By Anthony Diosdi
In an increasing global economy, workers are experiencing unprecedented mobility. As a result Americans and foreign nationals that become green card holders often participate in a pension or retirement plan in the foreign country. In most cases, the model resembles the one in the United States: Pretax money is contributed into retirement accounts where it accumulates tax-free until retirement. Unknown to many participants of these plans, the Internal Revenue Code often requires U.S. tax filers to disclose these plans on Internal Revenue Service (“IRS”) Form 3520 and/or Form 3520-A. The penalties for failing to disclose a foreign pension or foreign retirement plan on a Form 3520 and/or 3520-A can be substantial. Fairly recently, the IRS promulgated Rev. Proc. 2020-7. This revenue procedure provides an exemption from filing Forms 3520 and 3520-A for individuals with foreign pensions or foreign retirement plans. The revenue procedure also includes procedures for requesting an abatement or refund of penalties imposed under Internal Revenue Code Section 6677 for failure to comply with Internal Revenue Code Section 6048 reporting requirements concerning foreign pensions and retirement plans. This article discusses the types of foreign pensions and retirement plans that may be excluded from U.S. reporting requirements under Rev. Proc. 2020-17. This article also discusses the penalty abatement procedures under Rev. Proc. 2020-17 that apply to foreign pensions and foreign retirement plans.
An Overview of Rev. Proc. 2020-17
In March of 2020, the IRS published Rev. Proc. 2020-17. This revenue procedure provides an exemption from filing Forms 3520 and 3520-A for an “eligible individual’s” transaction with, of, an “applicable tax-favored foreign trust.” This revenue procedure, however, explains that this relief does not affect any reporting obligations under Internal Revenue Code Section 6038D or under any other provisions of U.S. law, including the requirement to file FinCEN Form 114, Report of Foreign Bank and Financial Accounts (“FBAR”). Moreover, Rev. Proc. 2020-17 does not affect previously issued guidance providing an exception from Section 6048 reporting with respect to distributions from certain foreign compensatory trusts under Notice 97-34, and an exception from all information reporting requirements under Section 6048 with respect to certain Canadian retirement plans under Rev. Proc. 2014-55.
Rev. Proc. 2020-17 provides an exemption from filing IRS Form 3520 and IRS Form 3520-A for an “eligible individuals’ transactions with, or ownership of, an “applicable tax-favored foreign trust.” An eligible individual is defined as an individual who is a U.S. citizen or resident who is compliant with all requirements for filing U.S. federal income tax returns and who has reported as income any contributions to, earnings of, or distributions from an “applicable tax-favored foreign trust.” The revenue procedure covers two types of foreign trust. The first is a foreign medical, disability, or educational trust. The second is a foreign pension or retirement trust. Since this article focuses on foreign pensions and foreign retirement plans, it does not discuss the first category of “applicable tax-favored foreign trusts.”
In order for a foreign pension or foreign retirement plan to be classified as a tax-favored foreign retirement trusts, it generally must satisfy the following requirements:
1. The pension or retirement plan must be created to operate exclusively or almost exclusively to provide, or to earn income for the provision of, pension or retirement benefit. See Rev. Proc. 2017, Section 5.03.
2. The pension or retirement plan generally must annually report information with respect to the trust to the relevant tax authorities in the trust’s jurisdiction. See Rev. Proc. 2020-17, Section 5.03(2).
3. The pension or retirement plan must only permit contributions with respect to income earned from the performance of personal services. See Rev. Proc. 2020-17, Section 5.03(3).
4. Contributions to the pension or retirement plan must: a) be limited by a percentage of earned income of the participant, b) be subject to an annual contribution limit of $50,000 or less, or c) be subject to a lifetime contribution limit of $1,000,000 or less. See Rev. Proc. 2020-17, Section 5.03(4).
5. Withdrawals from the pension or retirement plan must be conditioned upon reaching a specified retirement age, disability, or death, or penalties must apply to withdrawals made before such conditions are met. However, an exception is provided for early withdrawals for hardship or educational purposes, or for the purposes of a primary residence. See REv. Proc. 2020-17, Section 5.03(5).
6. If the pension or retirement plan is employer-maintained, then certain additional requirements must be met: a) the trust must be nondiscriminatory insofar as a wide range of employees, including rank and file employees, are eligible to make or receive contributions or accrue benefits under the terms of the trust; b) the trust must actually provide significant benefits for a substantial majority of eligible employees; and c) the benefits actually provided under the trust to eligible employees must be non discriminatory. See Rev. Proc. 2020-17, Section 5.03(6)(i); Section 5.03(6)(ii); Section 5.03(6)(iii).
Finally, Rev. Proc. 2020-17 provides that an “employer-maintained” plan must be “nondiscriminator.” However, the revenue procedure does not define this term.
Finally, Some IRS Guidance Regarding the Reporting of Foreign Pension and Retirement Plans
Prior to the enactment of Rev. Proc. 2020-7, there has been very little guidance from the IRS regarding the filing requirements for foreign pensions and retirement plans. The revenue procedure provides relief by removing Form 3520 and Form 3520-A filing requirements for some foreign pensions and foreign retirement plans. However, U.S. beneficiaries of such plans will need to have each foreign pension and foreign retirement plan analyzed to determine if it can be classified as a “tax-favored-foreign trust.” If a foreign pension or foreign retirement plan can be classified as a “tax-favored-foreign trust,” the pension or retirement plan would be exempt from reporting on Forms 3520 and 3520-A and associated penalties. Rev. Proc. 2020-17 includes procedures for eligible individuals who have been assessed a penalty under Section 6677 for failing to comply with Internal Revenue Code Section 6048 with respect to a tax-favored foreign trust (without regard to whether such failure was due to reasonable cause) to request an abatement of the penalty assessed, or a refund of the penalty paid. The request must be made by filing an IRS Form 843, Claim for Refund and Request for Abatement. Line 7 of the Form 843 should include the statement “Relief pursuant to Revenue Procedure 2020-17,” and should include an explanation of how the eligible individual meets each relevant requirement under Section 5.02 and how the foreign trust meets each relevant requirement under Section 5.03 or 5.04.
Conclusion
If you are the beneficiary of a foreign pension plan or foreign retirement plan and have been assessed a penalty for failing to timely report the foreign plan on Forms 3520 and/or 3520-A, you should consult with a qualified international tax attorney to determine Rev. Proc. 2020-17 exempts your foreign plan from filing U.S. information reporting requirements and associated penalties.
Anthony Diosdi is one of several tax attorneys and international tax attorneys at Diosdi Ching & Liu, LLP. Anthony focuses his practice on domestic and international tax planning for multinational companies, closely held businesses, and individuals. Anthony has written numerous articles on international tax planning and frequently provides continuing educational programs to other tax professionals.
He has assisted companies with a number of international tax issues, including Subpart F, GILTI, and FDII planning, foreign tax credit planning, and tax-efficient cash repatriation strategies. Anthony also regularly advises foreign individuals on tax efficient mechanisms for doing business in the United States, investing in U.S. real estate, and pre-immigration planning. Anthony is a member of the California and Florida bars. He can be reached at 415-318-3990 or adiosdi@sftaxcounsel.com.
This article is not legal or tax advice. If you are in need of legal or tax advice, you should immediately consult a licensed attorney.