Form 3520 Penalty Abatement: The Policy Change and What It Means

The IRS has historically assessed automatic penalties on late-filed Forms 3520 (Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts) without first reviewing whether the taxpayer had reasonable cause. The penalty is severe: 35% of the gross value of any distribution received from a foreign trust, or 5% of the gross value of the trust’s assets if the US person is treated as an owner, assessed for each year the form is late. For a Canadian TFSA holder who is also a US person, a $50,000 TFSA with three years of missed 3520s could generate penalties exceeding $50,000 (the penalties can exceed the account value). In late 2024, the IRS announced a procedural change that paused automatic assessment of these penalties pending review for reasonable cause. This page covers what changed, what it means for existing and new penalties, and the abatement arguments that work.

What are the Form 3520 penalties?

Form 3520 requires US persons to report transactions with “foreign trusts,” including contributions to and distributions from a foreign trust, and ownership of a foreign trust. The IRS treats Canadian TFSAs, RESPs, RDSPs, and certain other Canadian registered accounts as foreign trusts for US reporting purposes, even though they function as standard savings vehicles in Canada.

The penalties under IRC 6677 are:

For distributions received from a foreign trust: 35% of the gross distribution for each year the form is not timely filed. If you received $8,000 in TFSA withdrawals and did not file Form 3520 for three years, the penalty is $8,000 x 35% x 3 = $8,400.

For trust ownership (grantor trust reporting): The greater of $10,000 or 5% of the gross value of the trust’s assets for each year the form is late. A $60,000 TFSA generates a penalty of $3,000 per year (5% of $60,000). Over five years, that is $15,000 in penalties on a $60,000 account that the taxpayer considered a simple savings account.

For foreign gifts: 5% of the gift amount per month for each month the form is late, capped at 25% of the gift. If a Canadian parent gave you $100,000 and you missed the 3520, the penalty can reach $25,000.

These penalties apply regardless of whether any US tax was owed on the underlying income. A TFSA that generated $2,000 in investment income (which would be taxable on the US return but often offset by foreign tax credits) can produce $10,000 or more in reporting penalties. The penalty is for the missing form, not for missing tax.

For the full TFSA/3520 analysis, see can the IRS really penalize me for my TFSA?.

What changed in late 2024?

The IRS announced a procedural change directing the processing of late-filed Forms 3520 to review for reasonable cause before automatically assessing penalties. Previously, the IRS’s automated system assessed the full penalty immediately upon processing a late form, and the taxpayer then had to request abatement after the fact. The burden was on the taxpayer to respond to the penalty notice and affirmatively demonstrate reasonable cause.

Under the revised procedure, the IRS reviews the reasonable cause statement submitted with the late form before assessing any penalty. If reasonable cause is established, no penalty is assessed. If reasonable cause is not established or no statement is provided, the penalty is assessed normally.

This is a procedural change, not a statutory one. The penalty provisions in IRC 6677 are unchanged. The reasonable cause defense in IRC 6677(d) is unchanged. What changed is the timing: the IRS now reviews reasonable cause first instead of penalizing first and reviewing second.

The practical impact is significant for two groups: taxpayers filing late Forms 3520 going forward (who can submit a reasonable cause statement and avoid the penalty entirely if accepted), and taxpayers who already received penalties under the old automatic-assessment process (who can request abatement citing the same reasonable cause arguments, with the policy change as additional support that the IRS recognizes the automatic assessment was inappropriate).

How do I get an existing penalty abated?

If you already received a Form 3520 penalty under the old automatic-assessment process, request abatement by writing to the address on the penalty notice. The request should include:

1. The penalty notice number, the tax year, and the Form 3520 at issue.
2. A reasonable cause statement explaining why the form was late.
3. Supporting documentation (engagement letters, proof of professional reliance, evidence of compliance efforts).
4. A reference to the IRS’s revised procedures, noting that the IRS itself has recognized that automatic assessment without reasonable cause review was inappropriate.

The reasonable cause arguments for Canadian account holders are well-established:

Reliance on a professional. The most common and strongest argument. If your Canadian accountant (or even a US accountant unfamiliar with international reporting) did not advise you about Form 3520, and you provided them with all relevant information about your Canadian accounts, reliance on that professional is reasonable cause. Document the engagement: when you hired them, what you disclosed, and what they told you about US reporting obligations.

The account is not a “foreign trust” in any meaningful sense. A TFSA is a tax-free savings account administered by a Canadian bank. Calling it a “foreign trust” for US reporting purposes is a legal fiction. Congress enacted the foreign trust reporting rules to combat offshore tax evasion, not to penalize Canadians for having a savings account at TD Bank. While this is not a legal defense to the reporting obligation (the IRS’s position that TFSAs are foreign trusts has been consistently maintained), it supports the reasonable cause argument: the taxpayer did not know the account was reportable because no reasonable person would assume a Canadian savings account is a “foreign trust.”

No US tax was avoided. If the income from the account was reported on the US return (either directly or through PFIC reporting, or offset by the foreign earned income exclusion or foreign tax credits), the failure to file Form 3520 caused no loss to the Treasury. The penalty is disproportionate to the offense.

Prompt compliance. If you filed the missing forms as soon as you learned of the obligation (through a new accountant, through the streamlined procedures, or through independent research), prompt compliance supports reasonable cause.

What about Forms 3520-A?

Form 3520-A (Annual Information Return of Foreign Trust With a US Owner) is the trust’s return, filed by the trust or by the US person treated as the trust’s owner. For Canadian registered accounts (TFSAs, RESPs, RDSPs), the US person typically files Form 3520-A as a substitute return because the Canadian institution will not file it.

The penalty for a late Form 3520-A is the greater of $10,000 or 5% of the gross value of the trust’s assets (IRC 6677(a)). The policy change on Form 3520 penalties extends to the related Form 3520-A penalties, since both are assessed under section 6677 and both are subject to the same reasonable cause defense.

If you need to file late Forms 3520-A, include a reasonable cause statement with each one. The arguments are the same as for Form 3520.

What if I filed through Streamlined?

If you filed the missing Forms 3520 and 3520-A as part of an IRS Streamlined filing (SFOP or SDOP), the streamlined penalty waiver covers the tax penalties but does not automatically cover the information return penalties under IRC 6677. The IRS may assess Form 3520 penalties separately even after accepting the streamlined submission.

The policy change helps here: if you submitted a reasonable cause statement with the streamlined package (which you should), the IRS should review that statement before assessing the information return penalty. If the reasonable cause is accepted, no penalty is assessed. If not, you can request abatement separately, citing the same arguments plus the fact that you came forward voluntarily through an IRS-sanctioned compliance program.

For Form 5471 and 5472 penalties assessed alongside a streamlined filing, the same dynamic applies: the streamlined waiver does not cover the information return penalties, but reasonable cause abatement is available.

How does this affect RESP and RDSP holders?

RESPs (Registered Education Savings Plans) and RDSPs (Registered Disability Savings Plans) raise the same issues as TFSAs: the IRS may treat them as foreign trusts subject to Form 3520 reporting, even though they are standard Canadian registered accounts. The policy change applies to these accounts equally.

The reasonable cause argument for RESPs and RDSPs is at least as strong as for TFSAs: these are accounts specifically designed for education savings (RESP) or disability savings (RDSP), they are regulated by the Canadian government, they are not offshore tax avoidance vehicles, and no reasonable person would characterize them as “foreign trusts” without professional guidance.

The CESG (Canada Education Savings Grant) and CDSG (Canada Disability Savings Grant) contributions from the Canadian government into these accounts may themselves be treated as reportable transactions, adding another layer of reporting complexity that supports the “no reasonable person would know about this” argument.

What should I do next?

If you have a TFSA, RESP, RDSP, or other Canadian registered account and have not been filing Forms 3520 and 3520-A, the reporting obligation still exists. File the late forms with a detailed reasonable cause statement. If you are coming into compliance through streamlined, include the forms in the package.

If you already received penalties, request abatement in writing with the reasonable cause statement and supporting documentation. Reference the policy change. If the IRS denies the request, appeal to IRS Appeals within 30 days. For the general IRS penalty abatement process, including what to do if the IRS says no, see the penalty abatement guide.

This guide is general information, not tax advice for your specific situation. Which points apply, and how, depends on your facts.