US Taxation of Provident Funds & IRS Reporting Compliance

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Is Provident Fund Income Taxable in the U.S.?

US Taxation of Provident Funds: Is provident fund income taxable in the U.S.? According to the IRS, the answer is yes — provident funds are taxable. Provident funds are common retirement tools in countries such as Singapore, Hong Kong, Thailand, and more. Because the United States does not have a Provident Fund system in place, the U.S. taxation of provident funds can be complex.

Why are they taxable?

US Taxation of Provident Funds

US Taxation of Provident Funds &

Because these funds are privatized.

The World Bank issued (and re-issued) summary guidelines about foreign retirement planning for aging populations such as Hong Kong. Many of the Provident Funds fall into Pillar 2 or 3 (below), which resembles retirement planning more than social security.

In addition, the U.S. has not entered into tax treaties with several Provident Fund Countries, such as Singapore or Hong Kong.

Common Provident Funds Golding & Golding Handle:

U.S. Tax of Provident Funds

When it comes to completing a tax return, taxpayers get understandably concerned when trying to decipher whether their provident fund is taxable.

Common Provident Questions we receive are:

  • What is a Provident Fund?
  • Is a Provident Fund Taxable in the U.S.?
  • Is a Provident Fund Reportable in the U.S.?
  • But the money was never distributed?
  • Will the IRS penalize me?
  • How can I go back and fix prior returns?

World bank Pillar Framework

The world bank issued an (updated) framework to include a 5 pillar system to account for aging populations from around the world.

As provided by the World Bank:

A non-contributory “zero pillar”

Provides assistance in the form of a demogrant, social pension, or general social assistance typically financed by the local, regional or national government, fiscal conditions permitting, to deal explicitly with the poverty alleviation objective in order to provide all of the elderly with a minimal level of protection.

This ensures that people with low lifetime incomes are provided with basic protection in old age, including those who only participate marginally in the formal economy.

Whether this is viable—and the specific form, level, eligibility and disbursement of benefits depends upon the prevalence and need of other vulnerable The World Bank Pension Conceptual Framework 3 groups, availability of budgetary resources and the design of complementary elements of the pension system; ?

A Mandatory “first pillar”

[C]ontributions linked to varying degrees to earnings with the objective of replacing some portion of lifetime pre-retirement income. First pillars address, among others, the risks of individual myopia, low earnings, and inappropriate planning horizons due to the uncertainty of life expectancies, and the lack or risks of financial markets.

They are typically financed on a pay-as-you-go basis and thus are, in particular, subject to demographic and political risks.

A Mandatory “Second pillar”

[T]ypically an individual savings account (i.e. defined contribution plan) with a wide set of design options including active or passive investment management, choice parameters for selecting investments and investment managers, and options for the withdrawal phase. Defined contribution plans establish a clear linkage between contributions, investment performance and benefits; support enforceable property rights; and may be supportive of financial market development.

When compared to defined benefit plans they can subject participants to financial and agency risks as a result of private asset management, the risk of high transaction and administrative costs, and longevity risks unless they require mandatory annuitization; ?

A Voluntary “third-pillar” 

 (e.g. individual savings for retirement, disability or death; employer sponsored; defined benefit or defined contribution) but is essentially flexible and discretionary in nature.

Third pillars compensate for rigidities in the design of other systems but include similar risks as second pillars; and ?

A Non-financial “fourth pillar”

which includes access to informal support (such as family support), other formal social programs (such as health care and/or housing), and other individual financial and non-financial assets (such as home ownership and reverse mortgages where available).

Certain pillars are better suited to address the needs of the lifetime poor, informal sector workers at risk of becoming poor once they stop working, and workers covered by formal pension arrangements while also providing diversification for all income groups.

Provident Funds

In the U.S. the social security system most resembles the first pillar. There are not individual accounts, or choice of investment management, and options for withdrawal (other than age).

In most countries, the main Provident Fund accounts teeter between the second and third pillars.

In countries such as Singapore and Hong Kong, taxpayers have:

  • Individual Accounts
  • Options for complete withdrawal
  • Assigned account numbers
  • Options for investing strategies of their own accounts
  • voluntary contributions beyond the mandatory

For these reasons, the U.S. does not treat these foreign retirement plans the same as it treats U.S. social security.

U.S. Tax & Reporting Basics

U.S. persons may be subject to provident fund reporting and tax

U.S. Persons include:

  • U.S. Citizens
  • Legal Permanent Residents,
  • Foreign Nationals who meet the Substantial Presence Test

Different types of Provident Funds

There are many different types of provident funds, depending on which country you work in. Some of the more common types of funds include:

  • CPF – Central Provident Fund (Singapore)
  • CPF – Central Provident Fund (South Africa)
  • EPF – Employees Provident Fund (Malaysia)
  • EPF – Employees Provident Fund (Nepal)
  • TPF – Thailand Provident Fund (Thailand)
  • MPF – Mandatory Provident Fund (Hong Kong)

Example of Provident Fund

Even though the Provident Fund may receive tax-deferred treatment in its country of origin, that does not mean the United States recognizes that tax-deferred treatment as well.

Example: David is a U.S. Citizen and Permanent Resident of Singapore and therefore is required to contribute to his CPF. The Singapore CPF is one of the largest Provident Funds in the world with extremely high contribution rates.

David is a Highly Compensated Employee (“HCE”), with a salary upwards of $400,000.

As such, David has a large portion of his salary diverted into CPF through employer contributions. In addition, David contributes a significant portion of his own salary into the CPF.

Provident Funds – Employer Contributions

Since the mid-1990s, the IRS has taken the position that employer contributions to the CPF on behalf of the employee are not deductible by the employer and must be considered to be income.

For example, if an employer was to contribute $30,000 of David’s salary into the CPF, that $30,000 is to be considered income by David, and David would therefore have to pay U.S. tax on the employer contribution portion to the Provident Fund now.

In sharp contract, if the same money was contributed to a 401K, the U.S. would  recognize tax-deferred treatment in which that income is not currently be taxed, and grows tax-free until retirement.

Provident Funds – Employee Contributions

David does not receive a tax-deferred benefit.  If David decides to contribute $25,000 of his pretax salary towards the CPF, he still needs to report the the contributed amount as part of his current income (aka he cannot “deduct” the pretax contributions from his overall current tax liability).

If the contributions are post U.S. tax, the rules are different.

Provident Funds – Accrued Earnings

Because the United States does not recognize tax-deferred status on a CPF (employer or employee contributions), and there is no tax treaty with many of the countries which utilize Provident Funds as a retirement vehicle — the non-distributed accrued earnings are presently categorized as taxable.

In other words, if David’s CPF earned $7,000 in dividends and interest — even though David cannot access the money now, he would still have to pay tax on the non-distributed earnings.

The theory is that because the United States does not recognize tax-deferred treatment of either the employer or employee contributions to the fund, then by default the accrued but not distributed earnings should be taxed (and not receive tax-deferred treatment either).

It should be noted, that once David pays tax on the non-distributed earnings, it will increase his basis in so far as he will not be paying double-tax in the future, on the same income.

Example: Let’s say David was properly paying U.S. tax on all of his employer contributions, employee contributions and accrued earnings for his CPF, which is now worth $500,000. 

Once David begins to withdraw his money, David will not be taxed on the first $500,000 – or whichever amount David has already paid taxed on.

In addition, future distributions based may be taxed as a hybrid, to ensure that the portion of the distribution which is “principle” and is not taxed, versus the portion that is income generated on the principal – which has not yet been taxed.

In other words, it is not as it David is being double taxed (save for the fact that many provident funds are not taxed at distribution), but rather, David is being taxed now while the earnings accumulate – as opposed to later when the earnings are distributed (as to the portion of the distributions which is considered to have been already taxed).

Reporting of a Provident Fund

A Provident Fund must be reported on an FBAR, along with other forms if it meets the minimum threshold requirements.

Even though a Provident Fund is a retirement fund, and despite the fact that under many FATCA IGA (intergovernmental agreements) that the United States has entered into, a Foreign Financial institution may not have to report the Provident fund (excluded from the reporting) to the United States – you, as an individual still have a reporting requirement..

Therefore, each year when it is time for you to complete a tax return, there are a number of different forms you may have to file, depending on the facts and circumstances of your Provident Fund.

Two of the more common forms a person has the file are below:

FBAR (FinCEN 114)

The FBAR is used to Report Foreign Bank and Financial Accounts on an annual basis.

The form has a relatively low threshold requirement of $10,000. In other words, if you have an annual aggregate total of foreign accounts (including life insurance or retirement funds) that on any day of the year exceeds $10,000, then you are required to report this form. It does not matter if the money is in one account or spread over numerous accounts. And, it does not matter if the account is in your home country of citizenship or if you opened the account before relocating to the United States.

The US government does not look into the semantics that deeply; rather, if you meet the threshold requirement then you have to file the form. Starting in 2017 (to report 2016 maximum balance), the due date coincides with your tax return filing date (including extension).

When it comes to the FBAR, one of the main concerns are the FBAR Penalties.

FBAR Penalties

A penalty for failing to file FBARs. United States citizens, residents and certain other persons must annually report their direct or indirect financial interest in, or signature authority (or other authority that is comparable to signature authority) over, a financial account that is maintained with a financial institution located in a foreign country if, for any calendar year, the aggregate value of all foreign financial accounts exceeded $10,000 at any time during the year. The civil penalty for willfully failing to file an FBAR can be as high as the greater of $100,000 or 50 percent of the total balance of the foreign financial account per violation. See 31 U.S.C. § 5321(a)(5). Non-willful violations that the IRS determines were not due to reasonable cause are subject to a $10,000 penalty per violation.

Form 8938

Form 8938 is a byproduct of FATCA (Foreign Account Tax Compliance Act). It is a form that is required to be filed with the tax return each year when a person meets the threshold requirements for filing. Unlike the FBAR, which is an electronic form which is submitted directly to the Department of Treasury (The FBAR is not submitted with your tax return), Form 8938 is part of your tax return.

Form 8938 requires you to provide extensive information regarding foreign accounts and specified foreign assets. For example, with the FBAR, reporting is limited to accounts and insurance policies (although those terms can have a very broad meaning). Conversely, with form 8938, the person must report Income — along with assets and accounts.

Therefore, if you were to own stock of a foreign company, that would be considered a Specified Foreign Asset that would need to be reported on a Form 8938 — but would not be reported on an FBAR.

Moreover, with the FBAR, a person is required to report the maximum balance in the account, but is not required to report any income that is generated from the accounts. The 8938 is more depth than that. Rather, with form 8938, a person must report the account balance along with the annual income that is generated from form 8938 accounts or assets.

Additionally, the income must be broken down by type of income earned (such as royalties, dividends, interest, capital gains) and/or whether the income was earned through a custodial or deposit account and/or it was earned through one of the specified foreign assets.

Form 8938 Penalties

Beginning with the 2011 tax year, a penalty for failing to file Form 8938 reporting the taxpayer’s interest in certain foreign financial assets, including financial accounts, certain foreign securities, and interests in foreign entities, as required by IRC § 6038D. The penalty for failing to file each one of these information returns is $10,000, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return.

Foreign Provident Fund PFIC Treatment

The term PFIC stands for “Passive Foreign Investment Company.” 

When a foreign provident fund contains mutual funds in it, the mutual funds may be subject to annual reporting on the 1040 tax return using Form 8621. 

Provident Fund PFIC Tax Treatment

Because with most provident funds you cannot access the money until you reach a certain age. During all the while, the fund continues to grow and get larger. Meanwhile, you have not received any distributions that and therefore by time you receive the first distribution, it will probably be considered to be an excess distribution.

PFIC excess distributions kick in when the funds are distributed and/or redeemed.

Excess distributions are taxed at an extraordinarily high tax rate, and depending how long the fund has been growing and how long the fund’s been in existence from the initial contribution, through the time of withdrawal — the tax liability can reach upwards of 40% – 65% of the value of the distribution.

Never Reported the Provident Fund?

If you have never reported the Provident Fund, and/or the prior employer contributions or employee contributions to the United States government you can be considered out of compliance and subject to extreme high fines and penalties. With that said, you may be able to get back into compliance relatively safely by entering one of the approved IRS offshore voluntary disclosure programs.

A summary of the different programs are provided below:

Form 8833

Taxpayers may consider making a Form 8833 treaty position that the foreign provident fund should be treated as social security, but it does come with risks, that Taxpayers should assess before taking the position — which will impact several tax returns for future years and leave the prior returns subject to possible audit.

If the U.S. has not entered into a tax treaty with the county, then 8833 is not available.

What Can You Do?

Presuming the money was from legal sources, your best options are either the Traditional IRS Voluntary Disclosure Program, or one of the Streamlined Offshore Disclosure Programs.

We Specialize in Safely Disclosing Foreign Money

We have successfully handled a diverse range of IRS Voluntary Disclosure and International Tax Investigation/Examination cases involving FBAR, FATCA, and high-stakes matters for clients around the globe (In over 65 countries!)

Whether it is a simple or complex case, safely getting clients into compliance is our passion, and we take it very seriously.

Who Decides to Disclose Unreported Money?

What Types of Clients Do we Represent?

We represent Attorneys, CPAs, Doctors, Investors, Engineers, Business Owners, Entrepreneurs, Professors, Athletes, Actors, Entry-Level staff, Students, Former/Current IRS Agents and more.

You are not alone, and you are not the only one to find himself or herself in this situation.

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, and specifically IRS offshore disclosure. 

We are the “go-to” firm for other Attorneys, CPAs, Enrolled Agents, Accountants, and Financial Professionals across the globe. Our attorneys have worked with thousands of clients on offshore disclosure matters, including FATCA & FBAR.

Each case is led by a Board-Certified Tax Law Specialist with 20 years of experience, and the entire matter (tax and legal) is handled by our team, in-house.

*Please beware of copycat tax and law firms misleading the public about their credentials and experience.

Less than 1% of Tax Attorneys Nationwide Are Certified Specialists

Sean M. Golding is one of less than 350 Attorneys (out of more than 200,000 practicing California Attorneys) to earn the Certified Tax Law Specialist credential. The credential is awarded to less than 1% of Attorneys.

Recent Golding & Golding Case Highlights

  • We represented a client in an 8-figure disclosure that spanned 7 countries.
  • We represented a high-net-worth client to facilitate a complex expatriation with offshore disclosure.
  • We represented an overseas family with bringing multiple businesses & personal investments into U.S. tax and offshore compliance.
  • We took over a case from a small firm that unsuccessfully submitted multiple clients to IRS Offshore Disclosure.
  • We successfully completed several recent disclosures for clients with assets ranging from $50,000 – $7,000,000+.

How to Hire Experienced FBAR Counsel?

Generally, experienced attorneys in this field will have the following credentials/experience:

  • 20-years experience as a practicing attorney
  • Extensive litigation, high-stakes audit and trial experience
  • Board Certified Tax Law Specialist credential
  • Master’s of Tax Law (LL.M.)
  • Dually Licensed as an EA (Enrolled Agent) or CPA

Interested in Learning More about Golding & Golding?

No matter where in the world you reside, our international tax team can get you IRS offshore compliant. 

Golding & Golding specializes in FBAR and FATCA. Contact our firm today for assistance with getting compliant.