What is a Tax-Favored Foreign Retirement Trust, Exceptions

A Tax-Favored Foreign Retirement Account, What is it & Exceptions

Tax-Favored Foreign Retirement Account

One of the biggest headaches for U.S. Taxpayers across the globe who have retirement accounts in foreign countries is having to report them accurately on their U.S. tax return. While reporting these ‘accounts’ on the FBAR and Form 8938 is usually manageable, Forms 3520 and 3520-A can make the reporting much more complicated. The reason that this type of reporting is such a big headache, is because most of these retirement accounts are technically considered to be trusts. And, since foreign retirement accounts may be characterized as ‘trusts’ for U.S. tax and reporting purposes, it may necessitate the taxpayer having to file Form 3520 and Form 3520-A to report the foreign retirement accounts to the IRS. Adding insult to injury is that these two forms were not designed to require foreign retirement accounts to have to be reported. Rather, Forms 3520/3520-A were designed to avoid abusive tax schemes and other types of offshore trusts. Thus, many taxpayers who want to comply with the reporting rules and file these forms find it impossible to even obtain the information necessary to do so.

Recently, the IRS proposed certain regulations to help bring more guidance to taxpayers when it comes to having to report these tax-favored form retirement accounts. While there are already some rules in the book such as Revenue Procedure 2014-55 and Revenue Procedure 2020-17, under the regulation proposals, it would bring a little more clarity for taxpayers who are trying to be compliant.

Let’s look at some of the IRS’ key provisions on reporting tax-favored foreign retirement accounts.

First, Why is Reporting Tax-Favored Foreign Retirement Trusts Hard?

Primarily, the issue with tax-favored foreign retirement trusts is that the foreign country where the trust is located does not treat these types of retirement accounts as trusts. Instead, they are merely equivalent to a U.S. 401K, and thus the information underlying the investments is not available to the taxpayer until the Taxpayer begins receiving distributions (and even then, the amount of information they can get is limited). As a result, the taxpayer is not able to substantially comply with the reporting on Forms 3520 and Form 3520-A — as well as other international reporting forms as well. Thus, the taxpayer could be penalized for no fault of his own. Let’s take a look at what the proposed regulations provide for tax-favored foreign retirement accounts.

The IRS Has Power to Suspend 3520/3520-A Requirements

• • • “Section 6048(d)(4) authorizes the IRS to suspend or modify any requirement of section 6048 if the IRS determines that the United States has no significant tax interest in obtaining the required information. The Treasury Department and the IRS previously have issued guidance providing that information reporting under section 6048(c) is not required with respect to distributions from certain foreign compensatory trusts, provided that the U.S. person who receives the distribution reports the distribution as compensation income on an applicable Federal income tax return, and that information reporting under section 6048(a) through (c) is not required with respect to certain Canadian retirement plans.

    • See Section V of Notice 97-34; Rev. Proc. 2014-55, 2014- 44 I.R.B. 753. In addition, on March 16, 2020, the Treasury Department and the IRS issued Revenue Procedure 2020-17, which exempts from section 6048 information reporting requirements certain U.S. individuals’ transactions with, and ownership of, certain tax-favored foreign trusts that are established and operated exclusively or almost exclusively to provide pension or retirement benefits or to provide medical, disability, or educational benefits.”

Not a Reportable Event

• • • “A reportable event does not include transfers to certain foreign charitable trusts, foreign compensatory trusts, and tax-favored foreign retirement and nonretirement savings trusts, as discussed in section IV.D.2.i of this Explanation of Provisions. See proposed §1.6048-5.”

Definition of a Tax-Favored Foreign Retirement Trust

• • • “A tax-favored foreign retirement trust means a foreign trust that is established under the laws of a foreign jurisdiction to operate exclusively or almost exclusively to provide, or to earn income for the provision of, pension or retirement benefits and ancillary or incidental benefits, and that meets certain additional requirements, such as contribution limitations or value thresholds, conditions for withdrawal, and information reporting.”

    • See proposed §1.6048-5(b)(2). A tax-favored foreign non-retirement savings trust means a foreign trust that is established under the laws of a foreign jurisdiction to operate exclusively or almost exclusively to provide, or to earn income for the provision of, medical, disability, or educational benefits, and that also meets certain additional requirements, such as contribution limitations, conditions for withdrawal, and information reporting. See proposed §1.6048-5(b)(3). A tax-favored foreign de minimis savings trust means a foreign trust that is established under the laws of a foreign jurisdiction to operate as a savings vehicle, that is not treated as a tax-favored foreign retirement trust or a tax-favored foreign non-retirement savings trust, and that meets certain additional requirements, such as information reporting, and whose value is under a de minimis threshold. See proposed §1.6048-5(b)(4).

Tax-Favored Foreign Retirement Trust Exceptions

• • • “Tax-favored foreign retirement trusts, non-retirement savings trusts, and de minimis savings trusts Proposed §1.6048-5(b) provides an exception from section 6048(a) through (c) and proposed §§1.6048-2 through 1.6048-4 for certain eligible U.S. individuals’ transactions with, or ownership of, certain tax-favored foreign retirement trusts, nonretirement savings trusts, and de minimis savings trusts. These exceptions to section 6048 reporting generally follow the exceptions provided under Rev. Proc. 2020-17, but are modified to address comments received, including comments requesting that future guidance include an increase to the applicable contribution limitation thresholds, rules for tax-favored foreign retirement trusts that may allow limited contributions of unearned income, and relief with respect to certain trusts that do not fall within the listed categories but that have values below a certain threshold.”

Why Exempt Tax-Favored Foreign Retirement Trusts?

• • • “The Treasury Department and the IRS are of the view that it would be appropriate to exempt U.S. individuals from the requirement to provide information about these foreign trusts for several reasons. First, these foreign trusts generally are subject to written restrictions, such as contribution limitations, conditions for withdrawal, and information reporting, under the laws of the country in which they are established that are broadly consistent with the eligibility requirements under the Code for U.S. trusts serving similar policy goals. Second, U.S. individuals with an interest in these trusts may be required under section 6038D to separately report information about their interests in accounts held by, or through, these trusts.

    • Additionally, with respect to taxfavored foreign de minimis savings trusts and tax-favored foreign retirement trusts, the Treasury Department and the IRS are of the view that exempting U.S. individuals from the section 6048 requirements based on the value of the trust is appropriate and consistent with the reporting thresholds under section 6038D.”

Not all Tax-Favored Foreign Retirement Trusts Will Qualify

One important factor that taxpayers must keep in mind, is that not all tax-favored foreign retirement accounts will qualify under the proposed regulations. Similar to revenue procedure 2020-17, there are various eligibility requirements for a tax-favored retirement and slash or non-retirement trust to meet before qualifying for any exception. And, similar to the revenue procedures that precede these proposed regulations, some of the factors are ambiguous and not as straightforward as taxpayers would want to determine whether or not they are tax-favored foreign retirement trust qualifies to be excluded from having to file Form 3520 and Form 3520-A.

Which Tax-Favored Foreign Trusts Qualify?

• • • Tax-favored foreign retirement trust

      • “For purposes of this section, a tax favored foreign retirement trust means a foreign trust that is created, organized, or otherwise established under the laws of a foreign jurisdiction (the trust’s jurisdiction) as a trust, plan, fund, scheme, or other arrangement (collectively, a trust) to operate exclusively or almost exclusively to provide, or to earn income for the provision of, pension or retirement benefits and ancillary or incidental benefits, and that meets the following requirements established by the laws of the jurisdiction governing the trust:

        • (i) The trust generally is exempt from income tax or otherwise is tax-favored under the laws of the trust’s jurisdiction. For purposes of this section, a trust is taxfavored under the laws of the trust’s jurisdiction if it meets any one or more of the following conditions:

          • (A) Contributions to the trust that otherwise would be subject to tax are deductible or excluded from income, are taxed at a reduced rate, give rise to a tax credit, or otherwise are eligible for another tax benefit (such as a government subsidy or contribution); or

          • (B) Taxation of investment income earned by the trust is deferred until distribution or the investment income is taxed at a reduced rate (including exempt from tax).

        • (ii) Annual information reporting with respect to the trust (or of its participants or beneficiaries) is provided, or otherwise is available, to the relevant tax authorities in the trust’s jurisdiction.

        • (iii) Generally, only contributions with respect to income earned from the performance of personal services are permitted (with allowances made for limited contributions made by unemployed individuals).

        • (iv) The trust meets either the value threshold in paragraph (b)(2)(iv)(1) or any one of the contribution limitations in paragraph (b)(2)(iv)(2) of this section:

          • (1) Value threshold. The aggregate value of the trust(s) in the trust’s jurisdiction is limited to no more than $600,000 at any point during the taxable year (as adjusted under paragraph (b)(2)(iv)(3) of this section) regardless of the number of trusts established.

          • (2) Contribution limitations. The contributions to the trust(s) in the trust’s jurisdiction are limited to any one of the following: (i) A percentage of earned income of the participant, (ii) An annual limit of $75,000 (as adjusted under paragraph (b)(2)(iv)(3) of this section) or less, or (iii) A lifetime limit of $1,000,000 (as adjusted under paragraph (b)(2)(iv)(3) of this section) or less.

          • (3) Dollar limitations subject to adjustments—

            • (i) The value threshold in paragraph (b)(2)(iv)(1) and contribution limits in paragraph (b)(2)(iv)(2) of this section are determined using the U.S. Treasury Bureau of Fiscal Service foreign currency conversion rate on July 1 of the tax year (available at https://fiscaldata.treasury.gov/datasets/treasury-reporting-rates-exchange/treasuryreporting-rates-of-exchange).

            • (ii) In the case of calendar years beginning on or after January 1, 2025, the amounts under paragraph (b)(2)(iv)(1) and paragraph (b)(2)(iv)(2) of this section will be adjusted at the same time and in the same manner as the amounts are adjusted under section 415(d), except that the base period will be the calendar quarter beginning July 1, 2024.

            • (v) Withdrawals, distributions, or payments from the trust are conditioned upon reaching a specified retirement age, disability, or death, or penalties apply to withdrawals, distributions, or payments made before such conditions are met. A trust that otherwise meets the requirements of this paragraph (b)(2)(v), but that allows withdrawals, distributions, or payments for in-service loans or for reasons such as hardship, educational purposes, or the purchase of a primary residence, will be treated as meeting the requirements of this paragraph.

            • (vi) In the case of an employer-maintained trust:

              • (A) The trust is nondiscriminatory insofar as a wide range of employees, including rank and file employees, must be eligible to make or receive contributions or accrue benefits under the terms of the trust (alone or in combination with other comparable plans);

              • (B) The trust (alone or in combination with other comparable plans) actually provides significant benefits for a substantial majority of eligible employees; and

              • (C) The benefits actually provided under the trust to eligible employees are nondiscriminatory.”

      • Tax-favored foreign non-retirement savings trust

        • “For purposes of this section, a tax-favored foreign non-retirement savings trust means a foreign trust that is created, organized, or otherwise established under the laws of a foreign jurisdiction (the trust’s jurisdiction) as a trust, plan, fund, scheme, or other arrangement (collectively, a trust) to operate exclusively or almost exclusively to provide, or to earn income for the provision of, medical, disability, or educational benefits, and that meets the following requirements established by the laws of the trust’s jurisdiction:

          • (i) The trust generally is exempt from income tax or otherwise is tax-favored under the laws of the trust’s jurisdiction as defined in paragraph (b)(2)(i) of this section.

          • (ii) Annual information reporting with respect to the trust (or of its participants or beneficiaries) is provided, or otherwise is available, to the relevant tax authorities in the trust’s jurisdiction.

          • (iii) Contributions to the trust are limited to $10,000 (multiplied by the cost-ofliving adjustment determined under section 1(f)(3) for the calendar year by substituting “calendar year 2020” for “calendar year 2016” in section 1(f)(3)(A)(ii) and rounding to the nearest multiple of $1,000) or less annually, or $200,000 (multiplied by the cost-ofliving adjustment determined under section 1(f)(3) for the calendar year by substituting “calendar year 2020” for “calendar year 2016” in section 1(f)(3)(A)(ii) and rounding to the nearest multiple of $1,000) or less on a lifetime basis, determined using the U.S. Treasury Bureau of Fiscal Service foreign currency conversion rate on the last day of the tax year (available at https://fiscaldata.treasury.gov/datasets/treasury-reportingrates-exchange/treasury-reporting-rates-of-exchange)

          • (iv) Withdrawals, distributions, or payments from the trust are conditioned upon the provision of medical, disability, or educational benefits, or apply penalties to withdrawals, distributions, or payments made before such conditions are met.”

      • Tax-favored foreign de minimis savings trusts

        • “For purposes of this section, a tax-favored foreign de minimis savings trust means a foreign trust that is created, organized, or otherwise established under the laws of a foreign jurisdiction (the trust’s jurisdiction) as a trust, plan, fund, scheme, or other arrangement (collectively, a trust) to operate as a savings vehicle, that is not treated as a tax-favored foreign retirement trust, as described in paragraph (b)(2) or a tax-favored foreign non-retirement savings trust, as described in paragraph (b)(3), and that meets each of the following requirements:

          • (i) The trust generally is exempt from income tax or otherwise is tax-favored under the laws of the trust’s jurisdiction as defined in paragraph (b)(2)(i) of this section;

          • (ii) Annual information reporting with respect to the trust (or of its participants or beneficiaries) is provided, or otherwise is available, to the relevant tax authorities in the trust’s jurisdiction pursuant to the laws of the trust’s jurisdiction; and

          • (iii) The aggregate value of the trust(s) in the trust’s jurisdiction is limited to no more than $50,000 at any point during the taxable year (multiplied by the cost-of-living adjustment determined under section 1(f)(3) for the calendar year by substituting “[the year of the date of publication of the final regulations in the Federal Register]” for “calendar year 2016” in section 1(f)(3)(A)(ii) and rounding to the nearest multiple of $1,000) regardless of the number of trusts established. The $50,000 is determined using the U.S. Treasury Bureau of Fiscal Service foreign currency conversion rate on the last day of the tax year (available at https://fiscaldata.treasury.gov/datasets/treasuryreporting-rates-exchange/treasury-reporting-rates-of-exchange).”

Late Filing Penalties May be Reduced or Avoided

For Taxpayers who did not timely file their FBAR and other international information-related reporting forms, the IRS has developed many different offshore amnesty programs to assist taxpayers with safely getting into compliance. These programs may reduce or even eliminate international reporting penalties.

Current Year vs Prior Year Non-Compliance

Once a taxpayer missed the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, taxpayers should consider speaking with a Board-Certified Tax Law Specialist who specializes exclusively in these types of offshore disclosure matters.

Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)

In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful Taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties. 

Need Help Finding an Experienced Offshore Tax Attorney?

When it comes to hiring an experienced international tax attorney to represent you for unreported foreign and offshore account reporting, it can become overwhelming for taxpayers trying to trek through all the false information and nonsense they will find in their online research. There are only a handful of attorneys worldwide who are Board-Certified Tax Specialists and who specialize exclusively in offshore disclosure and international tax amnesty reporting. 

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure. 

Contact our firm today for assistance.