A $1 million inheritance from a foreign parent that goes unreported can result in a $250,000 IRS penalty, assessed automatically by the system, with the burden squarely on the taxpayer to prove reasonable cause.

At Kugelman Law, we routinely handle Form 3520 penalty matters — including initial examinations, penalty assessments, Appeals conferences, abatement submissions, and post-Farhy litigation strategy. This guide explains when Form 3520 is required, how the penalty works, what has changed after the Farhy v. Commissioner litigation, and how to approach abatement effectively.

What Is Form 3520?

Form 3520 is the Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts. It is informational — it does not compute tax — but it is required in several distinct circumstances:

• Receipt of more than $100,000 during the year in gifts or bequests from a nonresident alien individual or foreign estate (with aggregation rules for related donors)
• Receipt of gifts or distributions from foreign corporations or foreign partnerships exceeding the annually adjusted threshold (approximately $19,000 as recently indexed)
• Creation of, or transfers to, a foreign trust by a U.S. person
• Receipt of distributions from a foreign trust
• Ownership of a foreign trust under the grantor trust rules

Form 3520 is due on the same date as your individual income tax return — generally April 15, with available extensions to October 15. The form is filed separately from your Form 1040, mailed to a specific IRS address in Ogden, Utah, which means simple mail-handling errors can become penalty events.

How the Form 3520 Penalty Works

The IRS imposes Form 3520 penalties under IRC § 6039F for foreign gifts and § 6677 for foreign trust matters. The penalty structure differs depending on the violation:

Foreign Gifts and Bequests (IRC § 6039F)

For unreported foreign gifts and bequests, the penalty is 5% of the unreported amount per month that the failure continues, up to a maximum of 25%. For a $1 million inheritance received in 2023 and never reported, the maximum penalty exposure is $250,000.

Foreign Trust Transactions (IRC § 6677)

For failures related to foreign trust transfers, ownership, or distributions, the penalty is the greater of $10,000 or 35% of the gross reportable amount. This penalty can exceed the gift penalty in absolute dollars, and it applies to the U.S. person’s interactions with the trust — including distributions received.

Why the Penalty Is Assessed Automatically

Unlike income tax assessments, Form 3520 penalties are treated by the IRS as “assessable penalties” — meaning the IRS historically took the position that they could be assessed immediately without the pre-assessment deficiency procedures that apply to income tax. When a late-filed or delinquent Form 3520 is processed in Ogden, the penalty is often computer-generated and issued before any human examiner reviews the underlying facts. Taxpayers routinely receive CP15 notices assessing six-figure penalties on transfers that are clearly innocent — a foreign parent gifting cash for a down payment, a foreign grandparent leaving an inheritance, a foreign sibling sending wedding money.

Farhy v. Commissioner and the IRS Assessment-Authority Controversy

In 2023, the U.S. Tax Court in Farhy v. Commissioner, 160 T.C. No. 6, held that the IRS lacked statutory authority to assess penalties under IRC § 6038 for failure to file Form 5471 (a related but distinct foreign information return). The decision cast doubt on the IRS’s assessment authority for a category of international information return penalties that had long been treated as automatic.

In 2024, the D.C. Circuit reversed the Tax Court in Farhy v. Commissioner, 100 F.4th 223 (D.C. Cir. 2024), holding that § 6038 penalties are assessable. The reversal re-established the IRS’s ability to assess these penalties administratively, and the government has taken the position that it applies equally to other international information return penalties. However, the broader legal questions raised during the Farhy litigation — including parallel arguments about § 6039F and § 6677 assessment authority — remain a live issue in other circuits and in ongoing refund litigation.

Practically, this means Form 3520 penalty matters today require careful positioning. Administrative abatement remains the primary path for most clients, but preserving refund claims and litigation options after payment is increasingly important for large penalty assessments. Our firm monitors this area closely and adjusts client strategy as the case law develops.

Reasonable Cause: The Primary Defense

The IRS will abate a Form 3520 penalty where the taxpayer demonstrates reasonable cause for the failure and that the failure was not due to willful neglect. Reasonable cause is a facts-and-circumstances test. In our experience, the most frequently successful reasonable cause arguments involve:

• Reliance on a qualified tax professional who failed to advise of the filing requirement
• Good-faith misunderstanding about whether the transfer qualified as a reportable gift (for example, transfers from a foreign corporation the taxpayer believed was a personal bank account)
• Incapacity, illness, or death in the family affecting the taxpayer’s ability to file
• Ambiguity in the rules themselves — particularly for transfers involving foreign trusts, closely-held foreign entities, or civil-law jurisdictions where the U.S. “trust” concept does not translate cleanly
• First-time filer issues where the taxpayer had no prior knowledge of the U.S. filing system

What reasonable cause is not: “I didn’t know.” Standing alone, lack of knowledge is almost never sufficient. Effective submissions build a factual record supported by declarations, correspondence with advisors, medical records where relevant, and a narrative explaining why the failure was reasonable under the circumstances.

Delinquent Information Return Submission

For taxpayers whose noncompliance has not yet been discovered by the IRS, the Delinquent International Information Return Submission Procedures allow late-filed Forms 3520 to be submitted with a reasonable-cause statement, potentially avoiding penalties entirely. This path is available where the taxpayer has not failed to report associated taxable income — which is the usual posture for foreign gift cases, since the gifts themselves are not taxable.

When Form 3520 Ties to Broader Offshore Issues

Form 3520 rarely sits alone. Taxpayers who receive foreign gifts often also have unreported foreign financial accounts (triggering FBAR and Form 8938 obligations), unreported interests in foreign corporations (Form 5471), unreported passive foreign investment companies (Form 8621), or foreign trust reporting obligations on subsequent years. A proper engagement begins with a full offshore compliance audit so that the Form 3520 issue is not resolved in isolation while other, potentially larger, penalties remain outstanding.

Where broader foreign compliance issues exist, our firm evaluates the full range of voluntary disclosure options — including Streamlined Offshore Procedures, Delinquent FBAR Procedures, and Delinquent Foreign Information Procedures — to design a resolution that addresses every open issue with appropriate penalty protection.

What to Do If You’ve Already Received a Form 3520 Penalty Notice

If you have received a CP15 or similar notice assessing a Form 3520 penalty, several deadlines begin running immediately:

• You have 30 days from the notice to request abatement administratively
• You have 60 days to protest to IRS Appeals after denial of abatement
• After assessment and collection action, you may have rights to Collection Due Process, refund claims after payment, and, in some cases, refund litigation

Do not pay the penalty in full before evaluating your options. Paying first does not waive abatement rights, but it changes the procedural posture of the case in ways that affect strategy. Conversely, do not ignore the notice — collection action on a $250,000 penalty follows quickly if no response is submitted.

How Kugelman Law Handles Form 3520 Penalty Matters

Our process begins with a paid, privileged consultation with Alex Kugelman. We review the penalty notice, the underlying transfer, the Form 3520 as filed (if any), and the client’s broader offshore compliance posture. We develop a reasonable-cause submission, handle all Appeals conferences, and — where abatement is denied or the exposure warrants it — coordinate refund claims and post-payment litigation strategy.

Our firm has handled Form 3520 matters where six-figure penalties were fully abated on reasonable cause grounds, and we have also coordinated broader offshore disclosures that addressed Form 3520 issues alongside FBAR, Form 5471, and Form 8938 exposure. Results depend on specific facts. Past results do not guarantee future outcomes.

Speak with a Foreign Gift Reporting Attorney

Kugelman Law offers paid, privileged consultations with founder Alex Kugelman — fully protected by attorney-client privilege. We do not offer free consultations. We provide boutique, white-glove representation in Form 3520, FBAR, and offshore information return matters.

Call (415) 968-1780 or schedule your consultation here. Representation provided throughout California and nationwide.

Frequently Asked Questions About Form 3520 Penalties

Is a foreign gift taxable?

Generally no. The IRS does not tax the recipient of a gift from a foreign person — but the reporting obligation on Form 3520 is separate from taxability, and failure to report triggers the penalty even though the underlying gift is tax-free.

What is the threshold for reporting a foreign gift on Form 3520?

For gifts from a nonresident alien individual or foreign estate, the threshold is more than $100,000 in aggregate during the year. For gifts from foreign corporations or partnerships, the threshold is considerably lower and is indexed annually.

What is the maximum Form 3520 penalty?

For unreported foreign gifts under IRC § 6039F, the maximum is 25% of the unreported amount. For foreign trust matters under IRC § 6677, the penalty can reach 35% of the gross reportable amount.

Can the IRS really impose a $250,000 penalty on a $1 million inheritance?

Yes — and it does, routinely. The penalty is automated in many cases and is assessed before any examiner reviews the underlying facts. Reasonable cause abatement is the primary defense.

Does Farhy v. Commissioner eliminate Form 3520 penalties?

No. The D.C. Circuit reversed the Tax Court in Farhy in 2024, restoring IRS assessment authority for § 6038 penalties. The broader assessment-authority arguments remain live in other contexts and circuits, but Farhy alone does not eliminate Form 3520 liability or provide automatic abatement.

How do I request abatement of a Form 3520 penalty?

By submitting a written reasonable-cause statement to the IRS within 30 days of the penalty notice, supported by documentation and, where appropriate, sworn declarations. If abatement is denied, the matter can be protested to IRS Appeals.

What if I also have unreported foreign accounts or other foreign information returns?

The Form 3520 issue should be addressed as part of a broader offshore compliance review. Our firm coordinates Streamlined Offshore Procedures, Delinquent FBAR Procedures, and Delinquent Foreign Information Procedures to resolve multiple foreign reporting issues in a single integrated strategy.

Does Kugelman Law offer free consultations for Form 3520 matters?

No. We offer paid, privileged consultations with Alex Kugelman that are fully protected by attorney-client privilege — which is particularly important in offshore matters where willfulness and criminal exposure are sometimes at issue.

About the Author: Alex Kugelman

Alex Kugelman is the founder and managing attorney of Kugelman Law, a boutique tax controversy and cryptocurrency tax firm serving clients throughout California and nationwide. Admitted to the California Bar in 2008 (No. 255463) and the U.S. Supreme Court, Alex has nearly two decades of federal tax controversy experience, including litigation in U.S. Tax Court and U.S. District Court. He served as San Francisco Chair of the Federal Bar Association’s Tax Division in 2018 and is a member of the Marin County Assessment Appeals Board. He is a nationally recognized cryptocurrency tax authority, featured on the Bitcoin.tax podcast and The Mark Milton Show. J.D., Chapman University Fowler School of Law (2007); B.A., University of Colorado at Boulder (2001). Read Alex’s full bio.