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Foreign Pension or Trust

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Steven E Miller, CPA PC

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Do You Have a Foreign Pension or Trust?

Do you know? The answer could be very important. Why? The failure to disclose and report these pensions or trusts could expose you to very large penalties. Such penalties start at $10,000 per account per year!

The IRS Commissioner has stated on numerous occasions that assessing and collecting penalties is a primary focus of the agency. Since penalties for failure to file foreign investments, accounts and relationships are some of the highest, the IRS has redoubled their efforts to generate these penalties.

According to the National Taxpayer Advocate (2018), there are about 9 million US citizens living abroad. Then consider the number of those who used to live and work overseas but have returned to the US. Next add in the many people who were citizens of another country and have entered the US on an immigrant visa or work visa.

Each and every one of these people has potential foreign reporting complications!

This article briefly focuses on Foreign Pensions. Let's briefly review four types of pension plans: 1. Defined contribution plans (funded by the employer, employee or both); 2. Defined benefit plans (funded by the employer); 3. Self-directed plans (typically funded by self-employed persons); 4. Unfunded plans which are typically nonqualified plans offering supplemental benefits to executives.

U.S. Tax Reporting for Foreign Pensions:

Your investment in a US retirement account generally creates no taxable income until you begin taking the money out [i.e. distributions]. These plans are commonly referred to as a "Qualified Plans." They enjoy income tax deferral. Qualified Plan's investments may grow or shrink with the market, receive dividends, earn interest but none of its investment income appears on your Form 1040 until you begin putting the money in your pocket.

Foreign Pensions are a different ball game entirely!

US pensions and retirement accounts enjoy tax deferral on contributions and investment earnings within the plan. Surprise! Very rarely do foreign pensions get the same treatment (i.e. treated as "Qualified Plans"). IRC §402(b)(1) provides that an employer's contribution to such a plan results in taxable income to the employee! Keep in mind there are a lot of issues to consider as to whether the employee with a foreign pension must report current pension contributions or income to the US while they are working abroad.

Fundamentally, there are three moving parts: 1) employer contributions; 2) employee or self-employed contributions; 3) earnings within the plan. Also considered is the degree of employee contributions to the plan in proportion to the employer's contribution must also be factored into the equation of what is taxed and when.

If the plan is subject to tax here is what happens and when:

  • Contributions to the plan are added to your US income and taxed currently subject to a complicated list of hurdles and requirements.
  • Earnings and Accretions are taxed in the year of distribution or made available to the employee.
  • To get an idea of how complex this subject is, see the attached diagrams.

Does It Qualify for the §911 Exclusion?

Where the US person is working overseas and participating in a pension or other retirement plan, you would think that the employer contributions would obviously be considered foreign earnings[FEI] that qualify for the IRC §911 exclusion. IRC §911(b)(1)(B)(iii) specifically excludes your employer's contributions from FEI preventing you from sheltering those benefits from US tax! Your contributions into the retirement plan do qualify for the FEI exclusion but remember you aren't getting a tax deduction for them like you would into your 401k plan.

Tax Treaty to the Rescue?

The US has 62 comprehensive income tax treaties (Oct. 2019) in place. Many of these treaties address how pension distributions and earnings are to be taxed in each country and how transfers of funds between pensions may be exempt under certain circumstances. If your pension is in a non-treaty country, you are looking at potentially negative tax consequences. If your pension is in a treaty country, the treaty provides guidelines in many cases.

What is the Bottom Line?

It is NOT beneficial for a US person to participate in a foreign pension plan given these current conditions. This is a critical issue often overlooked when someone is considering or working in a foreign assignment. The intuitive answer would be just the opposite. We are trained to think that retirement plans provide good tax and long-term benefits. For a US person to participate in a foreign pension plan may be very counter-productive.

If you are dealing with a pension in a treaty country, current taxation may be deferred. But US reporting of these accounts is complicated and fraught with serious penalties including the reporting of foreign financial accounts (Form 114, Form 8938), foreign trusts (Form 3520) and the like. Most of those penalties BEGIN at $10,000 per instance and multiple forms required on your return translates into multiple penalties!

If you have a foreign pension or retirement account, DON'T bury your head in the sand and hope the problem goes away. Take action to resolve the potential issues. Find out IF you have a problem and then deal with it. It is much less expensive and painful if you address it now versus the IRS notifying you and them dealing with it.

Foreign Pension Chart 1
Foreign Pension Chart 2
Foreign Pension Chart

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