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Treasury Exempts Applicable “Tax-Favored Foreign Trusts” From The Form 3520… And Therefore Form 3520A Requirement



Form 3520 And Form 3520A

Introduction – A small step for forms, one giant leap for “formkind”

It’s true. Many Americans abroad will no longer have to file Form 3520 and Form 3520A to report their lives abroad! Early indications appear that many Americans will (assume their retirement vehicle does qualify as a trust) be required to report on Form 3520. This new initiative from Treasury a positive step in the right direction.

I have long thought that Treasury could solve many of the problems experienced by Americans abroad. Here is a wonderful example of Treasury taking the initiative to clarify the obvious:

Americans abroad do NOT use non-U.S. pension plans and non-U.S. tax-advantaged investing accounts to evade U.S. taxes. Hence, there is NO reason for the Form 3520 reporting requirement. This is an example of the tax compliance industry sitting down with Treasury, explaining a problem and getting a resolution. I suggest (and hope) that the same can be done for PFIC (Form 8621), Small Business Corporations (Form 5471) and other penalty-laden forms.

Yes, this announcement from Treasury in the form of RP 20-17 is a great achievement. Although it certainly doesn’t solve all the problems, it’s:

A small step for forms, one giant leap for “formkind”

The background to this problem – It starts in 1996 (same year as the beginning of the Exit Tax)…

Since 1996 Internal Revenue Code 6048 has required extensive reporting of almost any interaction with a foreign trust. Treasury has required that the reporting take place on Forms 3520 and 3520A. The forms are complex and subject to the draconian penalty regime described in Internal Revenue Code Section 6677. In order for an entity to be a foreign trust, it must be a trust. A “trust” for IRS purposes is defined by the Treasury Regulations as:

(a) Ordinary trusts. In general, the term “trust” as used in the Internal Revenue Code refers to an arrangement created either by a will or by an inter vivos declaration whereby trustees take title to property for the purpose of protecting or conserving it for the beneficiaries under the ordinary rules applied in chancery or probate courts. Usually the beneficiaries of such a trust do no more than accept the benefits thereof and are not the voluntary planners or creators of the trust arrangement. However, the beneficiaries of such a trust may be the persons who create it and it will be recognized as a trust under the Internal Revenue Code if it was created for the purpose of protecting or conserving the trust property for beneficiaries who stand in the same relation to the trust as they would if the trust had been created by others for them. Generally speaking, an arrangement will be treated as a trust under the Internal Revenue Code if it can be shown that the purpose of the arrangement is to vest in trustees responsibility for the protection and conservation of property for beneficiaries who cannot share in the discharge of this responsibility and, therefore, are not associates in a joint enterprise for the conduct of business for profit.

Americans abroad generally do (1) their retirement planning and (2) participate in pensions in other countries. In the same way that the United States has rules pertaining to retirement planning and pensions, other countries have their own systems, governed under their own laws. Because, Americans abroad are subject to taxation in both the United States and their country of residence, their retirement and pension plans are subject to both sets of laws. The application of the U.S. Internal Revenue Code has been an absolute nightmare for Americans abroad. They (and their tax preparers) don’t understand how the Internal Revenue Code applies to these “foreign” investment vehicles. This problem was accentuated in 2019 when the IRS levied a large number of $10,000 penalties (presumably by computer) on Americans who – by filing a Form 3520 and 3520A – were doing their level best to comply with U.S. laws. This problem was discussed at TaxConnections in numerous (brilliant) posts by U.S. CPA Gary Carter. You will find Mr. Carter’s “Form 3520A Penalty Fundraiser Posts” (my quotes not his) here.

When faced with a non-U.S. retirement account or a tax advantaged savings/investment account it’s important to consider whether it’s a trust at all.

In simple terms, many Americans abroad filed Form 3520 to report their non-U.S. pensions and tax advantaged investment accounts. A Form 3520 includes a correlative Form 3520A requirement – the penalties were levied in relation to Form 3520A. In any event, a massive effort: publicized by Kat Jennings of Tax Connections and spearheaded by Gary Carter (and others) led to the IRS reversing the Form 3520A penalties. Credit goes to all involved AND to U.S. Treasury for recognizing it’s mistake and reversing the penalties. In other words, this success on behalf Form 3520A victims was the result of publicity, education and recognition of the root of the problem.

What was/is the root of the problem?

The problem was the combination of Internal Revenue Code 6048 (mandating the reporting requirements for Foreign Trusts) coupled with the IRS lack of guidance. In my view, certain tax advantaged investment plans (TFSA in Canada or ISA in the U.K.) were not trusts to begin with and therefore (although the income is taxable) there is no 3520 requirement. But, (like most things applying to Americans abroad) the law was/is not clear. Some tax preparers were taking (what they thought was) a conservative stance and filing Form 3520. What a mess. Some commenters suggested the obvious: Many Treasury should just make it clear that normal investment vehicles in the lives of Americans abroad were either not trusts or were subject to Form 3520.

Treasury does the “right thing”: Announces that Form 3520 (and From 3520A) will not not be required for many foreign pensions and for many foreign tax advantaged accounts!

What follows is an “over simplification” and you should consult your tax advisor, but in general Revenue Procedure 20 – 17 establishes the following

1. For certain (most) foreign pensions and tax advantaged financial accounts Form 35320 reporting will no longer be required.

2. The end of the Form 3520 reporting is has no bearing on the Income Tax aspects and other reporting aspects of these plans. Example: TFSA income is still reportable as income to the U.S. taxpyayer. TFSAs and Foreign Pensions are still reportable on Form 8938. Obviously this has no impact on FBAR obligations. It means ONLY that Form 3520 and Form 35320A would not be required. (Frankly this is huge. It will save tax filers money and removes the threat of the draconian penalties.)

3. Those who have been assessed penalties under Internal Revenue Code Section 6677 will be able to apply for a refund of those penalties.

I will update these principles as necessary.

The devil is in the details – we need to read the text of Revenue Procedure 20-17. The full text of the Revenue Procedure is here:

rp-20-17

Here are the most relevant details supporting the conclusions above:

SECTION 4. SCOPE

Sections 3 and 6 of this revenue procedure apply to any eligible individual who, but for this revenue procedure, is (or was) required to report a transaction with, or ownership of, an applicable tax-favored foreign trust under section 6048.

SECTION 5. DEFINITIONS

.01 Applicable tax-favored foreign trust. For purposes of this revenue procedure, an applicable tax-favored foreign trust means a tax-favored foreign retirement trust as defined under section 5.03 of this revenue procedure or a tax-favored foreign nonretirement savings trust as defined under section 5.04 of this revenue procedure.

.02 Eligible Individual. 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).

.03 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.

(1) 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.

(2) 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.

(3) Only contributions with respect to income earned from the performance of personal services are permitted.

(4) 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 (available at https://www.fiscal.treasury.gov/reports-statements/treasury-reporting-rates-exchange).

(5) 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).

(6) 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 underthe trust to eligible employees are nondiscriminatory.

A trust that otherwise meets the requirements of this section 5.03 will not fail to be treated as a tax-favored foreign retirement trust within the meaning of this section solely because it may receive a rollover of assets or funds transferred from another taxfavored foreign retirement trust established and operated under the laws of the same jurisdiction, provided that the trust transferring assets or funds also meets the requirements of this section 5.03.

.04 Tax-Favored Foreign Non-Retirement Savings Trust. For purposes of this revenue procedure, a tax-favored foreign non-retirement savings 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, medical, disability, or educational benefits, and that meets the following requirements established by the laws of the trust’s jurisdiction.

(1) The trust is generally exempt from income tax or is otherwise tax-favored under the laws of the trust’s jurisdiction as defined in section 5.03(1) of this revenue procedure.

(2) Annual information reporting with respect to the trust (or about the beneficiary or participant) is provided, or is otherwise available, to the relevant tax authorities in the trust’s jurisdiction.

(3) Contributions to the trust are limited to $10,000 or less annually or $200,000 or less on a lifetime basis, determined using the U.S. Treasury Bureau of Fiscal Service foreign currency conversion rate on the last day of the tax year (available at https://www.fiscal.treasury.gov/reports-statements/treasury-reporting-rates-exchange).

(4) Withdrawals, distributions, or payments from the trust are conditioned upon the provision of medical, disability, or educational benefits, or apply penalties to withdrawals, distributions, or payments made before such conditions are met.

A trust that otherwise meets the requirements of this section 5.04 will not fail to be treated as a tax-favored foreign non-retirement savings trust within the meaning of this section 5.04 solely because it may receive a rollover of assets or funds transferred from another tax-favored foreign non-retirement savings trust established and operated under the laws of the same jurisdiction, provided that the trust transferring assets or funds also meets the requirements of this section 5.04

You and your tax prepare will have to assess what this means for you.Like many aspects there will be winners and losers. You and your tax preparer will have to analyze whether your pension plans.

How does Revenue Procedure 20 – 17 apply to the Australian Superannuation?

An early report from Dr. Karen Alpert of Fix The Tax Treaty includes:

Thanks for your post on Revenue Procedure 20-17. This will, indeed, help many Americans Abroad. However, the requirements that Treasury has imposed on what they will consider a “qualified retirement trust” are too restrictive. Other countries don’t necessarily follow the US practice of severely limiting tax advantaged savings.

Superannuation does not meet their definition of “Tax-favored foreign retirement trust” because contributions can be made that are not connected with income from personal services (even though the vast majority of contributions are the required employer contribution of 9.5% of earnings) and annual contribution limits exceed USD $50,000 (non-concessional contributions can be AUD $100,000 per year). There is no lifetime limit on super, though the maximum benefit of tax free earnings in retirement can only be claimed for the first AUD 1.6 million in the account. A lifetime limit of USD 1million seems quite low to me, though it is contributions, not balance. Many countries have higher limits for those over 50 to allow them to catch up – will those higher limits mean that the whole system doesn’t qualify under this Rev Proc, even though the specific individual may not be old enough to use them?

So, while many countries’ retirement accounts may qualify, the US is deciding what they deem to be an appropriate tax concession and penalizing US citizens for living in countries that are more generous. Furthermore, defining limits in USD means that any country where the limits are close will qualify some years but not others due to currency fluctuation. It seems to me that the requirements of section 5.03 or 5.04 depend on the rules in the foreign jurisdiction, not taxpayer-specific facts. The IRS should issue an annual list of qualifying plans/jurisdictions to reduce taxpayer uncertainty.

Have a question? Contact John Richardson or make a comment below.

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The Reality of U.S. Citizenship Abroad

My name is John Richardson. I am a dual citizen. I am a lawyer – member of the Bar of Ontario. This means that, any counselling session you have with me will be governed by the rules of “lawyer client” privilege. This means that:

“What’s said in my office, stays in my office.”

I am also a member of the American Citizens Abroad Professional Tax Advisory Council (PTAC). This is an advisory panel focused on assisting American Citizens Abroad in an FBAR and FATCA world.

The U.S. imposes complex rules and life restrictions on its citizens wherever they live. These restrictions are becoming more and more difficult for those U.S. citizens who choose to live outside the United States.

FATCA is the mechanism to enforce those “complex rules and life restrictions” on Americans abroad. As a result, many U.S. citizens abroad are renouncing their U.S. citizenship. Although this is very sad. It is also the reality.

4 thoughts on “Treasury Exempts Applicable “Tax-Favored Foreign Trusts” From The Form 3520… And Therefore Form 3520A Requirement

  1. Avatar Karen says:

    Thanks, John. I think it’s important to reiterate that this Rev Proc does not expand the definition of trust. If a retirement plan was NOT a trust under US rules before (and being called ‘trust’ under local law is not sufficient), this doesn’t make it a trust. What this does is to provide a safe harbor under which it is no longer important to determine whether a retirement plan is a trust. If it meets the definition of “Tax Favored Retirement Trust” in terms of contribution limits and tax benefits, then whether it is actually a trust is irrelevant – the reporting is the same either way (no 3520/3520A).

    It’s also interesting to note that the contribution limits listed are slightly LOWER than the contribution limits for similar US plans (the limitation for defined contribution plans under §415(c)(1)(A) is $57,000 in 2020 – https://www.irs.gov/pub/irs-drop/n-19-59.pdf). Plus, because of the word “permitted” in sections 5.03(3) and 5.03(4) – Australian superannuation does not fit into this definition, even if the only contributions in a given taxpayer’s account are well within the limits given. Australia allows nonconcessional contributions of up to AUD100,000 per year, in addition to the mandated 9.5% employer contribution.

    I would be curious to hear from people in other countries whether they think that retirement plans in their country would fit into the definition of “Tax Favored Retirement Trust”

  2. On May 11, 2009 (dated e-mail with Eileen Sherr AICPA Karen Brodsky Deloitte) I spoke with Bill Yates IRS chief counsel intl’ lawyer who spearheaded the successful Form 8891 reporting drive who said Form 3520 reporting IS required for RESPs, albeit completely undesired by the IRS but Treasury would not absolve such filing requirement as IRS was unwilling to make a blanket statement regarding whether RESPs were trusts or not, because they do not currently have the capacity to decide this on a global basis.

    I posed the question to him that perhaps RESPs should be exempt b/c they should not be treated as foreign trusts under Section 7701(a)(31) of the Code, which defines a foreign trust as one whose foreign source income “is not includible in gross income under subtitle A.”

    We looked at the Code section together, which at face, that quote appears to be made in conjunction to estates and not trusts (whereas the section in entirety is described as estates and trusts”) and he said that it referred only to estates and not trusts. I told him about a Rev Rul that interpreted it as applying equally to foreign trusts, to which he replied that the Ruling was wrong in such interpretation.

  3. Avatar David Johnstone says:

    John,

    Excellent post. Based on my reading of the Revenue Procedure, as well as feedback from practitioners in the UK or Australia, I have grave reservations about the claim that this Revenue Procedure will help “many” Americans abroad. Perhaps this is an example of an attempt to simplify things from a legal perspective that in practice – once one does the math – may lead to greater complexity and help a very small number of people at best.

    First, initial feedback from the UK and Australia indicate that professionals believe that, as currently drafted, those countries’ private retirement savings plans (UK SIPP’s and Australian Superannuation) will not be covered by this Revenue Procedure. Given that these countries account for a large percentage of Americans abroad, returning expats, and resident aliens, the fact that this “relief” does not seem to apply to them appears to amount to a shocking oversight. Surely the Treasury can at least take into consideration the main retirement plans offered in the English speaking countries, in which cases there is no language difficulty. I would go further and argue that the Treasury should look at the main retirement plans in the 10 countries in which the most Americans abroad live, based on State Department or FVAP estimates, for example, and then draft a ruling that will exempt the plans in those countries.

    Second, as drafted, the conditions for foreign retirement savings plans are clearly designed to be based on and more restrictive than US-based plan contribution limits. For instance, the UK and Australia (and other countries too) do not limit yearly or lifetime contributions as described in this Revenue Procedure, nor do the contributions in those countries always need to come from income earned from personal services performed. These two points alone appear to suffice to exclude them from any benefit from this Revenue Procedure. In fact, United States retirement plans would not qualify for this exemption, because amongst other reasons, the United States does not apply a lifetime contribution limit, as far as I am aware, and the yearly contribution limit stands at $57,000, which is significantly higher than the $50,000 limit proposed! While it is arguably laudable for Treasury to seek to preemptively prevent US-based tax optimization advisors from looking to create new foreign tax-advantaged retirement savings accounts in friendly jurisdictions for their US-resident clients, this inward-looking US focus leads to a situation in which no relief may actually be applicable to current or former foreign residents, who are or have often been required by local laws to contribute to local retirement savings plans. Further, far from reducing the number of forms 3520 or 3520A that are required to be filed, I believe that in practice the current drafting may actually expand the number of foreign retirement savings plans that fall under these reporting rules, without any change to the underlying tax owed, even though the intention clearly appears to be to clarify things and reduce the number of preventive filings.

    Third, I have reservations regarding section 5.04 regarding non-retirement savings accounts. The indicative list of what constitutes a trust for the purposes of this section appears to be far wider than the statutory definition. Although the statutory definition should take precedence, to the extent that the Treasury or the IRS will rely upon the definitive version of this Revenue Procedure, I believe that the risk exists that foreign medical, disability, or education savings plans or accounts that were not heretofore considered to be trusts could now be considered to be reportable trusts. For instance, many insurance contracts appear to be considered as trusts based on the indicative list. In addition, as with the retirement savings plans, foreign savings plans such as those described in this section are highly unlikely to impose the thresholds or fulfill the reporting requirements mentioned in this Revenue Procedure.

    In summary, this Revenue Procedure appears to not be applicable to a significant percentage of Americans abroad, and appears to assume that foreign countries base their laws for their retirement and non-retirement tax advantages savings plans or accounts for local residents on US law, and in a more restrictive manner than the US, which is clearly not the case for the large countries where most Americans abroad live or from which US resident aliens originate.

    Given the above, surely it would be much simpler for the Treasury to state that retirement savings plans established under the legislation of countries with which the US has an income tax treaty will automatically be considered to be exempt from reporting under forms 3520 and 3520A. If the Treasury is concerned about countries that are small enough to change their legislation to offer US residents the ability to participate in local retirement savings accounts, thus siphoning off savings from the US, then Karen Alpert’s suggestion for the Treasury to maintain a list of foreign qualifying plans may be practicable. I personally believe that basing the list on income tax treaties would require the least amount of time and effort for the Treasury: agents could just monitor foreign developments and maintain a smaller list of new foreign plans that do not qualify for the reporting exemption. For countries that do not have income tax treaties with the US, the current draft of the Revenue Procedure may constitute a good starting point, as long as the conditions for exemption are not more restrictive than equivalent US-based plans.

    Hence I would propose the addition of a new section X.X, as follows: “Except as provided below, all retirement and non-retirement savings plans established under the laws of any country with which the United States has signed or ratified an income tax treaty will be exempt from foreign trust information reporting requirements. A list of non-qualifying foreign plans will be updated annually. This list will be made available to taxpayers on the IRS website.” I should specify that this information should be on the IRS website so that it is easily accessible and not buried in some document which only tax professionals are likely to access.

    Ultimately the best relief for those living abroad who are considered to be US Persons by the US tax code remains a move to Residence Based Taxation, in line with what is practiced by every other country except for Eritrea, as well as every one of the 50 states. The Treasury certainly has enough talented and experienced staff members who can gather the best practices from those jurisdictions and come up with a world-leading tax policy for expats, former expats, and resident aliens. For those returnees, naturalized citizens or resident aliens currently in the US, the proposed Revenue Procedure may be a good first draft and starting point, but for Americans currently residing abroad, it is hard to see how this Revenue Procedure provides any relief in practice.

  4. Avatar George says:

    What happens if a penalty was already applied regarding a 3520-A filing (for a TFSA in my case)? Will the IRS reconsider the penalty? Even if it was paid after an appeal to the IRS Ogden office was denied?

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