201601.13
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Foreign Pension Plans Reporting | FBAR Lawyers – International Tax

Golding & Golding - U.S. and International Tax Lawyers

Golding & Golding – U.S. and International Tax Lawyers

Foreign Pensions and FBAR Compliance Lawyers: When it comes to reporting foreign accounts on an FBAR (Report of Foreign Bank And Financial Accounts) there are two main issues involving foreign pension plans.

The first issue is whether the account must be reported on the FBAR; the second issue is whether there is an immediate tax liability on the earnings, or if the earnings which have not yet been distributed may receive tax deferred treatment.

Foreign Pensions

Since each country has different rules and regulations regarding their own Pension and Retirement Plans, the issues surrounding foreign tax planning can get very complicated, very quickly – especially when it involves the taxation of foreign pensions. That is because whether or not the foreign pension will be taxed may largely be impacted by the specific tax treaty the United States has entered into with the Foreign Country — in conjunction with general international tax principles.

Generally, a pension in the United States receives tax-deferred treatment while it grows. That means that while the earnings that are accruing but not distributed, the pension is not taxed on the annual accruals (which are accrued but not distributed). Rather, the income derived from the pension will be taxed in the future when the money is distributed.

Depending on whether the U.S. has entered into an international Tax Treaty with the foreign country will help determine if the pension is taxable. The language is usually contained in section 18-20 of the IRS Tax Treaty(s).

A Few Quick Issues to keep in mind:

– Tax Deferred Treatment by the U.S. is not “presumed” just because it is tax deferred abroad;

– Different rules may apply to whether it is a Government Pension or Private Pension;

– Different rules may apply to whether it is an Employer or Private Company Pension;

– Is the Employer or Employee deemed the owner (aka, the employee contributions exceed the Employer’s);

– Immediate tax liability is more common when the employee was an HCE (Highly Compensation Employee);

– Some foreign pensions may be considered a Foreign Trust (resulting in a 3520-A Reporting issue)

Foreign Pensions

With foreign pensions, the process is different.  The IRS has provided the following guidelines for Foreign Pensions:

General Rule: Treaties—Pension/Annuity Articles

As a general rule, the pension/annuity articles of most tax treaties allow the country of residence (as determined by the residency article) to tax the pension or annuity under its domestic laws. This is true unless a treaty provision specifically amends that treatment. Some treaties, for example, provide that the country of residence may not tax amounts that would not have been taxable by the other country if you were a resident of that country. In some cases, government pensions/annuities or social security payments may be taxable by the government making the payments. There also may be special rules for lump-sum distributions. You need to look at each treaty carefully.

If you live in a foreign country and receive a pension/annuity paid by a U.S. payor, you may claim an exemption from withholding of U.S. Federal Income Tax (FIT) under a tax treaty by completing Form W-8BEN and delivering it to the U.S. payor. You must report your U.S. Taxpayer Identification Number (TIN) on Form W-8BEN for it to be valid for treaty purposes.

If you live in the USA and receive a pension/annuity paid by a payor from a foreign country, you must claim your desired treaty withholding exemption on the form, and in the manner specified by the foreign government. If the foreign government, and/or the foreign withholding agent, refuses to honor the treaty claim, make the treaty claim on your income tax return, or other prescribed form, filed with the foreign country. Additionally, you may be able to claim a Foreign Tax Credit on your U.S. federal individual income tax return for any foreign income tax withheld from your foreign pension or annuity.

Tax Treaty Residency Issues

When deciding whether a tax treaty applies, identify your tax residency (Article 4 under most treaties). Then find out if the relevant treaties have articles which deal with pensions, annuities, government payments or social security payments. Remember each tax treaty is unique — just because one treaty allows a certain treatment does not mean another treaty will allow the same treatment.

Your residency determines how treaty articles on pensions and annuities will be applied. Use the domestic laws of each country to identify your residency, IRC 7701(b) in the case of the USA (Green Card Test and/or Substantial Presence Test). If, after applying the domestic law of each country, you are a resident of both countries, apply the Tiebreaker Rules:

  • In which country do you have a Permanent Home available to you?
  • With which country do you have closer personal and economic relations?
  • In which country do you have an Habitual Abode?
  • Of which country are you a National?

If none of the above tiebreaker rules works, then residency will be decided by the Competent Authorities of each country upon request by the taxpayer. Refer to Competent Authority Assistancefor information on how to make a competent authority assistance request.

Some treaties have special rules, e.g., the USA-Canada and the USA-UK treaties have special rules for taxpayers who have U.S. green cards. You must read the residency article from beginning to end to find any special rules.  You must also read all the Protocols of the treaty to see if the residency rules have been amended by a later Protocol.  If you are a U.S. citizen, you also may need to refer to the so-called “saving clause” (typically found in Article 1) for special rules that allow the United States to tax in some cases as if the treaty had not entered into force.

Foreign Social Security Pensions 

Most income tax treaties have special rules for social security payments.  In many cases, foreign social security payments are taxable by the country making the payments.  Unless specified otherwise in an income tax treaty, foreign social security pensions are generally taxed as if they were foreign pensions or foreign annuities. Unless a tax treaty allows it (see, e.g., the USA-Canada treaty), they are not eligible for exclusion from taxable income the way a U.S. social security pension might be.

Foreign Employer Contributions
If you worked abroad, your Cost might include amounts contributed by your employer that were not includible in your gross income. This applies to contributions made either:

  • before 1963 by your employer for that work,
  • after 1962 by your employer for that work if you performed the services under a plan that existed on March 12, 1962, or
  • after 1996 by your employer on your behalf if you were a foreign missionary (a duly ordained, commissioned, or licensed minister of a church or a lay person).

Foreign Contributions while a Nonresident Alien

Your contributions and your employer’s contributions are not part of your Cost if the contribution was based on compensation for services performed outside the United States while you were a nonresident alien and not subject to income tax under the laws of the United States or any foreign country (but only if the contribution would have been taxable if paid as cash compensation when the services were performed).

                                                                         

What About FBAR Reporting?

In addition to tax issues involving foreign pensions, there are specific reporting requirements. Depending on the type of account, whether the pension is in a general fund or specific account, and other factors – it will determine whether you must file an annual FBAR statement for the specific account.

The following is a summary provided by Golding & Golding:

FBAR

If you, your family, your business, your foreign trust, and/or PFIC (Passive Foreign Investment Company) have more than $10,000 (in annual aggregate total at any time) overseas in foreign accounts and either have ownership or signatory authority over the account, it is important that you have an understanding of what you must do to maintain FBAR (Report of Foreign Bank and Financial Accounts) compliance. There are very strict FBAR filing guidelines and requirements in accordance with general IRS tax law, Department of Treasury (DOT) filing initiatives, and FATCA (Foreign Account Tax Compliance Act).

Filing FBARs and ensuring compliance with IRS International Tax Laws, Rules, and Regulations is extremely important for anyone, or any business that maintains:

  • Foreign Bank Accounts
  • Foreign Savings Accounts
  • Foreign Investment Accounts
  • Foreign Securities Accounts
  • Foreign Mutual Funds
  • Foreign Trusts
  • Foreign Retirement Plans
  • Foreign Business and/or Corporate Accounts
  • Foreign Life Insurance Policies (including Life Assurance)
  • Foreign Accounts held in a CFC (Controlled Foreign Corporation); or
  • Foreign Accounts held in a PFIC (Passive Foreign Investment Company)

lead to significant fines, penalties, and other possible consequences. 

                                         

What can I do to get FBAR Compliant?

If you are out-of-compliance, one of the most effective methods for getting into compliance is the IRS Offshore Voluntary Disclosure Program.

IRS Voluntary Disclosure of Offshore Accounts

Offshore Voluntary Disclosure Tax law is very complex. There are many aspects that go into any particular tax calculation, including the legal status, marital status, business status and residence status of the taxpayer.

When Do I Need to Use Voluntary Disclosure?

Voluntary Disclosure is for individuals, estates, and businesses who are out of compliance with the IRS and the Department of Treasury. What does that mean? It means that if you are required to file a U.S. tax return and you don’t do so timely, then you are out of compliance.

If the IRS discovers that you are out of compliance, you may become subject to extensive fines and penalties – ranging from a warning letter all the way up to tax liens, tax levies, seizures, and criminal investigations. To combat this, you can take the proactive approach and submit to Voluntary Disclosure.

Golding & Golding – Offshore Disclosure

At Golding & Golding, we limit our entire practice to offshore disclosure (IRS Voluntary Disclosure of Foreign and U.S. Assets). The term offshore disclosure is a bit of a misnomer, because the term “offshore” generally connotes visions of hiding money in secret places such as the Cayman Islands, Bahamas, Malta, or any other well-known tax haven jurisdiction – but that is not the case.

In fact, any money that is outside of the United States is considered to be offshore; the term offshore is not a bad word. In other words, merely because a person has money offshore (a.k.a. overseas or in a foreign country) does not mean that money is the result of ill-gotten gains or that the money is being “hidden.” It just means it is not in the United States. Many of our clients have assets and bank accounts in their homeland countries and these are considered offshore assets and offshore bank accounts.

The Devil is in the Details…

If you do have money offshore, then it is very important to ensure that the money has been properly reported to the U.S. government. In addition, it is also very important to ensure that if you are earning any foreign income from that offshore money, that the earnings are being reported on your U.S. tax return.

It does not matter whether your money is in a country that does not tax a particular category of income (for example, many Asian countries do not tax passive income). It also does not matter if you are a dual citizen and/or if that money has already been taxed in the foreign country.

Rather, the default position is that if you are required to file a U.S. tax return and you meet the minimum threshold requirements for filing a U.S. tax return, then you have to include all of your foreign income. If you already paid foreign tax on the income, you may qualify for a Foreign Tax Credit. In addition, if the income is earned income – as opposed to passive income – and you meet either the Bona-Fide Resident Test or Physical-Presence Test, then you may qualify for an exclusion of that income; nevertheless, the money must be included on your tax return.

What if You Never Report the Money?

If you are in the unfortunate position of having foreign money or specified foreign assets that should have been reported to the U.S. government, but which you have not reported —  then you are in a bit of a predicament, which you will need to resolve before it is too late.

As we have indicated numerous times on our website, there are very unscrupulous CPAs, Attorneys, Accountants, and Tax Representatives who would like nothing more than to get you to part with all of your money by scaring you into believing you are automatically going to be arrested, jailed, or deported because you have unreported money. While that is most likely not the case (depending on the facts and circumstances of your specific situation), you may be subject to extremely high fines and penalties.

Moreover, if you knowingly or willfully hid your foreign accounts, foreign money, and offshore assets overseas, then you may become subject to even higher fines and penalties…as well as a criminal investigation by the special agents of the IRS and/or DOJ (Department of Justice).

Getting into Compliance

There are five main methods people/businesses use to get into compliance. Four of these methods are perfectly legitimate as long as you meet the requirements for the particular mechanism of disclosure. The fifth alternative, which is called a Quiet Disclosure a.k.a. Silent Disclosure a.k.a. Soft Disclosure, is ill-advised as it is illegal and very well may result in criminal prosecution.

We are going to provide a brief summary of each program below. We have also included links to the specific programs. If you are interested, we have also prepared very popular “FAQs from the Trenches” for FBAR, OVDP and Streamlined Disclosure reporting. Unlikes the technical jargon of the IRS FAQs, our FAQs are based on the hundreds of different types of issues we have handled over the many years that we have been practicing international tax law and offshore disclosure in particular.

After reading this webpage, we hope you develop a basic understanding of each offshore disclosure alternative and how it may benefit you to get into compliance. We do not recommend attempting to disclose the information yourself as you may become subject to an IRS investigation insofar as you will have to answer questions directly to the IRS, which you can avoid with an attorney representative.

If you retain an attorney, then you will get the benefit of the attorney-client privilege which provides confidentiality between you and your representative. With a CPA, there is a relatively small privilege which does provide some comfort, but the privilege is nowhere near as strong as the confidentiality privilege you enjoy with an attorney.

Since you will be dealing with the Internal Revenue Service and they are not known to play nice or fair – it is in your best interest to obtain an experienced Offshore Disclosure Attorney.

1. OVDP 

OVDP is the Offshore Voluntary Disclosure Program — a program designed to facilitate taxpayer compliance with IRS, DOT, and DOJ International Tax Reporting and Compliance. It is generally reserved for individuals and businesses who were “Willful” (aka intentional) in their failure to comply with U.S. Government Laws and Regulations.

The Offshore Voluntary Disclosure Program is open to any US taxpayer who has offshore and foreign accounts and has not reported the financial information to the Internal Revenue Service (restrictions apply). There are some basic program requirements, with the main one being that the person/business who is applying under this amnesty program is not currently under IRS examination.

The reason is simple: OVDP is a voluntary program and if you are only entering because you are already under IRS examination, then technically, you are not voluntarily entering the program – rather, you are doing so under duress.

Any account that would have to be included on either the FBAR or 8938 form as well as additional income generating assets such as rental properties are accounts that qualify under OVDP. It should be noted that the requirements are different for the modified streamlined program, in which the taxpayer penalties are limited to only assets that are actually listed on either an FBAR or 8938 form; thus the value of a rental property (reduced by any outstanding mortgage) would not be calculated into the penalty amount in a streamlined application, but it would be applicable in an OVDP submission.

An OVDP submission involves the failure of a taxpayer(s) to report foreign and overseas accounts such as: Foreign Bank Accounts, Foreign Financial Accounts, Foreign Retirement Accounts, Foreign Trading Accounts, Foreign Insurance, and Foreign Income, including 8938s, FBAR, Schedule B, 5741, 3520, and more.

What is Included in the Full OVDP Submission?

The full OVDP application includes:

  • Eight (8) years of Amended Tax Return filings;
  • Eight (8) Years of FBAR (Foreign Bank and Account Reporting Statements);
  • Penalty Computation Worksheet; and
  • Various OVDP specific documents in support of the application.

Under this program, the Internal Revenue Service wants to know all of the income that was generated under these accounts that were not properly reported previously. The way the taxpayer accomplishes this is by amending tax returns for eight years.

Generally, if the taxpayer has not previously reported his accounts, then there are common forms which were probably excluded from the prior year’s tax returns and include 8938 Forms, Schedule B forms, 3520 Forms, 5471 Forms, 8621 Forms, as well as proof of filing of FBARs (Foreign Bank and Financial Account Reports).

OVDP Penalties

The taxpayer is required to pay the outstanding tax liability for the eight years within the disclosure period – as well as payment of interest along with another 20% penalty on that amount (for nonpayment of tax). To give you an example, let’s pick one tax year during the compliance period. If the taxpayer owed $20,000 in taxes for year 2014, then they would also have to include in the check the amount of $4,000 to cover the 20% penalty, as well as estimated interest (which is generally averaged at about 3% per year). This must be done for each year during the compliance period.

Then there is the “FBAR/8938” Penalty. The Penalty is 27.5% (or 50% if any of the foreign accounts are held at an IRS “Bad Bank”) on the highest year’s “annual aggregate total of unreported accounts (accounts which were previously reported are not calculated into the penalty amount).

For OVDP, the annual aggregate total is determined by adding the “maximum value” of each unreported account for each year, in each of the last 8 years. To determine what the maximum value is, the taxpayer will add up the highest balances of all of their accounts for each year. In other words, for each tax year within the compliance period, the application will locate the highest balance for each account for each year, and total up the values to determine the maximum value for each year.

Thereafter, the OVDP applicant selects the highest year’s value, and multiplies it by either 27.5%, or possibly 50% if any of the money was being held in what the IRS considers to be one of the “bad banks.” When a person is completing the penalty portion of the application, the two most important things are to breathe and remember that by entering the program, the applicant is seeking to avoid criminal prosecution!

                         

2. Streamlined Domestic Offshore Disclosure

The Streamlined Domestic Offshore Disclosure Program is a highly cost-effective method of quickly getting you into IRS (Internal Revenue Service) or DOT (Department of Treasury) compliance.

What am I supposed to Report?

There are three main reporting aspects: (1) foreign account(s), (2) certain specified assets, and (3) foreign money. While the IRS or DOJ will most likely not be kicking in your door and arresting you on the spot for failing to report, there are significantly high penalties associated with failing to comply.

In fact, the US government has the right to penalize you upwards of $10,000 per unreported account, per year for a six-year period if you are non-willful. If you are determined to be willful, the penalties can reach 100% value of the foreign accounts, including many other fines and penalties… not the least being a criminal investigation.

Reporting Specified Foreign Assets – FATCA Form 8938

Not all foreign assets must be reported. With that said, a majority of assets do have to be reported on a form 8938. For example, if you have ownership of a foreign business interest or investment such as a limited liability share of a foreign corporation, it may not need to be reported on the FBAR but may need to be disclosed on an 8938.

The reason why you may get caught in the middle of whether it must be filed or not is due largely to the reporting thresholds of the 8938. For example, while the threshold requirements for the FBAR is when the foreign accounts exceed $10,000 in annual aggregate total – and is not impacted by marital status and country of residence – the same is not true of the 8938.

The threshold requirements for filing the 8938 will depend on whether you are married filing jointly or married filing separate/single, or whether you are considered a US resident or foreign resident.

Other Forms – Foreign Business

While the FBAR and Form 8938 are the two most common forms, please keep in mind that there are many other forms that may need to be filed based on your specific facts and circumstances. For example:

  • If you are the Beneficiary of a foreign trust or receive a foreign gift, you may have to file Form 3520.
  • If you are the Owner of a foreign trust, you will also have to file Form 3520-A.
  • If you have certain Ownerships of a foreign corporation, you have to file Form 5471.
  • And (regrettably) if you fall into the unfortunate category of owning foreign mutual funds or any other Passive Foreign Investment Companies then you will have to file Form 8621 and possibly be subject to significant tax liabilities in accordance with excess distributions.

Reporting Foreign Income

If you are considered a US tax resident (which normally means you are a US citizen, Legal Permanent Resident/Green-Card Holder or Foreign National subject to US tax under the substantial presence test), then you will be taxed on your worldwide Income.

It does not matter if you earned the money in a foreign country or if it is the type of income that is not taxed in the country of origin such as interest income in Asian countries. The fact of the matter is you are required to report this information on your US tax return and pay any differential in tax that might be due.

In other words, if you earn $100,000 USD in Japan and paid 25% tax ($25,000) in Japan, you would receive a $25,000 tax credit against your foreign earnings. Thus, if your US tax liability is less than $25,000, then you will receive a carryover to use in future years against foreign income (you do not get a refund and it cannot be used against US income). If you have to pay the exact same in the United States as you did in Japan, it would equal itself out. If you would owe more money in the United States than you paid in Japan on the earnings (a.k.a. you are in a higher tax bracket), then you have to pay the difference to the U.S. Government.

                           

3. Streamlined Foreign Offshore Disclosure

What do you do if you reside outside of the United States and recently learned that you’re out of US tax compliance, have no idea what FATCA or FBAR means, and are under the misimpression that you are going to be arrested and hauled off to jail due to irresponsible blogging by inexperienced attorneys and accountants?

If you live overseas and qualify as a foreign resident (reside outside of the United States for at least 330 days in any one of the last three tax years or do not meet the Substantial Presence Test), you may be in for a pleasant surprise.

Even though you may be completely out of US tax and reporting compliance, you may qualify for a penalty waiver and ALL of your disclosure penalties would be waived. Thus, all you will have to do besides reporting and disclosing the information is pay any outstanding tax liability and interest, if any is due. (Your foreign tax credit may offset any US taxes and you may end up with zero penalty and zero tax liability.)

*Under the Streamlined Foreign, you also have to amend or file 3 years of tax returns (and 8938s if applicable) as well as 6 years of FBAR statements just as in the Streamlined Domestic program.

                      

4. Reasonable Cause Statement

When a Person, Estate, or Business is out-of-tax compliance for failing to report Foreign Income and/or Foreign Assets, the applicant has relatively few options for timely and safely getting into tax and foreign reporting compliance — before fines and penalties are issued.

While the most common options include the Offshore Voluntary Disclosure Program or the Streamlined Offshore Disclosure Program, there is another alternative. It is called making a Reasonable Cause submission.

Reasonable Cause Process

An individual should never attempt offshore disclosure without the assistance of a qualified attorney. With that said, it is even more important to ensure that if you are even considering a reasonable cause submission, that you do so only with the help of an attorney. That is because only with an attorney do you receive the benefit of the attorney-client privilege.

Unlike the Streamlined Program or OVDP where there are strict procedures to be followed, a reasonable cause submission is different. It should be noted that a person can submit a reasonable cause application for any number of different reasons; it is not limited only to offshore money and reporting foreign accounts. It should also be noted that there are potentially high risks and penalties associated with this Reasonable Cause process, so you have carefully weigh your options. 

With a reasonable cause submission, the attorney will carefully evaluate and analyze the facts and circumstances of your case in detail. He or she should sit down with you either in person or via teleconference if you are non-local and assess the pros and cons of the potential submission in order to determine what the benefits and detriments may be to a reasonable cause disclosure. Thereafter the attorney will amend the returns, prepare the necessary forms, and draft a persuasive Reasonable Cause Letter.

At Golding & Golding, we are Tax Attorneys (with Masters of Tax Law) and Enrolled Agents credentialed by the IRS (Highest Credential awarded by the IRS), so we can handle your entire submission (Taxes, Legal, and Audit Defense) in-house, for a flat-fee.

Reasonable Cause Examples

If you were completely non-willful in your failure to disclosure and were unaware that there was any reporting requirement, then the thought of paying any penalty may sound absurd and you may consider Reasonable Cause as an alternative option.

Reasonable Cause is determined on a Case by Case basis in accordance with your specific facts and circumstances.

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