Amplifying its efforts to crack down on U.S. taxpayers’ use of Malta pension funds to attempt to achieve federal income tax savings, the IRS recently has issued proposed regulations identifying these funds as listed transactions and appears to have launched criminal investigations into these plans.

Background

Some U.S. taxpayers have been taking the position that a combination of the income tax treaty between the United States and Malta and local Maltese law regarding person retirement schemes provides them with an exemption from federal income tax for income associated with pension funds that they establish in Malta.

Here’s a brief explanation. The U.S.-Malta income tax treaty prohibits each state from taxing a pension plan established in the other state that is beneficially owned by an individual resident of the first state if the pension plan would be exempt from taxation in that other state.[1]

Some examples of U.S. pension plans where this provision could apply include an individual retirement account (IRA) under section 408 or a Roth IRA under section 408A of the Internal Revenue Code with an individual beneficiary who is Malta resident.[2] Generally, amounts in an IRA are not taxed until there is a distribution.[3] Likewise, a Roth IRA generally is not taxed on its earnings, and certain distributions from a Roth IRA may be exempt from tax.[4] There are certain limitations, however, on what constitutes and IRA and Roth IRA. Non-cash contributions are prohibited, and such contributions must be limited to the individual’s earned income.[5]

U.S. taxpayers have argued that Malta’s Retirement Pension Act of 2011 should entitle them to a similar exemption from U.S. federal income tax under the treaty with respect to earnings in and distributions from these schemes. The IRS has provided an example of this fact pattern:
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