Dear US taxpayers with foreign pensions,
I’m normally too busy to write during tax season, but today something significant enough happened to merit an exception.
The IRS released Revenue Procedure 2020-17, which will be published in the Internal Revenue Bulletin on March 16, and could have implications for your 2019 tax return.
By the way, if you have not started working on your 2019 tax return yet, you should!
What’s the big deal about this new Rev. Proc?
It provides relief to US participants of foreign pensions and other tax favored foreign accounts. I’m going to focus this newsletter on the relief on foreign pension reporting, which can be one of the biggest headaches for US taxpayers who are working or have worked abroad.
As you are likely already aware, the IRS generally considers foreign pensions to be foreign trusts. Foreign trusts have special reporting requirements, including Form 3520 – Annual Report to Report Transactions with Foreign Trusts and Receipts of Certain Foreign Gifts and Form 3520-A – Annual Information Return of Foreign Trust with a U.S. Owner. They may also need to be reported on the FBAR, Form FinCEN 114 and on the FATCA Form 8938 – Statement of Specified Foreign Financial Assets.
That’s a load of reporting requirements…..
To add insult to injury, penalties for reporting errors or omissions on any of these forms can be quite steep. Form 3520 and 3520-A, for example, carry failure to file penalties of the greater of $10,000 or 35% of the unreported amount…. per infraction!
These two forms are precisely the forms for which this Rev. Proc. provides relief, so that’s nice.
Let’s explore the extent of the relief, who can benefit, and how.
Who can benefit?
Any US taxpayer, such as a US Citizen, green card holder or a resident of the USA, who is a beneficiary in a foreign pension or owns a foreign retirement account can benefit from this procedure.
If you are an American who worked or works abroad, you likely have at least one foreign retirement accounts, so this will matter to you. If you are immigrant in the USA, you may also have these types of accounts.
What relief is provided?
Form 3520 and Form 3520-A are no longer required if certain conditions, reasonable in my opinion, are met.
What are those conditions?
There are several.
One of the most important ones applies to you, the taxpayer. In order to benefit from the procedure, you are required to be a compliant taxpayer. This means that you must have fully reported and paid taxes, when relevant, on your contributions, distributions, and income earned in or from your foreign pensions or foreign retirement accounts. If you are not sure if you have reported this correctly, you may need to consult a qualified tax professional.
Another important requirement is with respect to the pension or retirement account itself. There are contribution limitations and other conditions. The contribution limitations are $50,000/year or $1,000,000 per lifetime. Other conditions include that the pension is set up under the laws of a foreign country to provide tax advantaged retirement savings to its domestic workers, that the amounts contributed are known and based on earnings from personal services, that distributions are allowed at retirement or due to death or disability, etc.
It would be too lengthy to list all the conditions, but other than the contribution limitations, which may be an issue in countries with generous employer pensions and strong currencies, most foreign retirement accounts and pensions should qualify.
What about FBAR and FATCA reporting?
I’m afraid those requirements still apply. Form FinCEN 114 and Form 8938 are not impacted by this Rev. Proc., just Forms 3520 and 3520-A. Please do not forget to file your FBAR and Form 8938 if you meet the filing thresholds!
The FBAR are Form 8938 may not be nearly as complex and daunting to prepare as Forms 3520 and 3520-A, but the failure to file penalties are still quite high.
Is that all?
No, there’s more.
Some of you may have been imposed penalties for failure to file Form 3520 or 3520-A to report contributions, distributions or income from foreign pensions. There has been a recent spike in the assessment of these penalties, which created a lot of ruckus in the tax professional community, which is likely to have influenced the decision of the IRS to provide this relief.
If you have been unfortunate enough to have been assessed these penalties, and the pensions in question meet the relevant criteria, plus the statute of limitations for refund on the relevant returns is still open, you can request abatement or refund of those penalties.
You can do this by filing Form 843 – Claim for Refund and Request for Abatement, indicating on the form that relief is requested pursuant to Rev. Proc. 2020-17 and mailing the form to the IRS in Ogden, UT 84201-0027. With penalties so high for trust reporting issues, a lot of money could be at stake for you.
Many foreign employer pensions qualify as Employees Trusts, which are special kinds of trusts under US tax law. Foreign pensions that qualify as Employees Trusts were already exempted from Form 3520 reporting under Treasury Regulations or prior IRS guidance.
Describing in detail when a foreign pension qualifies as an Employees Trusts exceeds the scope of this newsletter, but an example I’m very familiar with, because I work with many US taxpayers with Swiss ties, are Swiss Pillar 2 occupational pensions.
Pillar 2s are employer pensions that would most resemble 401ks in the USA, although they have significant differences. US Swiss Pillar 2s generally qualify as Employees Trusts, if the participant has not made significant buy-ins into their Pillar 2 accounts. Form 3520 or 3520-A reporting was therefore already not required for most Swiss Pillar 2 participants, so this Rev. Proc. isn’t likely to changed much for them.
With respect Pillar 3a owners, though, this is different. Pillar 3as are a type of individual retirement account in Switzerland that resembles a Traditional IRA in the USA. Many other foreign countries offer individual retirement accounts that can resemble Swiss Pillar 3s or US IRAs.
It is quite likely that the IRS considers Pillar 3as foreign grantor trusts, which normally requires Form 3520-A, and potentially Form 3520, to be filed annually. There was no specific guidance about this potential requirement until now. There was therefore a risk that having a Pillar 3a and not filing Form 3520 and 3520-A annually could eventually cause a big headache with the IRS. Thanks to this Rev. Proc., this concern is now gone.
Pillar 3as should easily meet all the relevant requirements to be exempt from reporting under the Rev. Proc, and this merits a small celebration. Woo hoo!
Before anyone goes rushing into investing in a Pillar 3 or other individual foreign pensions, though, one final comment about PFICs. Swiss ETFs or mutual funds, and other foreign investment funds that are the typical investment vehicles used in foreign individual retirement accounts, are generally classified as PFICs for US tax purposes. PFICs are taxed punitively and have extensive filing requirements of their own, and this Rev. Proc. provides no relief from those PFIC requirements.
Even if Form 3520 and 3520-A are no longer required for many foreign individual retirement accounts, don’t forget about reporting the PFICs that they may hold. This should be a topic for another discussion! I will leave it here for now.
As a final note, I must remind you that the purpose of this letter is to inform you about tax law changes and new IRS guidance, and not to provide tax advice specifically for you. Your individual facts and circumstances impact how laws, regulations and revenue procedures apply to your situation. How this guidance applies to your case, which I am not familiar with, is for you or your tax advisor to determine.
I hope you found the letter informative. Please share it with your advisor, colleagues, friends or anyone who you believe may find it helpful.
Until next time!