Wondering how FATCA impacts your foreign pension fund? You’re probably familiar with FBAR filings, which require US persons to disclose their holdings in foreign financial institutions. Although some foreign pensions fall within this net, some do not. Find out what you need to do to meet your FATCA reporting requirements.
The new FATCA (Foreign Account Tax Compliance Act) regulations added a two pronged reporting requirement:
- Form 8938 Statement of Specified Foreign Financial Assets by taxpayers
- Reporting and withholding from the actual foreign institutions.
This is all done in an act to promote transparency of foreign assets held by US taxpayers.
How is the Form 8938 Different From the FBAR in Regard to Foreign Pensions?
Form 8938 specifically requires the reporting of foreign pensions, as opposed to only some pensions being reportable on the FBAR (specifically, you do not need to report on accounts you do not retain control over on the FBAR). Furthermore, the Form 8938 is a requirement of the IRS, as opposed to the FBAR, which is under the jurisdiction of the Treasury Department. There are questions related to whether foreign grantor trust forms (3520 and 3520-A) are filed, as well as whether the account in question has any related income on the Individual Tax Return itself.
The closer scrutiny of the foreign pensions also means that the IRS will be ensuring that, should the foreign pension qualify as a PFIC or grantor trust, income is being properly reported and additional taxes are calculated.
What is a PFIC?
A PFIC, or Passive Foreign Investment Company, is defined by meeting one of two rules:
- Income Test–75% or more of its gross income come from passive investments
- Asset Test–at least 50% of the average assets held are producing passive income
It is important to note that the United States looks at the actual character of an entity rather than the title. As such, a pension account may qualify as a PFIC if, in essence, it is like a “company.”
If the pension qualifies as a PFIC individuals generally need to file Form 8621, and there may be additional tax due on income actually, or even constructively, received.
Why Would My Foreign Pension Possibly be Considered a Foreign Grantor Trust?
The US tax law is very specific as to what qualifies as a qualified retirement plan, and the majority of foreign pension plans just do not qualify under the rules. Given the setup of a pension plan—that the individual puts money into a “fund” that is regulated by someone else, who protects and conserves the funds for the individual—the pension can easily fall into the definition. Furthermore, taking examples from court rulings (such as with Canadian RRSPs), the IRS is making it clear they consider pensions a special arrangement that requires more than a reporting only upon distribution, or even a fund that requires annual income disclosure.
What Does the FATCA Regulation Mean to the Foreign Pension Program?
FATCA legislation subjects Foreign Financial Institutions (FFI) to a 30% withholding tax on all payments and proceeds from sale of the assets belonging to US taxpayers and therefore deemed US-sourced. This tax will be levied unless the FFI agrees to abide by certain guidelines set by the IRS, including annual reporting all US taxpayers that partake in the plans.
As many countries have mandatory pension schemes, and many companies must provide some kind of deferred compensation scheme to employees, the IRS received feedback specifically in regard to pensions. To help ease the administrative burden, exceptions are provided to foreign pensions, should the pension pass certain tests – making themselves “certified deemed compliant” in the eyes of the IRS. This may be a bit confusing so let’s look at it more closely.
In order to qualify as “certified deemed compliant”, the foreign pension must:
- Be organized for the intent of providing retirement benefits (a private savings account or British Individual Savings Account, ISA, would not qualify for example);
- Contributions must consist only of employer, employee, or government funds, and must be related to the compensation received by employees;
- The subscribers to the plan cannot own more than 5%;
- Contributions and growth in the plan are deductible in the foreign jurisdiction;
- More than 50% of the plan assets must be provided for by employers and the government
There are separate tests for those institutions, which qualify as a small fund having fewer than 20 participants.
Should the pension qualify, they will not need to report and withhold on US participants.
What Does This Mean to Me?
The obligation to report contributions and earnings does not change for the individual. The FATCA regulation holds to the actual institution running the pension. Even if the institution is exempt, the individual must still report and disclose. Penalties go up to $50,000 for noncompliance, and there may be a 40% surtax on underpayment of tax associated with undisclosed assets.
US taxpayers are required to include both employee and employer contributions in taxable income. Fund growth needs to be included and taxed on the return annually, even if not actually received by the individual.
Certain individuals may be able to exclude contributions (both employee and employer), as well as fund growth, by means of a comprehensive tax treaty (for example, the US/UK tax treaty). In this situation, the foreign pension is treated similar to that of a qualified US retirement plan (for instance, 401K) and taxation is deferred to a later point, generally upon receipt of the funds.