The resolution of three recent cases at the IRS Independent Office of Appeals support our longstanding view that no Form 3520 or 3520-A are required to report a TFSA to the IRS. As background, last year the IRS released guidance that exempted taxpayers from filing these forms for the RESP and the RDSP, but that guidance does not apply to the TFSA. In 2015, I wrote an article that the TFSA did not require a Form 3520 or Form 3520-A. In three separate cases at the IRS Independent Office of Appeals, we have used the logic of that article to get penalties abated. In each case, the taxpayer filed the Form 3520 or Form 3520-A to report the TFSA after the relevant due date for the form and, following a recent trend, the IRS imposed penalties of at least USD $10,000 due to the late-filing. However, under Code section 6677, there can be no penalties for late-filing the Form 3520 or 3520-A if those forms were not required to be filed in the first place. Our position on appeal was that since the TFSA is not a trust, neither form was required and thus the penalty should be eliminated. In all three cases, the IRS Independent Office of Appeals agreed with our position and fully abated all of the penalties. It is important to note that this position doesn’t represent the official view of the IRS on the issue and is not binding, but it is strongly indicative that no Form 3520 or 3520-A is required.
A summary of the argument we used is as follows:
- Under the Canadian Income Tax Act, there are three ways that a TFSA can be formed. One of them is described as a trust arrangement. But the Supreme Court of Canada has recently held that even though a piece of legislation uses the word “trust” to describe an arrangement, that doesn’t necessarily mean that a trust is formed (see here at paragraphs 64 and 65). On the logic outlined in the decision, the TFSA would not be a trust since it does not meet the criteria to be a trust under Canadian law (despite the use of the word trust in the Canadian Income Tax Act).
- Of course, the determination of whether the TFSA requires an IRS Form 3520 or Form 3520-A is made irrespective of its status under Canadian law.
- There is a reasonable position that the TFSA is not a legal entity because it is not much more than an investment account custodied at a financial institution with some tax advantages. Generally, bank accounts are not considered legal entities.
- Even if the TFSA is considered to be a legal entity, it is not a trust. The technical definition of a trust under US tax law is found in the Treasury Regulations*. The key part of that definition is that a trust exists where “trustees take title to property for the purpose of protecting or conserving it for the beneficiaries under the ordinary rules applied in chancery or probate courts.” The TFSA doesn’t meet this definition because:
- The financial institution administering the TFSA doesn’t take title to the property in the TFSA. It is just the custodian of the account. Put differently, it simply holds the investments for the owner of the TFSA.
- The purpose of a TFSA is not to protect or conserve property for the beneficiary. Its purpose is to shelter investment income from Canadian, not US, tax. The investments can be taken out of the TFSA by the owner at any time.
- The TFSA is not formed under laws of “chancery or probate courts”. It is created under the Canadian Income tax law and not trust law.
- Even if the financial institution took title to the property, the Form 3520 and 3520-A filing requirement is arguably excused under IRS Revenue Ruling 2013-14 which addresses an analogous situation involving the Mexican Land Trust.
In short, our view has always been that the TFSA is not a trust under US tax law and so no Form 3520 or Form 3520-A is required. That view has recently been supported by the resolution of three separate cases. Our position remains that no 3520 or 3520-A is required to be filed to tell the IRS about the TFSA.
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* 301.7701-4(a).