Big News for US Expats – Foreign Pension Owners Can Say Goodbye to Foreign Trust Reporting
In a major shift in reporting policy, the IRS announced in Revenue Procedure 2020-17 that it plans to promulgate regulations providing that U.S. owners of qualifying foreign pensions will no longer have to report their pension ownership or activities on the Forms 3520 (Annual Return To Report Transactions With Foreign Trusts) and 3520-A (Annual Information Return of Foreign Trust With a U.S. Owner).
Pension reporting has been a hot-button issue for U.S. expats for many years, largely due to the fact that the IRS has historically offered little guidance on how foreign pensions fit within the trust reporting rules. The Revenue Procedure is an important step (or even leap) in providing relief to U.S. expats owning foreign pensions, but more guidance will be needed to flesh out the qualifying rules for this new reporting exception.
Under the current language of the Code and regulations, the obligation to file Forms 3520 and 3520-A may be triggered in a number of instances, including if employee contributions to the plan exceed employer contributions. In such case, the employee is considered the owner of the employee contribution portion of the trust under the “grantor” trust rules, and the trust is bifurcated into two pieces. The piece qualifying as a grantor trust has an annual filing requirement on Forms 3520 and 3520-A and may have additional reporting requirements depending on the pension’s underlying investments (e.g., PFIC reporting). If the employer contributions exceed the employee contributions, the entire plan is generally treated as a “non-grantor” trust that does not trigger an annual 3520 or 3520-A filing obligation.
The requirement to file the Form 3520 can also arise in the year that distributions are made from the foreign pension.
Revenue Procedure 2020-17 – Foreign Pension Reporting Relief
In the Preamble to the Revenue Procedure, the IRS points out, correctly, that basic foreign pensions are already subject to local reporting and often trigger the obligation to file a number of international tax forms, including Form 8938 (Statement of Specified Foreign Financial Assets), otherwise known as the FATCA form, and the Report of Foreign Bank and Financial Accounts (the “FBAR” form). Therefore, trust reporting has become duplicative for foreign pensions.
The Revenue Procedure therefore modifies the reporting requirements under Internal Revenue Code section 6048 (i.e., trust reporting on Forms 3520 and 3520-A) to exclude US individuals’ transactions with, or ownership of, so-called “tax-favored foreign trusts” that are “retirement” trusts (i.e., pensions) or “non-retirement” trusts (i.e., saving vehicles for the provision of, medical, disability, or educational benefits from information reporting).
In order a foreign pension to qualify as a tax-favored foreign retirement trust, it must meet a number of requirements.
To quote from Section 5 of the Revenue Procedure, a pension trust must satisfy the following requirements:
(1) The trust is generally exempt from income tax or is otherwise tax-favored under the laws of the trust’s jurisdiction. For purposes of this revenue procedure, a trust is tax-favored if it meets any one or more of the following conditions: (i) contributions to the trust that would otherwise be subject to tax are deductible or excluded from income, are taxed at a reduced rate, give rise to a tax credit, or are otherwise eligible for another tax benefit (such as a government subsidy or contribution); and (ii) taxation of investment income earned by the trust is deferred until distribution or the investment income is taxed at a reduced rate.
(2) Annual information reporting with respect to the trust (or of its participants or beneficiaries) is provided, or is otherwise available, to the relevant tax authorities in the trust’s jurisdiction.
(3) Only contributions with respect to income earned from the performance of personal services are permitted.
(4) Contributions to the trust are limited by a percentage of earned income of the participant, are subject to an annual limit of $50,000 or less to the trust, or are subject to a lifetime limit of $1,000,000 or less to the trust.
(5) 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 section 5.03(5), 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 section 5.03(5).
(6) In the case of an employer-maintained trust, (i) 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), (ii) the trust (alone or in combination with other comparable plans) actually provides significant benefits for a substantial majority of eligible employees, and (iii) the benefits actually provided under the trust to eligible employees are nondiscriminatory.
The IRS has requested comments on the Revenue Procedure in order to craft its regulations. The initial reaction of the practitioner community, in our view, has been that while the above rules are sensible in spirit, they may be too technically restrictive, and may they therefore disqualify some of the most basic pension offered in major foreign countries. We expect to see comments suggesting broader qualifying provisions that better capture the intended scope of the reporting exemption.
Abatement Relief for IRS Penalties
Importantly, Section 6 of the Revenue Procedure states that individuals who have been assessed penalties for late reporting of a tax-favored foreign trust may request an abatement of any penalties previously assessed. This is welcome relief given the aggressive approach the IRS has taken recently on penalizing taxpayers for the late reporting of foreign pensions, despite giving taxpayers little guidance on if, when, and how to file.
In order to obtain an abatement of penalties, Section 6 of the Revenue Procedure states that “a Form 843 requesting relief under this revenue procedure should be mailed to Internal Revenue Service, Ogden, UT 84201-0027.” Line 7 of the Form requires that taxpayers explain specifically how both the taxpayer and the pension qualify for the relief provided under the Revenue Procedure.
We will be monitoring the progress of this issue in the weeks to come and provide an update on the regulations once they are published.
Joshua Ashman, CPA & Nathan Mintz, Esq.