRC §6677(a) that provides a penalty should not “exceed the gross reportable amount,” and “a taxpayer should not be liable for any two penalties if their combined assessment would add up to more than the gross reportable amount for any one violation” as support its ruling.  The district court found that the gross reportable amount for an owner’s untimely filing is the gross value of assets held at the end of the tax year, which was $0 at the end of 2007. Thus the government was limited to 5% of zero in this case.

However, the panel criticized this reading, stating:

The court’s reasoning misses the fact that “gross reportable amount” has more than one meaning under § 6677(c). The definition of “gross reportable amount” varies depending on the subsection of § 6048 an individual violated. For example, “in the case of a failure relating to [§] 6048(b)(1)” (the owner’s filing requirement), the gross reportable amount is “the gross value of the portion of the trust’s assets at the close of the year.” 26 U.S.C. § 6677(c)(2) (emphasis added). By contrast, “in the case of a failure relating to [§] 6048(c)” (the beneficiary’s filing requirement), the gross reportable amount is “the gross amount of the distributions.” Id. § 6677(c)(3) (emphasis added). As a result, the prohibition against applying a penalty that “exceed[s] the gross reportable amount,” id. § 6677(a), refers not to a single, common amount but instead is based on the specific violation. A 35% penalty of the “gross amount of the distributions,” here $3.2 million, does not exceed the “gross reportable amount” of the $9.2 million Wilson received as the beneficiary.[10]

The panel also found that the law did not limit the IRS to assessing only a single penalty:

Equally unavailing is Plaintiffs’ contention that the government may only assess one penalty because § 6677(a) states that a “person required to file . . . [a] return [under § 6048] shall pay a penalty equal to . . . 35 percent.” See id. § 6677(a) (emphasis added); Appellees’ Br. at 31. “[A] penalty” does not mean the government may impose only a single penalty even if the taxpayer violates multiple filing requirements under § 6048. This is made clear by the fact that the same sentence upon which Plaintiffs rely states, in full, that “the person . . . shall pay a penalty equal to . . . 35 percent of the gross reportable amount,” 26 U.S.C. § 6677(a) (emphasis added), and as discussed above “gross reportable amount” has different meanings, permitting more than one penalty depending on the nature of the untimely filing. The structure and text of § 6677 reflect that if an individual fails to timely file “any . . . return required to be filed by [§] 6048,” id. (emphasis added), she is subject to a 35% penalty based on each return she fails to file as required under § 6048. Construed in its statutory context, “a penalty” cannot carry the weight with which Plaintiffs burden it.[11]

The panel also dismisses the trial court’s analysis that looked at Forms 3520 and 3520-A, along with their instructions, as support for a one penalty only reading of the statute. The panel summarized the trial court’s position in this area as follows:

According to the court, because a trust owner who received a distribution and reported it in the trust’s Form 3520-A “is not required to otherwise report the distribution on Form 3520,” “Form 3520 disregards the beneficiary status of the trust owner in favor of his owner status, at least for the limited purpose of tracking distributions to the owner.” Id.[12]

But the panel notes two issues with this view.  First, the panel points out that the law looks at the information that must be disclosed, penalizing each failure, not basing a penalty on how many forms are required to make these disclosures:

First, even if Wilson needed to file “a single Form 3520,” id. at *6, § 6048 is concerned with the actual disclosure requirements, not the form on which the required disclosures are made. Filing a Form 3520 without providing all of the required information, such as the distributions, still violates § 6048.[13]

As well, the law requires a beneficiary to report any distributions he/she received, regardless of which form he/she is filing:

Second, the court overlooks the fact that regardless of whether the person files Form 3520, Form 3520-A, or both, she must disclose any distributions she received from a foreign trust even if she is the sole owner and sole beneficiary. The option to disclose the distributions that an owner received from the trust in Form 3520-A does not “favor” the owner status. Indeed, as the government articulated, “[t]he instructions simply provide that, if the foreign trust at issue filed a Form 3520-A that properly reported all distributions as part of the trust’s annual reporting (which did not occur here), the trust owner can simply direct the IRS to the [Form] 3520-A already filed (by checking the appropriate box on Part II of Form 3520 and attaching his ownership statement) and need not report that information again on Part III of the Form 3520.” Appellant’s Br. at 47–48.[14]

Finally, the panel rejects the argument that the forms and their instructions create ambiguity on the reporting obligation, finding the unambiguous law controls regardless of what the forms may or may not imply:

Relatedly, Plaintiffs argue that Form 3520-A (the annual return for the trust), which includes separate subsections to report distributions to owners and beneficiaries, and the instructions for the form “evidence that the [IRS] did not view a distribution to the trust owner to be reported as a distribution to a trust beneficiary.” Appellees’ Br. at 22. Plaintiffs see this as “further evidence that the [IRS] did not view a distribution made to a trust owner as falling within the reporting requirements [of §] 6048(c) for beneficiaries.” Id. Form 3520-A and its instructions carry no such implications. The separate reporting for owners and beneficiaries does not erase the owner’s concurrent beneficiary status for the purpose of § 6048(c). Moreover, even if we were to find that the forms generate some ambiguity, “[t]he only role [extratextual] materials can properly play is to help ‘clear up . . . not create’ ambiguity about a statute’s original meaning.” McGirt v. Oklahoma, 140 S. Ct. 2452, 2469 (2020) (citation omitted).[15]

[1] Edward K. Zollars, CPA, “Taxpayer Who Was Both Beneficiary and Owner of Foreign Trust Only Liable for Owner Penalty for Failure to File Form 3520,” Current Federal Tax Developments website, November 22, 2019, https://www.currentfederaltaxdevelopments.com/blog/2019/11/22/taxpayer-who-was-both-benfeciary-and-owner-of-foreign-trust-only-liable-for-owner-penalty-for-failure-to-file-form-3520 (retrived July 28, 2021)

[2] Emily Wilson, as Executrix of the Estate of Joseph A. Wilson v. United States of America, Case 20-603, CA2, July 28, 2021, https://www.taxnotes.com/research/federal/court-documents/court-opinions-and-orders/foreign-trust-owner-beneficiary-faces-higher-reporting-penalty/76y5y (retrieved July 28, 2021)

[3] Emily Wilson, as Executrix of the Estate of Joseph A. Wilson v. United States of America, Case 20-603, CA2, July 28, 2021

[4] Emily Wilson, as Executrix of the Estate of Joseph A. Wilson v. United States of America, Case 20-603, CA2, July 28, 2021

[5] Emily Wilson, as Executrix of the Estate of Joseph A. Wilson v. United States of America, Case 20-603, CA2, July 28, 2021

[6] Emily Wilson, as Executrix of the Estate of Joseph A. Wilson v. United States of America, Case 20-603, CA2, July 28, 2021

[7] Emily Wilson, as Executrix of the Estate of Joseph A. Wilson v. United States of America, Case 20-603, CA2, July 28, 2021

[8] Emily Wilson, as Executrix of the Estate of Joseph A. Wilson v. United States of America, Case 20-603, CA2, July 28, 2021

[9] Emily Wilson, as Executrix of the Estate of Joseph A. Wilson v. United States of America, Case 20-603, CA2, July 28, 2021

[10] Emily Wilson, as Executrix of the Estate of Joseph A. Wilson v. United States of America, Case 20-603, CA2, July 28, 2021

[11] Emily Wilson, as Executrix of the Estate of Joseph A. Wilson v. United States of America, Case 20-603, CA2, July 28, 2021

[12] Emily Wilson, as Executrix of the Estate of Joseph A. Wilson v. United States of America, Case 20-603, CA2, July 28, 2021

[13] Emily Wilson, as Executrix of the Estate of Joseph A. Wilson v. United States of America, Case 20-603, CA2, July 28, 2021

[14] Emily Wilson, as Executrix of the Estate of Joseph A. Wilson v. United States of America, Case 20-603, CA2, July 28, 2021

[15] Emily Wilson, as Executrix of the Estate of Joseph A. Wilson v. United States of America, Case 20-603, CA2, July 28, 2021