In Estate of Joseph A. Wilson v. United States of America, an estate brought an action for the return of $3,221,183, which it paid to the Internal Revenue Service as a penalty for a late filing of Form 3520.
Joseph Wilson established an overseas trust in 2003 of which he was the grantor and sole beneficiary. From 2003-2007, Joseph filed various income tax and information returns with the IRS, reporting the trust’s assets and interest accrued. In 2007, Joseph terminated the trust and transferred the assets ($9,203,381) back to his bank account in the United States. Joseph was late in filing his Form 3520 for calendar year 2007, which is required annually to disclose distributions from a foreign trust, with different requirements for trust grantors/owners and for trust beneficiaries. After Joseph filed his 2007 Form 3520, the IRS assessed a late penalty of $3,221,183, representing 35% of the distributions of the trust during 2007 (that is, 35% of $9,203,381). Joseph paid this amount, but submitted a claim for refund to the IRS for the entire $3,221,183 plus interest.
Refund Claim Filed by Estate
Joseph died prior to the filing of the claim at issue, and his estate proceeded to file such claim in the U.S. District Court for the Eastern District of New York, claiming that “[i]n assessing a 35% penalty, the IRS’ position is based on its erroneous position that, pursuant to IRC Section 6058(c), Wilson, as beneficiary of the trust, was subject to a 35% penalty on the amount of the trust distributions not timely reported in Form 3520”, but this assertion ignores IRC Section 6048(b), which applies to Wilson as the grantor owner of the Trust. 6048(b) would instead impose a 5% penalty on such distributions.
Court Has Jurisdiction
The IRS filed a motion to dismiss Joseph’s claim on the basis that the court lacked subject matter jurisdiction due to Joseph’s failure to exhaust administrative remedies. More specifically, the IRS alleged that Joseph failed to set forth in detail the ground for the refund and facts sufficient to apprise the IRS of the basis for the refund, which would enable the commissioner to make an intelligent administrative review of the claim. The court denied the motion to dismiss because Joseph made it “abundantly clear” that his claim was that he should have been assessed a 5% penalty under IRC Sections 6048(b) and 6677(b). The court further held that Joseph identified sufficient facts on which the claim for refund is based, provided the figures necessary to perform a refund calculation, and alerted the commissioner to the erroneous assessment percentage as well as the proposed correct percentage.
5% Penalty Applies
The estate’s cross-motion for partial summary judgment asked the court to decide that: (1) the court has jurisdiction over the grounds raised in plaintiffs’ complaint; (2) Joseph, as the sole grantor and sole beneficiary of a foreign trust, is subject only to a 5% penalty for untimely filing IRS Form 3520 under 26 USC Section 6048 and 6677; and (3) the 5% penalty should be assessed against the trust’s account balance at the close of 2007. The court held that it established that it had subject matter jurisdiction over the estate’s claim in its dismissal of the IRS’ motion to dismiss. The court also agreed with the estate that Joseph is subject only to a 5% penalty. “Because Wilson was the owner of the foreign trust, there is no doubt both that Section 6048(b) applied to him and that his violation of Section 6048(b) would result in a 5% penalty under Section 6677(b).” Further, the court held that Section 6677 doesn’t permit a single person untimely filing a single IRS form (in this case, Form 3520) to be penalized as two different people—as an owner and as a beneficiary; rather, Section 6677(b)(2)’s substitution clause replaces “35 percent” with “5 percent” in the case of an owner of a foreign trust, as is the case here. Therefore, the court agreed with the estate and granted its motion for partial summary judgment.