Explaining The VGBL for U.S. Tax Purposes, FBAR, FATCA & PFIC
Explaining The VGBL for U.S. Tax Purposes, FBAR, FATCA & PFIC
The VGBL is a very common investment vehicle in Brazil. It is generally used in conjunction with retirement planning to assist Brazilian taxpayers with supplemental income when they are getting ready to retire. For taxpayers who are also U.S. persons for tax purposes and own a VGBL, it can get very complicated because the tax treatment in Brazil is different than the treatment in the United States. Unlike other foreign countries in which the United States has entered into a tax treaty, there is no tax treaty with Brazil; therefore, VGBL can receive tougher tax treatment than its treaty-country counterparts (such as the Australian Superannuation). Let’s review the basics of how this type of investment vehicle is typically treated for tax purposes, noting that different tax practitioners may have different strategies, and for individuals who have to report their own VGBL, they should be sure to consult with a board-certified tax law specialist — especially if they have not been reporting it on various international information reporting forms.
First, what is U.S. Worldwide Income/Citizenship-Based Taxation?
Unlike most other countries across the globe, the United States taxes individuals based on their U.S. person status. While the technical name is ‘citizenship-based taxation,’ it also applies to lawful permanent residents and foreign nationals who meet the substantial presence test. Therefore, any taxpayer who is considered a U.S. person for tax purposes (not just U.S. citizens) is typically taxed on their worldwide income, including income associated with foreign pension plans unless an exception, exclusion, or limitation applies.
FBAR (FinCEN Form 114)
The FBAR is the most common international information reporting form. In any year that a taxpayer has more than $10,000 in annual aggregate total on any day of the year in foreign accounts, they are required to report all of the accounts on the annual FBAR. Many different types of accounts are reported for FBAR purposes, including foreign pension plans such as a VGBL.
Form 8938 (FATCA)
Form 8938 was developed in accordance with FATCA (Foreign Account Tax Compliance Act). And unlike the FBAR, there are many different threshold requirements depending on whether the taxpayer lives in the United States or lives abroad and whether the taxpayer is filing single or married filing separately vs. married filing jointly. Like the FBAR, all different types of accounts are reported for Form 8938 purposes, including foreign pension plans such as the VGPL.
Form 8621 (PFIC)
The Form 8621 is used to report PFICs — which are passive foreign investment companies. These types of investments come in all shapes and sizes, but most commonly they include things like investment funds such as mutual funds, ETFs, and other pooled funds. The reason why this is more complicated for the VGBL than other investment plans is that there are typical exceptions for having to report Form 8621 for pension and other types of trusts when the country the investment is located in is a treaty country; since Brazil is not a treaty country with the United States, that exception does not apply.
Form 3520/3520-A (Foreign Trust)
The Form 3520 and 3520-A are used to report foreign trust ownership along with foreign trust distributions. While technically, a VGBL may be considered a foreign trust, for the most part, most tax professionals do not report the VGBL as a foreign trust but instead report it as an investment and include Form 8621. As mentioned above, you should consult with a board-certified tax law specialist to go over your specifics and develop a strategy.
U.S. Income Tax of a VGBL
Beyond the reporting of a VGBL is understanding the tax implications of owning and investing in this type of Brazilian pension plan:
Contributions
Unlike some countries like the UK, the contributions made to the VGBL are included in your income and cannot be excluded like they are for investments such as a 401K.
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For example, if you made $300,000 working in Brazil and your employer contributed $30,000 pretax dollars to your VGBL, you cannot exclude that $30,000 from your U.S. tax base when reporting your income for the year (even if it would not be included in your Brazilian income tax filing)
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Growth
Growth within a VGBL may be taxable because there is no treaty that eliminates the tax. With that said, because most of the time the VGBL includes things such as a prefix, there are different rules involving PFIC and whether the income has been distributed or not. In addition, if funds have been redeemed or switched out, this may impact the tax implications as well.
Distributions
In general, distributions from foreign pension plans including VGBLS are taxable in the year it was distributed to the taxpayer.
Late Filing Penalties May Be Reduced or Avoided
For Taxpayers who did not timely file their FBAR and/or other international information-related reporting forms, the IRS has developed many different offshore amnesty programs to assist Taxpayers with safely getting into compliance. These programs may reduce or even eliminate international reporting penalties.
Current Year vs. Prior Year Non-Compliance
Once a Taxpayer missed the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, Taxpayers should consider speaking with a Board-Certified Tax Law Specialist who specializes exclusively in these types of offshore disclosure matters.
Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)
In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful Taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties.
Need Help Finding an Experienced Offshore Tax Attorney?
Hiring an experienced international tax attorney to represent you for unreported foreign and offshore account reporting can be overwhelming for Taxpayers trying to sift through the false information and nonsense they find in online research. Only a handful of attorneys worldwide are Board-Certified Tax Specialists who specialize exclusively in offshore disclosure and international tax amnesty reporting.
*This resource may help Taxpayers seeking to hire offshore tax counsel: How to Hire an Offshore Disclosure Lawyer.
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