U.S. citizens and residents are generally required to file IRS Form 3520 to report their ownership of, or transactions with, foreign trusts. The potential penalty for noncompliance is the greater of US $10,000, 35% of the amount contributed to, or distributed from, the trust, or 5% of the gross value of the portion of the trust’s assets treated as owned by the U.S. citizen or resident. A separate Form 3520-A is required from the trustee, or, in its absence, a separate similar filing by the owner of the trust. The potential noncompliance penalty for Form 3520-A is similar to Form 3520.
This triggers troublesome reporting with respect to certain foreign pension plans, and certain foreign savings plans such as Canadian Registered Education Savings Plans (RESPs) and Registered Disability Savings Plans (RDSPs). A separate rule previously eliminated any required filing of Forms 3520 and 3520-A for certain Canadian retirement plans. The new rules issued in IRS Revenue Procedure 2020-17 now also exempt certain non-Canadian foreign pensions, as well as Canadian RESPs and RDSPs from Form 3520 and 3520-A filing requirements, provided, with respect to RESPs and RDSPs, “withdrawals, distributions, or payments from the trust are conditioned upon the provision of medical, disability, or education benefits, or apply penalties to withdrawals, distributions, or payments made before such conditions are met”
You can read the new rule here – https://www.irs.gov/pub/irs-drop/rp-20-17.pdf
According to Revenue Procedure 2020-17, effective March 16, 2020, Forms 3520 and 3520-A are not required by an “eligible individual”, with respect to the individual’s transactions with, or ownership of, “applicable tax-favored foreign trusts”.
An eligible individual means an individual who:
- is, or at any time was, a U.S. citizen or resident and who, for any “open” tax year,
- is compliant (or comes into compliance) with all requirements for filing a U.S. federal income tax return (or returns) covering the period such individual was a U.S. citizen or resident, and
- to the extent required, has reported as income, any contribution to, earnings of, or distribution from, an applicable tax-favored foreign trust on the applicable tax return (or amended return).
The “open” period generally (but not always) includes the tax years, within three years, of the time the last tax return was filed.
However, if an individual is current with U.S. income tax filings, and fully compliant with all income tax matters, (except for filing Forms 3520 and 3520-A), there is no requirement to file the prior omitted Forms 3520 and 3520-A
But individuals who are not fully compliant with U.S. income tax matters (ignoring whether they have filed all required Forms 3520 and 3520-A) may become compliant, and thus exempt from filing future (as well as prior) related Forms 3520 and 3520-A, by filing delinquent or amended U.S. income tax returns. Any penalties may potentially be avoided by entering into one of the IRS amnesty programs, as long as those programs remain open.
Applicable Tax-Favored Foreign Trusts
There are two types of applicable tax-favored foreign trusts:
- Tax-Favored Foreign Retirement Trust, and
- Tax-Favored Foreign Non-Retirement Savings Trust.
- tax-favored under the laws of the trust’s jurisdiction,
- annual information reporting must be provided or otherwise available, to the relevant tax authorities in the trust’s jurisdiction,
- contributions to the trust must be limited by a percentage of earned income of the participant, subject to an annual limit of US $50,000 or less to the trust, or subject to a lifetime limit of US $1,000,000 or less to the trust,
- withdrawals, distributions, or payments must meet certain restrictions, and
Tax-Favored Foreign Retirement Trust
A tax-favored foreign retirement trust means a foreign trust for U.S. tax purposes that is created, organized, or otherwise established under the laws of a foreign jurisdiction (the trust’s jurisdiction) as a trust, plan, fund, scheme, or other arrangement (collectively, a trust) to operate exclusively or almost exclusively to provide, or to earn income for the provision of, pension or retirement benefits and ancillary or incidental benefits, and that meets all the requirements set out in Section 5.03 of Revenue Procedure 2020-17.
Amongst other requirements, the retirement trust must be:
in the case of an employer-maintained trust there must be nondiscrimination provisions.
Please review Section 5.03 of Revenue Procedure 2020-17 for all of the other requirements.
A trust that otherwise meets the requirements will not fail to be treated as a tax-favored foreign retirement trust solely because it receives a rollover of assets or funds transferred from another tax -favored foreign retirement trust established and operated under the laws of the same jurisdiction, provided that the trust transferring assets or funds also meets the requirements of Section 5.03.
RELIEF FROM PRIOR FORMS 3520/3250-A PENALTIES
Eligible individuals who were previously assessed Form 3520 and/or 3520-A penalties may apply for an abatement or refund of the penalties (for any open tax year), by filing IRS Form 843 with the IRS at:
Internal Revenue Service
Ogden UT 84201-0027
On line 7 of Form 843, the individual must write “Relief Pursuant to Revenue Procedure 2020-17”, and include an explanation of why the individual is entitled to penalty relief.
RELIEF FOR INDIVIDUALS OR PLANS THAT DO NOT QUALIFY
For an individual who owns, or has transactions with, a foreign pension plan, but is not an eligible individual (or does not become one) as defined above, or has a pension plan that does not qualify with the above requirements, there are separate rules which may provide full or partial exemptions from filing Form 3520 or Form 3520-A.
A separate exemption for filing Form 3520 exists for transfers to, certain foreign compensatory trusts,12 and for distributions from, certain foreign compensatory trusts, provided the distribution is reported as compensation income by the recipient. In many cases, there may be a separate exemption from the requirement to report ownership of the pension plan, on the basis the individual is not an “owner” of the plan.
As mentioned above, an entirely separate rule previously eliminated any required filing of Form 3520 or Form 3520-A for certain Canadian retirement plans.
Other Tax-Favored Savings Plans
Individuals who are non-compliant with foreign tax-favored non-retirement savings plans, other than RESPs and RDSPs, may consider entering one of the present IRS amnesty programs before those programs expire.
FORM 8938 AND FBAR REPORTING IS STILL REQUIRED!
Notwithstanding the new rules described above, the interest in the foreign trusts must still be reported on Form 8938 “Statement of Specified Foreign Financial Asset” under separate Section 6038D, and on FinCEN Form 114 “Report of Foreign Bank and Financial Accounts” (FBAR).
Here’s more on this – https://www.mooresrowland.tax/2014/11/fbars-and-form-8938.html
Below are some of the common misconceptions among U.S. expats and inpats which may cause them to be incompliant with their reporting and/or filing obligations:
- Foreign Pension Plan Contributions: Employee contributions may not be deductible on the U.S. tax return but are always eligible for foreign earned income exclusion. Employer contributions are also not currently taxable on the U.S. tax return until distribution occurs.
- Foreign Pension Plan Earnings: Similar to employer contributions, these are not currently taxable on the U.S. tax return until distribution occurs.
- Transfer of Assets Between Foreign Pension Plans Within the Same Country: Routine transfer of assets incidental to change of employment has no U.S. tax ramifications since these assets remain inaccessible until distribution occurs.
- Asset Appreciation Within Foreign Pension Plan: Gains and losses whether from changes in asset value or disposition of holdings are not taxable until distribution occurs.
- Foreign Pension Plan Under Foreign Employer: Employer plans do not need to be reported on FinCEN Form 114 for FBAR since these are not bank or financial accounts per se.
While most U.S. expats and inpats attempt, in good faith, to file complete and accurate returns, in spite of various misconceptions, few understand the implications of or are even aware of the existence of the four-letter word, PFIC. PFIC stands for Passive Foreign Investment Company and refers to any foreign corporation with certain percentages of income or holdings in assets with respect to passive income.
Here’s more on this – https://www.mooresrowland.tax/2015/08/what-is-pfic.html