In early March 2020, the IRS issued guidance in a Revenue Procedure that outlined that certain U.S. taxpayers may no longer fall within the potentially onerous reporting requirements in respect of their foreign retirement plan. Allowing application retrospectively and therefore providing penalty relief for some taxpayers, the guidance is welcome relief for certain taxpayers ahead of the current tax filing season.
The challenge of foreign retirement plans
For internationally mobile employees in the United States who have foreign retirement funds and U.S. tax residents overseas, foreign retirement plans have been a complex area for reporting and taxation. While taxpayers are encouraged to save for their retirement, participation in a non-U.S. retirement plan while working for a foreign employer can bring unexpected consequences for taxes. Furthermore, as it can be mandatory to be enrolled in a retirement contribution scheme in some countries, U.S. taxpayers overseas have had to keep track of the tax implications of participation.
U.S. taxpayers have a number of technical considerations to address when approaching a tax-advantaged retirement plan, including:
- Treatment of the employee contributions – will contributions made by the employee be tax deductible?
- Treatment of the employer contributions – will contributions made by an employer be regarded as taxable employment income?
- Can relief be sought under a double tax treaty that the U.S. has concluded?
- Does the retirement plan require reporting on Form 8938, “Statement of Specified Foreign Financial Assets,” within a Federal tax return?
- Does the retirement plan contain investments such as a Passive Foreign Investment Company (PFICs) that require reporting on Form 8621, “Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund”?
- Does the retirement plan require reporting on FinCEN Form 114, “Report of Foreign Bank and Financial Accounts (FBAR)”?
Additionally, some foreign pensions may be structured as a trust and as such, taxpayers have had to undertake complex review and challenging reporting of these trusts on Forms 3520 or Form 3520-A. The penalties for non-compliance, including late filing, can be considerable.
Exemption from U.S. trust reporting
The Revenue Procedure provides an exemption for U.S. taxpayers with certain types of tax-favored foreign retirement trusts from filing Forms 3520 and 3520-A. Recognizing that tax-favored foreign trusts generally are subject to written restrictions, such as contribution limitations, conditions for withdrawal and information reporting, which are imposed under the laws of the country in which the trust is established, the IRS will allow exemption from reporting where certain criteria are met.
The criteria, which outline the type of qualifying trust, its use for retirement benefits and conditions regarding contributions, withdrawals and reporting, must be reviewed to determine whether a taxpayer can benefit from the exemption. For those who can, it will be a welcome reduction in tax compliance complexity though importantly, other reporting obligations still remain and should be reviewed.
For U.S. taxpayers who have been delinquent with Forms 3520 or 3520-A reporting in prior tax years, the guidance also provides a mechanism to obtain penalty abatement and penalty refunds for taxpayers for trusts that fall within the exemption.
Subject to the statute of limitations for refund or credit, a U.S. taxpayer that has been penalized for a delinquent filing of Form 3520 or 3520-A for a covered trust may file Form 843, “Claim for Refund and Request for Abatement,” with the Ogden, Utah, Service Center explaining why the particular trust meets the requirements of the revenue procedure.
The impact for globally mobile employees
Internationally mobile U.S. taxpayers face a range of complexities in the compliant management of their tax affairs, with foreign retirement plans being a particularly challenging area. The guidance in the Revenue Procedure allows certain taxpayers the opportunity to reduce some of that complexity going forward.
Taxpayers should review whether existing or new foreign retirement plans qualify for relief and should continue to monitor for changes. Importantly, as other reporting requirements may still apply, U.S. taxpayers should consider what other compliance obligations need to be met.
For U.S. multinational employers, the exemption may allow for reduced compliance costs and while a determination on whether employer-related retirement plans qualify for the exemption, companies may support review to ease the burden on their internationally mobile employees.
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