New Foreign Retirement Trust 3520 Exemptions & Penalty Relief Example
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New Foreign Retirement Trust Reporting Exemption & Penalty Relief
3520 Penalty Relief & Exemptions for Foreign Trusts: Back in March of 2020, the IRS released Revenue Procedure 2020-17. The purpose of this Revenue Procedure is to provide certain foreign trusts from having to report on Form 3520 and 3520-A. The trusts referred to in the Revenue Procedure are not for your traditional types of trusts, but are rather limited to foreign tax deferred status trusts and foreign employment trusts.
The idea behind this Revenue Procedure is that most of these trusts qualify as accounts or specified foreign financial assets anyway, and are already being reported on the FBAR and Form 8938.
Let’s review some of the basics of how the Revenue Procedure plays out in real life and how the ambiguity is impacting whether the Revenue Procedure applies to certain foreign retirement trusts specifically — using the Australian Superannuation as a baseline example.
IRC 6048 vs. 6038
Internal Revenue Code Section 6048 refers to the reporting of foreign trusts. IRC section 6038 refers to the reporting of specified foreign financial assets — typically reported on a Form 8938. Sometimes, this leads to duplicative reporting.
Example: If a US taxpayer has a foreign pension such as an Australian superannuation, it is reportable on the FBAR and Form 8938. (Noting: The FBAR is not a tax form but is rather a FinCEN Form that has enforced by the IRS since 2003). A Superannuation is a foreign financial account and reported on the FBAR.
Likewise, it qualifies as a foreign pension account and is reported on Form 8938.
Purpose of Rev. Proc. 2020-17
The two categories of trusts that are excluded from reporting on Form 3520/3520-A are:
- Tax-favored foreign trust; and
- Tax-favored foreign non-retirement savings
As provided by the revenue procedure itself, the concept behind this procedure is that this information is essentially already being reported on other forms. In addition, these types of trusts are restrictive with respect to contributions and distributions — similar in the US to a 401K equivalent.
Who is Eligible?
As provided by the Revenue Procedure:
- “For purposes of this revenue procedure, an eligible individual means an individual who is, or at any time was, a U.S. citizen or resident (within the meaning of section 7701(a)(30)(A)) and who, for any period during which an amount of tax may be assessed under section 6501 (without regard to section 6501(c)(8)), 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 under U.S. tax law, has reported as income any contributions to, earnings of, or distributions from, an applicable tax-favored foreign trust on the applicable return (including on an amended return).”
What does this mean?
It means that in order to qualify as an eligible individual, the person must either be a resident or qualify as a resident under the tax code and is compliant with all federal filing requirements. In other words, if a person is noncompliant, then this revenue procedure may not apply.
Tax Favored Foreign Retirement Trust
- “Tax-Favored Foreign Retirement Trust. For purposes of this revenue procedure, 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 the following requirements established by the laws of the trust’s jurisdiction.”
What does this mean?
For many Taxpayers with foreign pension accounts, this particular definition is crucial. The problem with the definition is the inherent ambiguity contained there in some of the elements. Let’s take a look, using the Australian Superannuation:
Exempt from Tax or Tax Favored in Foreign Country
- “The trust is generally exempt from income tax or is otherwise tax-favored under the laws of the trust’s jurisdiction. For purposes of this revenue procedure, a trust is tax-favored if it meets any one or more of the following conditions: (i) contributions to the trust that would otherwise be subject to tax are deductible or excluded from income, are taxed at a reduced rate, give rise to a tax credit, or are otherwise eligible for another tax benefit (such as a government subsidy or contribution); and (ii) taxation of investment income earned by the trust is deferred until distribution or the investment income is taxed at a reduced rate.”
What does this mean?
The Superannuation is generally exempt from income tax or is otherwise tax-favored under the laws of the trust’s jurisdiction. The Super is generally mandatory and a hybrid of a 401K and Social Security. Depending on whether the contributions are concessional or non-concessional contributions, will impact the taxability — but it is a tax favored trust under the laws of Australia.
Annual Information
- “Annual information reporting with respect to the trust (or of its participants or beneficiaries) is provided, or is otherwise available, to the relevant tax authorities in the trust’s jurisdiction.”
What does this mean?
It means the annual report is provided to the country’s tax jurisdiction.
Each year, the beneficiary of the superannuation fund (e.g., employee or former employee) receives a statement showing the value and income as of June 30th (which is the end of the Australian tax year).
Contributions Regarding Performance
- “Only contributions with respect to income earned from the performance of personal services are permitted.
What does this mean?
It means only contributions from income are permitted.
With the Australian superannuation, the primary contributions are made as a result of employment. But, other contributions can be made; for example selling a house — in which there is a limitation. So, is the mere fact that an employment pension allows non-mandatory contributions mean that Revenue Procedure 2020-17 will not apply?
The superannuation starts with employment, so is subsection 3 of Rev. Proc. 5.03 saying that post non-employment contributions to an otherwise employment pension negates the applicability of this Revenue Procedure?
Contributions Limited
- “Contributions to the trust are limited by a percentage of earned income of the participant, are subject to an annual limit of $50,000 or less to the trust, or are subject to a lifetime limit of $1,000,000 or less to the trust. These contribution limits are determined using the U.S. Treasury Bureau of Fiscal Service foreign currency conversion rate on the last day of the tax year.”
What does this mean?
This means the amount and totality of contributions is limited — but to what extent?
The language under subsection 4 is ambiguous. it provides the following limitation:
- “Contributions to the trust are limited by a percentage of earned income of the participant, are subject to an annual limit of $50,000 or less to the trust, or are subject to a lifetime limit of $1,000,000 or less to the trust.”
What makes this portion of the procedure ambiguous is that it is unclear whether the $50,000 limitation is per person or per retirement plan. In other words, can each person only contribute up to $50,000 or less to the trust in a year (annual limit), or does the plan limit contributions of each individual person to up to $50,000 per year.
Here is an example: Keith contributes $48,000 to his superannuation in the current year, but technically if additional non concessional contributions are included, the total contributions could exceed $50,000 USD.
Is the annual $50,000 limitation for Keith specifically, or is it that the superannuation cannot allow contributions to the trust to exceed $50,000 annually?
The language provides contributions to the trust are limited by a percentage of earned income, but it does not clarify if that limitation is by the employee on behalf of the employee, or the plan on behalf of all employees.
While it may seem like an exercise in mincing words, when you consider the cost to have to file an annual 3520/3520-A — coupled by the automatic assessed penalties that seem to flow freely from the IRS for non compliance with 3520/3520-A, it is very important.
Withdrawals Limited
- “Withdrawals, distributions, or payments from the trust are conditioned upon reaching a specified retirement age, disability, or death, or penalties apply to withdrawals, distributions, or payments made before such conditions are met. A trust that otherwise meets the requirements of this section 5.03(5), but that allows withdrawals, distributions, or payments for in-service loans or for reasons such as hardship, educational purposes, or the purchase of a primary residence, will be treated as meeting the requirements of this section 5.03(5).”
What does this mean?
It means there are certain conditions related to withdrawals and payments to the beneficiary.
The superannuation does meet subsection 5 which limits withdraws, distributions, or payments to reaching a retirement age or other life altering event such as disability.
Employment Maintained Trust
- “In the case of an employer-maintained trust, (i) the trust is nondiscriminatory insofar as a wide range of employees, including rank and file employees, must be eligible to make or receive contributions or accrue benefits under the terms of the trust (alone or in combination with other comparable plans), (ii) the trust (alone or in combination with other comparable plans) actually provides significant benefits for a substantial majority of eligible employees, and (iii) the benefits actually provided under the trust to eligible employees are nondiscriminatory.”
What does this mean?
The Superannuation generally meets the requirements under subsection 6 for employer maintain trusts.
Penalty Abatement and Refunds
If you have a foreign retirement employment trust that meets the threshold for being exempt from reporting under Revenue Procedure 2020-17 but you have already been penalized, you are in luck.
The last part of the Revenue Procedure provides an outlet for taxpayers who have already been penalized to receive a refund of their prior penalty. The procedures are relatively straightforward as follows:
- “In General. Subject to the limitations of sections 6402 and 6511, eligible individuals who have been assessed a penalty under section 6677 for failing to comply with section 6048 with respect to an applicable tax-favored foreign trust (without regard to whether such failure was due to reasonable cause under section 6677(d)) and who wish to obtain relief under this revenue procedure may request an abatement of the penalty assessed, or a refund of the penalty paid, under section 6677 by filing Form 843, Claim for Refund and Request for Abatement. Eligible individuals are not precluded from requesting relief under any other applicable relief provisions.
- Under section 6402(a), the Secretary is authorized to credit, within the applicable period of limitations, an overpayment against any liability in respect of an internal revenue tax of the person who made the overpayment, and must generally refund any balance to that person, subject to the requirements of section 6402(c), (d), (e), and (f) (providing for offset for past-due support and certain debts to federal and state governments). Section 6511(b)(1) provides that no credit or refund shall be allowed or made after the expiration of the period of limitation prescribed in section 6511(a), unless the taxpayer filed a claim for credit or refund within that period.
- Where to File. A Form 843 requesting relief under this revenue procedure should be mailed to: Internal Revenue Service, Ogden, UT 84201-0027.
- Filing Requirements for Form 843. Eligible individuals should complete the form and write the statement “Relief pursuant to Revenue Procedure 2020-17” on Line 7 of the form. In addition, Line 7 should include an explanation of how the eligible individual meets each relevant requirement under section 5.02 of this revenue procedure and how the foreign trust meets each relevant requirement under section 5.03 or 5.04 of this revenue procedure.
In conclusion, Revenue Procedure 2020-17 was developed in part to assist taxpayers with certain tax deferred foreign retirement trusts. Some of the foreign trusts may qualify for an exemption from reporting but the Revenue Procedure is ambiguous at times and not all foreign retirement trusts will qualify. Likewise, if a person has already been penalized, they may qualify for penalty relief.
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