US Taxation of Australian Superannuation Funds
The United States Government has not officially classified the Australian Superannuation for U.S. tax purposes. Therefore, exactly how the IRS taxes contributions, growth, distributions, and reporting is still up for debate. Nevertheless, there are some general accepted positions on U.S. Taxation of Australian Superannuation Funds.
1. What is the Australia Superannuation Fund?
In Australia, superannuation, or just "super", is compulsory for all people who have worked and reside in Australia. The balance of a person's superannuation account, or for many people, accounts, is then used to provide an income stream when retiring. Federal law dictates minimum amounts that employers must contribute to the super accounts of their employees, on top of standard wages or salaries.
The Australian Government outlines a set percentage of employees income that should be paid into a super account. Since July 2002, this rate has increased from 9 per cent to 9.5 per cent in July 2020, and will stop increasing at 12 per cent in July 2027. Employees are also encouraged to supplement compulsory superannuation contributions with voluntary contributions, including diverting their wages or salary income into superannuation contributions under so-called salary sacrifice arrangements.
An individual can withdraw funds out of a superannuation fund when the person meets one of the conditions of release, such as retirement, terminal medical condition, or permanent incapacity, contained in Schedule 1 of the Superannuation Industry (Supervision) Regulations 1994. As of July 1, 2018, members have also been able to withdraw voluntary contributions made as part of the First Home Super Saver Scheme (FHSS).
As of 30 June 2018, Australians have AU$2.7 trillion in superannuation assets, making Australia the 4th largest holder of pension fund assets in the world. As of 30 June 2019, the balance was AU$2.9 trillion.
2. How is it taxed in Australia?
Superannuation in Australia is taxed by the Australian taxation system at three points: on contributions received by a superannuation fund, on investment income earned by the fund, and on benefits paid by the fund.
Superannuation contributions are either concessional or non-concessional contributions.
- Concessional contributions (sometimes referred to as "before-tax" contributions) are contributions for which someone (such as an employer) has or will receive a tax deduction. Concessional contributions include superannuation guarantee (SG) contributions, salary sacrifice contributions, other employer contributions and contributions claimed as a personal tax deduction. Concessional contributions are taxed in the fund. While taxable components do not change the tax payable by the superannuation fund, they may be a factor in calculating the tax payable on withdrawals from a super fund.
- Non-concessional contributions (also referred to as "undeducted" or "after-tax" contributions) are contributions for which no-one has or will receive a tax deduction. Non-concessional contributions are, generally, not taxed in the fund.
Where an investment or other asset is sold or otherwise disposed, the profit on sale is subject to a capital gains tax.
Superannuation funds can claim a capital gains tax discount where the asset has been owned for at least 12 months. The discount applicable to superannuation funds is 33%, reducing the effective tax rate on capital gains from 15% to 10%.
No discount or adjustment is available if an asset is sold at a loss. Capital losses can only be applied against capital gains and cannot be claimed against other income, but may be carried forward to the next year and applied against the later year's capital gains.
The taxable income of a superannuation fund is the fund's assessable income less allowable deductions. Assessable income includes concessional (i.e., taxable) contributions received, net investment income and discounted capital gains. It does not include exempt income and undeducted contributions. Undeducted contributions are those which the employer or the member cannot or has chosen not to claim as a deduction from their respective assessable income.
The taxable income of a superannuation fund is taxed at a flat rate of 15%; however, concessional contributions of those members whose taxable income exceeds $300,000 are subject to a rate of 30%. In reality, the actual average tax rate can be lower than this, typically around 6.5%,[because:
- the dividend imputation system allows a credit for imputation credits on Australian shares, which may result in a tax refund.
- capital gains on assets held more than 12 months may be entitled to a capital gain tax discount.
- other tax credits such as foreign tax credits may apply.
Additional taxes are payable if contributions received exceed the applicable contribution caps.
Taxation of benefits is very complex and depends on whether:
- the benefit is received as a lump sum or a pension
- the benefit is received for retirement, death or disability
- the benefit is paid to a dependent or non-dependent
- the tax payer was a member of a fund prior to 1983
For recipients of social security payments, pension amounts are taxed as normal income through the PAYG system except where there is a deduction for the portion of the benefits funded by undeducted contributions (the "deductible amount") or at a 15% rebate on the pension amount less the deductible amount.
3. What about the Australia - US Treaty
There are two separate and distinct bodies of law that could potentially apply to the issue.
First, there is domestic U.S. tax law; Title 26 of the United States Code, which is known as the Internal Revenue Code.
Second, there is international treaty law; the Convention Between the Government on the United States of America and the Government of Australia for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income, which is more commonly known as the U.S.-Australia Income Tax Treaty. Domestic U.S. tax law applies by default unless a taxpayer affirmatively elects to apply the treaty and explains the application on IRS Form 8833. A taxpayer that takes a treaty position without disclosing it on IRS Form 8833 will be liable for civil tax penalties for which there is no statute of limitations. You may also be exposed to criminal tax penalties if your failure to file IRS Form 8833 was intentional.
As provided by the U.S. Australia Tax Treaty, Article 18(2)
(2) Social Security payments and other public pensions paid by one of the Contracting States to an individual who is a resident of the other Contracting State or a citizen of the United States shall be taxable only in the first-mentioned State.
At the present time, the Social Security referred to in the tax treaty refers to “social security and other public pensions.” There is no mention of Superannuation.
Is Superannuation Social Security?
*Australia already has its own Public Social Security, and the term “Social Security Payments” in the tax treaty is further clarified as “and other public pensions…”
Is Superannuation a Public Pension?
It is employer funded and even though the government may make matching contributions for lower income wage earners, that does not make it a public pension.
4. The U.S.-Australian Social Security Totalization Agreement
Totalization Agreements, also referred to as bilateral agreements, eliminate dual social security coverage (the situation that occurs when a person from one country works in another country and is required to pay social security taxes to both countries on the same earnings).
Each Totalization Agreement includes rules intended to assign a worker’s coverage to the country where the worker has the greater economic attachment.
The agreements generally ensure that the worker pays social security taxes to only one country, provided the worker and the employer meet the procedural requirements under the agreement for obtaining an exemption from the other country’s social security taxes.
5. Is it treated as Social Security?
The goal of a Totalization Agreement: To avoid a taxpayer from having income withheld in each jurisdiction for employment.
For Australia, the agreement covers “Superannuation Guarantee” (SG) contributions that employers must make to retirement plans for their employee. But, this statement in the agreement comes with an important clarification by the SSA, on Page 1 of the Totalization Agreement:
“Australia’s Social Security program, which is separate from the SG program, is supported by general tax revenues not covered by the agreement.”
The above referenced clarification relates to the fact that the totalization agreement refers to Australia Superannuation Contributions and not Australian Social Security, since the Australian Social Security is not employment funded.
Unlike the U.S. Social Security Program, the Australian Social Security Program is not funded through employment. Rather, it is funded through general tax revenue.
By including this reference to Social Security in the Totalization Agreement, it serves to reiterate that the purpose of the Totalization Agreement is to avoid duplicate withholding for employees — not to make any general statement about whether SG contributions are considered Social Security of U.S. tax purposes outside for the Totalization Agreement.
Thus, the social security program in Australia is not covered by the totalization agreement, and the agreement does not expand the definition of social security to include superannuation.
As a result, the fact that the SSA refers to Superannuation as being privatized social security would not expand the definition to include social security and other public pensions as referenced in the U.S. and Australia tax treaty Article 18.
6. Are contributions taxable to the US?
Contributions to Superannuation do not receive the same tax deferred treatment outright as it would under other treaties, such as the UK Treaty, and are presumably taxable.
That is because the treaty does not per se eliminate it as it does in the UK Tax Treaty (subject to limitations).
7. Is growth in the fund taxable income to the US?
While the Pension is growing in a retirement fund with a treaty country, the treaty should protect the growth, since the pension is not being “paid to an individual” as the language provides in the Tax Treaty.
The general proposition is that the growth is not taxable, unless distributions are being taken, or the person is an HCE.
If the employee is considered to be an HCE (Highly Compensated Employee), the rules are different, and the growth may be taxable.
8. Are distributions taxable to the US?
Generally, they are taxable — subject to issues of withdrawing corpus or principal, which is a return of basis — and not taxed, since it is not income.
If you became a U.S. person after your contributions began, you may require a forensic analysis to assist with which portion of each withdrawal is taxable, or not — and if there will be any U.S. on Australian Superannuation Funds.
A person will gross-up their retirement income as regular income, and then their taxes due will be based on their progressive tax rate.
Foreign Tax Credits may apply.
IRS Form 8833 must be filed to fully disclose to the Internal Revenue Service that the taxpayer is excluding gains within and/or distributions from their Australian Superannuation Fund
9. How is it reported on US returns?
Generally speaking, you include an Australian Super on your tax return. Reporting the Superannuation on the FBAR, FATCA, PFIC, etc. The U.S. may tax – Contributions, Growth, and Withdrawals.
10. Is it Treated as Foreign Grantor Trust (Form 3520)?
Generally, a superannuation such as an Australian Superannuation is not considered a foreign grantor trust. However, a superannuation can become a foreign grantor trust.
How? If the individual grantor contributes more than 50% to the trust, the IRS may deem the superannuation a foreign grantor trust. This requires the filer to now submit a Form 3520-A.
Generally, the Super is not considered a PFIC, but depending on various different factors, the Super can transform into a PFIC, and then may require a Form 8621 and/or 3520 and 3520-A.