The Internal Revenue Service has decided to stop automatically levying penalties when a taxpayer files a form reporting foreign gifts and inheritance bequests too late and it will start reviewing the reasonable cause statements that taxpayers provide when they file the forms too late.

The change in policy comes in response to a request from National Taxpayer Advocate Erin Collins, who wrote about it in a blog post last week and leads the Taxpayer Advocate Service. The American Institute of CPAs also advocated for the change in two letters to the IRS last year. 

The IRS had been automatically assessing penalties for late-filed Forms 3520, Part IV, which deal with reporting foreign gifts and bequests, at the time when they were filed. 

“By the end of the year the IRS will begin reviewing any reasonable cause statements taxpayers attach to late-filed Forms 3520 and 3520-A for the trust portion of the form before assessing any Internal Revenue Code (IRC) § 6677 penalty,” Collins wrote. “This favorable change will reduce unwarranted assessments and relieve burden on taxpayers by giving them the opportunity to explain their situation before the IRS assesses a penalty. TAS has recommended these changes for years and the IRS listened. IRS Commissioner Danny Werfel announced these changes during the UCLA Extension Tax Controversy Conference.”

The international information return penalty regime was mandated by Congress as a way to deter tax avoidance and discourage U.S. taxpayers from hiding their income and assets in other countries. Collins noted, however, that high net worth individuals and large companies usually weren’t the ones penalized. “They have sophisticated advisors and generally avoid these penalties or successfully obtain abatements,” she wrote. “By contrast, lower-income individuals, immigrants, and small businesses generally do not have advisors with the same expertise, and these taxpayers tend to inadvertently trigger the penalty.”

According to the statute, many of the penalties apply even when there’s no underlying tax liability, and the information reporting requirements and associated penalties can apply to specified foreign financial assets, certain interests in foreign business entities, and gifts or inheritances from foreign sources.

Approximately 10 years ago the IRS changed its policy on IIR penalties and started automatically assessing penalties when taxpayers voluntarily filed late returns. “No questions asked – just the imposition of potentially life-altering penalties,” Collins wrote. “After the IRS automatically assessed large penalties against these taxpayers, the IRS started collection efforts against them. My office reviewed many of the IIR penalties assessed for the past decade, and contrary to what most people assumed these penalties were assessed against unsuspecting lower-income taxpayers, small businesses and immigrants.”

The penalties were being unfairly levied against taxpayers who had come forward and voluntarily listed those assets on their tax returns. “We are all aware that our tax system is based upon voluntary compliance,” Collins wrote. “The IRC incentivizes taxpayers to comply by applying penalties for noncompliance (the proverbial carrot and the stick approach). However, the stick should only apply to negligent, reckless or intentional conduct. Taxpayers should not be penalized when they discover errors or mistakes and voluntarily come forward and file late or corrected tax or information returns. Our tax system should reward taxpayers’ efforts to do the right thing. We all benefit when taxpayers willingly come into the system by filing or correcting their returns.”