Failure to File Information Returns For Foreign Trust Keeps Statute Of Limitations Open For Individual’s Income Tax
Fairbank v Commissioner is the latest in a long line of important cases originating from the IRS’s use of the John Doe Summons (JDS) process to gather information about US individuals who had money parked in overseas accounts.
Fairbank involves Section 6501(c)(8). That section provides that an individual who fails to file information returns with respect to certain activities, including owning a foreign trust and receiving distributions from an overseas trust, faces an exception to the normal three-year statute of limitation (SOL) on assessment. When a taxpayer fails to file those information returns, instead of three years from the filing of the income tax return, the clock on the SOL on assessment for income tax does not begin to run until the taxpayer furnishes information to the IRS about the trust investments.
The taxpayer in Fairbank was no stranger to overseas investments and accounts. In the early 1980’s, when Mrs. Fairbank was married to her first spouse, IRS had issued jeopardy assessments approaching $15 million after the IRS discovered that her ex husband had shifted substantial assets to New Zealand and Switzerland and had not filed tax returns for a few years.
Fast-forward a bit. Mrs. Fairbank and her ex divorced, and as per the divorce negotiations and settlement the ex transferred cash to Mrs. Fairbank. The cash went to a Swiss-based UBS account in the name of Xavana Establishment, an entity formed in Liechtenstein.
In 2008 a federal court approved the IRS issuance of a JDS to UBS, which provided Fairbank’s name to the IRS. That triggered an income tax examination, and Fairbank eventually filed FBAR forms and information returns relating to ownership of and distributions from a foreign corporation, but not the filing of Forms 3520 or 3520A, relating to the ownership of and distributions from a foreign trust.
In 2018, after determining that there was additional income tax due to the overseas accounts, IRS issued notices of deficiency for 2002-09 with taxes and penalties stemming from the income approximating about $120,000. Fairbank had timely filed those individual returns, and in the absence of an exception to the three-year SOL, any assessment with respect to income tax liability would be time barred.
IRS argued that Fairbank’s failure to file the trust information forms meant that Section 6501(c)(8) applied and thus its stat notices preserved the possibility of a timely assessment. Fairbank argued that she effectively provided the information that the IRS required under Section 6048 pertaining to trust ownership and distributions. (As an important aside, she also argued, unsuccessfully, that Xavana was a corporation and not a trust; the opinion found that her control over the corpus and income rendered the trust a grantor trust and not a corporation—much of the opinion digs into entity classification issues.)
In finding that 6501(c)(8) controlled and the SOL on assessment was still open, the opinion declined to definitively state that taxpayers had to file Forms 3520 and 3520 A to avoid the exception in 6501(c)(8) to apply. In footnote 32, however, the opinion did state that analogous case law provides that information can be considered a return for purposes of the SOL rules even if it is not on the specific form the IRS typically requires.
That substance over form approach did not help Fairbank, however, as the opinion concluded that they had not provided enough information about Xavana’s activities:
We conclude that Mrs. Fairbank, as the deemed U.S. owner of Xavana Establishment, has failed to provide any written return to respondent setting forth a full and complete accounting of Xavana Establishment’s activities for the years at issue. See I.R.C. §6048(b)(1).
Similarly, we conclude that Mrs. Fairbank, as Xavana Establishment’s U.S. beneficiary, has failed to make any return that includes the name Xavana Establishment and which outlines the aggregate amount of distributions she received during each of the tax years at issue from Xavana Establishment.
Whether a taxpayer can satisfy the 6501(c)(8) requirement in the absence of filing a specific form presents an interesting issue. While the opinion suggests that a taxpayer who has sufficiently demonstrated that the IRS received all of the information that a form would have provided might have prevailed, in footnote 33 the opinion cautions that even if “we were to accept petitioners’ argument that a specific form is not required to trigger the running of the period of limitations, we would create uncertainty in an area of the law where absolute clarity benefits both the IRS and taxpayers.”
I suspect that Fairbank would be ok with that uncertainty, and while the SOL rules are meant to provide a date certain, it is hard to see why the IRS should have additional time to assess if it has elsewhere received all the information it would have received on a specific form. That issue awaits resolution in another case, however.
One final point. The opinion notes that in 2010 Congress added a reasonable cause exception to 6501(c)(8), but in footnote 30 it states that the taxpayer “did not adequately raise the issue.” That is tough. The reasonable cause analysis would lean heavily on standards developed in the context of civil penalties, including the seminal 1985 Supreme Court Boyle case. While Boyle generally provides that you cannot delegate tax return filing obligations to a third party, perhaps in Fairbank counsel’s advice in 2014 to only file an information return with respect to a foreign corporation, and not a return with respect to a foreign trust, would have amounted to substantive legal advice, rather than nondelegable advice concerning filing deadlines that was directly at issue in Boyle.