Is your Non-US Pension Actually a Foreign Trust?
Recently the IRS have become very aggressive in their pursuit of non-compliant taxpayers with foreign information to report. Every year the IRS releases a list of top priorities and campaigns of non-compliance that they will target and you guessed it right offshore non-compliance is on that list! Foreign Information Reporting, in particular the reporting, or rather non-reporting, of foreign trusts owned by, or for the benefit of, US Taxpayers has been receiving especially aggressive attention from the IRS this year with penalty notices going out left, right and center. This article acts as an extension to my previously written blog article in the hope that US taxpayers have more information and are made aware of how important it is to comply with these filing requirements. American Citizens and Lawful permanent Residents (Greencard holders) who live overseas may need to report their non-US pensions to the IRS.
A non-US pension is not given the same tax-favoured treatment as if it were a 401(K) or an IRA for example.
In fact the Internal Revenue Code has a vast amount of classification rules for pensions that if your non-US pension does not meet then it will instead be classed as a Foreign Trust.
Why a trust you might ask?
Well, essentially when you strip back all the jargon, a pension is a trust. Your assets are held in trust, and the assets preserved until the time which you can derive a benefit from them i.e. withdrawal upon retirement.
Depending on the type of non-US pension you participate in, and the amount of contributions you have made over the life of that pension plan you may have to report this pension as a Foreign Grantor Trust.
How Do I Know?
There is so much information on the topic of taxation of cross-border pension arrangements that it can be mighty overwhelming. This area of tax and reporting should definitely have a professional involved.
Most employment based pension plans in the UK are defined contribution plans which means they will be classed as a non-qualified pension plan under US Tax Law. This pension plan will not receive the same tax favoured treatment as a qualified plan and instead will be governed by the rules for either Exempt Employee Trusts or Foreign Grantor Trusts.
The amount of contributions you make to the pension plan over the life of the plan will ultimately determine if you have a Foreign Grantor Trust or not.
Generally, if you, the taxpayer, owns the majority of the assets within the UK pension (trust) then it is classed as a Foreign Grantor Trust requiring some in depth reporting to the IRS.
You have worked in your job for several years with your employer and contribute to the employer sponsored pension plan that is a defined contribution type scheme.
Each year your contributions change slightly with the changing laws but this year you note that you might fall under the above conditions as your contributions to the plan have increased significantly on prior years.
When looking at your contributions to the plan since you joined you find that you have contributed 51% of all the cash contributions and your employer has contributed 49% of the total contributions to the plan.
This is considered a Foreign Grantor Trust under US Tax Law and requires certain Foreign Information reporting to be done each year with your US tax return.
What about my SIPP or other personal pension plan that I contribute to? There is a lot of back and forth between professionals on whether or not a SIPP or similar UK pension should be classed as a Foreign Grantor Trust or not.
My opinion is that so long as your SIPP meets the definition of a UK pension and is not classed as a Qualified Pension plan under US law it is a Foreign Grantor Trust subject to the required reporting. Who owns the assets in the SIPP? You, the taxpayer, 100%. It’s more likely that not you need to report your SIPP on the below forms each year.
What Do I Need To Do?
If the above scenario sounds familiar to you then you are required to report your UK pension(s) as a foreign grantor trust each year with your US tax return.
There are two forms that should be submitted.
The first is Form 3520-A: Annual Information Return of a Foreign Trust with a US Owner due by March 15th, each year with an available 6 month extension.
The second is Form 3520: Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts. This return is due by the normal due date of your Federal tax return with an available 6 month extension.
The tax law surrounding this type of international reporting is quite complex, lengthy and the the UK/US Tax Treaty may need to be referenced.
It is highly recommended that you have an experienced professional prepare these forms as the penalties are very punitive being the great of:
- 5% of your pension pot value
These penalties apply per form, per trust(pension) , per year of non-compliance.
More detail can be found at the IRS Webpage section for International Taxpayers.
Don’t forget that foreign pensions are also reportable on the FinCen 114 (FBAR) and Form 8938 Statement of Specified Foreign Financial Assets.
Do I Need to Pay Tax?
Well, that depends.
The following transaction with a non-qualified foreign pension plan are generally taxable in the view of the IRS:
- Accretions (income & growth within the plan)
- Rollovers to another plan
Employer matched contributions to your non-US pension plan are also considered taxable income which can be a double “non-tax” issue as these are not taxable in the UK.
Employer contributions are treated as other income, and not compensation for employment services. That means, if you use the Foreign Earned Income Exclusion you cannot exclude these employer contributions. They remain taxable unless you have enough foreign tax credits to cover the US tax.
Non-US Pensions usually invest in foreign mutual funds or other pooled investment vehicles. This type of holding is classed as a Passive Foreign Investment Company and fall under the PFIC reporting rules are very punitive and can create a heavy tax burden on the taxpayer.
Be careful if you have several plans and want to consolidate these into one arrangement. when assets are distributed to you in the pursuit of a rollover to another UK pension this is considered a taxable event. If you did not fall under the previous Foreign Grantor Trust Rules prior to a rollover you will afterwards as you take ownership of all the assets in pursuit of the rollover event.
Is there any relief?
Well, yes. The UK and US have a comprehensive tax treaty in place that addresses the treatment of pensions and could lend a lot of relief from taxation. An application of the UK/Us Tax Treaty does not exempt a taxpayer from reporting their UK pension as a Foreign Grantor Trust if required. Form 3520+3520-A are required to be filed by the due date of the return or penalties apply. In addition to this, a correct Treaty-Based Return Disclosure position must be filed with your Federal income tax return to disclose the treaty position taken. Tax Preparers should take note of this as a penalty of $1000, under I.R.C section 6114, can be imposed on preparers for not submitting this return when required. However, every situation is different and the fact and circumstances need to be looked at very carefully in order to determine whether or not the tax treaty applies. again, another reason why you should consult with a tax professional who is experienced in International Taxation of US taxpayers. Is There An Exemption? You’re right, right. There definitely is an exemption from reporting if you meet the criteria set forth in Revenue Procedure 2020-17.
To qualify a pension must meet all criteria:
- Exemption from income tax or tax-favoured in the UK.
- Annual information reporting is provided to HMRC.
- Contributions made are in respect to income earned from personal services.
- Contributions are limited to:
- Annual limit of $50,000
- Lifetime limit of $1,000,000
- Withdrawals, distributions, or payments are allowed at retirement, disability, or death or otherwise penalties apply.
- The employer sponsored plan is non-discriminatory i.e. available to all employee and on comparable terms.
Unfortunately UK Pensions do not qualify for exemption under Revenue Procedure 2020-17. It may have been the case that this Rev.Proc. aimed as giving exemption to plans such as a UK SIPP but as it stands right now, the guidance falls short and there simply isn’t enough clarity to determine confidently that SIPPs are exempt. In fact, only a very small number of pensions may qualify for exemption, such as:
- Australian Superannuation
- Canadian RESPs and RRSPs
- Swiss Pillar 3 plans
- Hong Kong MPFs.
The feedback given to the IRS Chief Counsel is that the Revenue Procedure does not cover enough foreign pensions and we are anticipating an update to the rules. How Will They Even Know? This is a question I hear very often and my response is always the same…….don’t risk it! Governments are upgrading their technological facilities as fast as we are, maybe faster, to combat tax evasion and crime. In order to assist with complying with the Foreign Account Tax Compliance Act (FATCA) enacted by President Obama, the US and UK have Automatic Exchange of Information Agreements and International Tax Compliance acts in place. These agreements and acts basically allow the sharing of information of US taxpayers form financial institutions to the US government in an attempt to clamp down on tax evasion, crime and non-compliance. Need More Advice S.E. Tax Professionals Ltd is dedicated to sharing our industry expertise and knowledge to help you fathom the complexities of our tax system. We believe that paying tax should be fair, just and not a burden.
More information can be found on the IRS International Taxpayers webpage however, you can also visit our Facebook page every Wednesday where we answer your questions online for free. Are you self employed and need help?