Classifying foreign pension plans for U.S. tax reporting can be confusing and contain many pitfalls.
Further complicating matters is that other countries consider their plans to be social security plans, but they are not treated as such under U.S. tax law. This leads to incorrect application of tax treaty benefits to foreign pensions.
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Grantor Trust vs. Employee’s Trust
Foreign pensions (i.e., defined contribution plans) are trusts. Since they are not “qualified” for U.S. tax purposes, they are nearly always either grantor trusts or nonexempt employee’s trusts.
Where an employee’s contributions are greater than the employer’s, the result is a grantor trust. Otherwise, the trust is an employee’s trust.
Nonexempt employee’s trusts are governed by IRC Section 402(b). Examples of such trusts include:
- Singaporean CPF
- Indian EPF
- Australian Superannuations (but not self-managed supers)
Contributions to Nonexempt Employee’s Trusts
Section 402(b)(1) states that employer contributions to employee’s trusts are included as taxable income in accordance with IRC 83.
IRC 83 provides that employer contributions are included in gross income if funds are not “subject to a substantial risk of forfeiture.” Funds of most common foreign pensions such as those listed previously are not subject to substantial risk of forfeiture. Hence, employer contributions should be included in gross income when made.
Growth and Distributions from Employee’s Trusts
Section 402(b)(2) provides that the amount actually distributed or made available to an employee by a nonexempt employee’s trust shall be taxable in the year which distributed or made available to the employee.
Under Treas. Reg. 1.451-2, funds are made available whenever a participant would be entitled to receive the distribution upon giving notice of intent to withdraw those amounts. While distributions are often conditioned upon reaching retirement age, in some cases, the funds can be withdrawn for a wide variety of situations such as with Singapore CPFs. In such cases, the growth would be taxable.
Under Section 402(b)(4), if an employee is “highly compensated” in a non-broad based plan, then there is no tax deferral, even if funds have not yet been distributed or made available.
Tax treaties should be reviewed since they can alter the above, as is the case with Australian superannuations.
Form 3520 and 3520-A
Under Section 402(b)(3), the beneficiary of an employee’s trust is not considered the owner of any portion of such trust. These forms are not necessary for employee’s trusts.
FBAR and Form 8938
Foreign pensions should be reported on the FBAR and Form 8938.
What should non-compliant taxpayers do?
If taxpayers are non-compliant with the foreign asset and income reporting requirements, they should consider applying to one of IRS’s voluntary disclosure programs: