Unwinding a Superannuation Social Security Tax Treaty Election

In recent years, it has become commonplace for taxpayers who are U.S. persons for tax purposes such as U.S. citizens, Lawful Permanent Residents, or foreign nationals who meet the substantial presence test to have worked in Australia and maintain one or more superannuation funds. Superannuation is similar to a 401K in the United States but also has similarities to Social Security as well. With that said, the IRS does not take the position that superannuation is the same as privatized social security so that the taxpayer does not have to report it on their tax returns. While the U.S. And Australia have entered a Tax Treaty, it predates the creation of the Australian superannuation laws. Thus, over the past few years, some tax professionals (and even some Attorneys) have convinced taxpayers to file Form 8833 to make a treaty election to treat Australian superannuation as privatized Social Security so that there was no reporting required on the FBAR, Form 8938, or Form 3520. And, if distributions were being received, these distributions were not taxable in the United States because Social Security is taxable only in the country of source (Australia). This is not a strong position, and many taxpayers are now very worried about their risk of fines and penalties.

The IRS Challenges the ‘Privatized Social Security Agreement’ Argument

The IRS does not take the position that Australian superannuation is equivalent to privatized Social Security. As a result, taxpayers who made these elections so that they did not report income if they received distributions or reported on the FBAR or Form 8938 — and possibly Form 3520 in situations (primarily) in which it is an SMSF — are rightfully concerned that they may become subject to significant fines and penalties.

How is Superannuation Treated (Generally)

In general, because Australia is a treaty country, most taxpayers take the position that superannuation is not taxable to a U.S. person until they begin to receive distributions. While the IRS can challenge this position, for the most part, they have not done so. What makes superannuation ambiguous is that there is no mention of superannuation in the Australia-U.S. tax treaty (the treaty pre-dates superannuation). In addition, there is a totalization agreement between the United States and Australia, which means if a taxpayer works in Australia for an Australian employer then generally they will only pay into the Australian Social Security system and not the United States system. In Australia, this is typically done by way of Superannuation Guarantee (SG) contributions that employers must make to retirement plans for their employees.

Did the Taxpayer make a Treaty Election and File Form 8833?

When taxpayers approach us in this type of environment, typically what happens is the taxpayer hires a tax professional and sometimes even a lawyer who tells them to take the position that their superannuation is not reportable for FBAR or Form 8938 — and if the taxpayer is receiving income distributions, that these distributions are not taxable. The election is made and then renewed each year, opening the taxpayer up to increased risks of examinations, fines, and penalties. Subsequently, the taxpayer no longer wants to take this position, but unwinding it is not that simple.

This is Different Than Electing to be a Foreign Person for Tax Purposes

The ‘Privatized Social Security Election’ is not a situation in which the U.S. person resides in a treaty country and elects to be treated as a foreign person for tax purposes. Instead, this is a situation in which the person is considered a U.S. person for tax purposes and elects that the superannuation is simply not taxable or reportable.

Is Super Social Security or Pension?

When comparing a superannuation to Social Security or a pension, it is clearly more similar to a pension than social security.

Why?

- - Taxpayers have their own separate accounts;
  - They may have multiple superannuations at different companies;
  - Each Superannuation account has a set amount of money in their superannuation;
  - Australia has its own social security system separate from superannation, and
  - if necessary, they can take out a lump sum.

Thus, the IRS does not take the position that this type of pension is similar enough to U.S. Social Security that the taxpayer can take the position that the Australian superannuation does not have to be reported because it is equivalent to Social Security. While the totalization agreement does cause some ambiguity, the IRS has never stated its position that Australian superannuation is the same as Social Security for U.S. income tax purposes. And, unless the U.S. government says that, then making a Form 8833 election puts the taxpayer in a precarious position.

Was the FBAR or Form 8938 Filed?

If the taxpayer was required to file the FBAR or Form 8938 but did not do so because they did not calculate the value of their superannuation, they could be considered non-compliant. Likewise, if the taxpayer did file the FBAR or Form 8938, but did not report the superannuation because they were counseled that this type of asset is not reportable, then there is an additional concern of willfulness versus non-willfulness which hinges in part on whether the reliance on a treaty election that the IRS does not expressly recognize is non-willful

* Form 3520 and Form 3520-A may be required in some situations, noting that Revenue Procedure 2020-17 along with the proposed foreign trust regulations may minimize the number of taxpayers we would have to file the forms 3520/ 3520-A

What Should Taxpayers Do Next?

For taxpayers who made this type of treaty election, oftentimes when it is determined that they will remain a U.S. person in the future, they do not want to continue making this type of election any further. Taxpayers who previously made this election may consider going back and submitting to one of the offshore disclosure programs or possibly making a reasonable cause submission to resolve the treaty issue and request a penalty waiver. It is important to note that taxpayers who are considering this position should do so before they are contacted by the IRS.

Late Filing Penalties May be Reduced or Avoided

For Taxpayers who did not timely file their FBAR and 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?**

When it comes to hiring an experienced international tax attorney to represent you for unreported foreign and offshore account reporting, it can become overwhelming for taxpayers trying to trek through all the false information and nonsense they will find in their online research. There are only a handful of attorneys worldwide who are Board-Certified Tax Specialists and who specialize exclusively in offshore disclosure and international tax amnesty reporting.

Golding & Golding: About Our International Tax Law Firm

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

Contact our firm today for assistance.