US Taxation of Spain Pension Plans

US Taxation of Spain Pension Plans

Spanish Pension Plan U.S. Tax Rules

The United States tax system treats certain foreign pensions differently than U.S.-based pension plans, such as 401K. In order to evaluate the taxation of foreign pensions — such as pensions from Spain — there are a few moving parts to consider.

      • Is there a Tax Treaty with foreign country?

      • Was the income earned as a U.S. Person or prior to becoming a U.S. Person?

      • Is there a Totalization Agreement with the foreign country?

      • Has the IRS issued any rulings or procedures involving the specific type of income

The U.S. has entered into multiple tax treaties with Spain, which generally means that the income earned in the pension will not be taxable to U.S. persons with Spanish pensions until after the income is distributed — but because Spain follows the 3-pillar pension systems, the IRS may take the position that certain income in Pillar 2 or Pillar 3 is taxable, even before it is distributed.

Reporting on FBAR, FATCA, 3520, and 8621

It is also important to note that beyond the US Taxation of Spain Pensions, Foreign pensions are also required to be reported on various IRS international reporting forms as well.

      • FBAR (FinCEN Form 114)

      • Form 8938 (FATCA)

      • Form 8621 (PFIC)

      • Form 3520 (Trust and Rev 2020-17 Exception)

We will summarize if a Spain Pension Plan is Taxable in the US, and how the reporting rules work.

The 3-Pillar Pension System in Spain

The pension plan system in Spain is a common three (3) Pillar structure. In accordance with the World Bank Pillar framework (which recently transitioned from a three-pillar to a five-pillar system), Spain’s pension system has three components:

      • Pillar 1: State Pension Scheme

      • Pillar 2: Occupational Pension

      • Pillar 3: Voluntary Private Savings

The U.S. Tax liability and IRS Reporting for the Spanish Pension of a U.S. Person will differ from how the pension is taxed in Spain. Generally, Pillar 1 is characterized as social security, while Pillars 2 and 3 are treated as “pension.”

First Pillar Public Pension (Social Security)

Social Security is mandatory in Spain. It involves contributions from both the employer and the employee. In Spain, the employer contributes 29.90%, while the employee contributes 6.35%. The total max out salary contribution rate is 4,070.10 EUR per month. As with most countries, there are some exceptions and limitations based on the totalization agreement, and self-employment status.

U.S & Spain Totalization Agreement

  • The U.S. and Spain have entered into a Totalization Agreement. It provides in pertinent part:

      • “While you work—If your work is covered by both the U.S. and Spanish Social Security systems, you (and your employer, if you are employed) would normally have to pay Social Security taxes to both countries for the same work. However, the agreement eliminates this double coverage so you pay taxes to only one system (see the section on “Coverage and Social Security taxes“).

      • When you apply for benefits—You may have some Social Security credits in both the U.S. and Spain but not have enough to be eligible for benefits in one country or the other. The agreement makes it easier to qualify for benefits by letting you add together your Social Security credits in both countries. For more details, see the section on”Monthly Benefits“.

      • Before the agreement, employees, employers and self-employed persons could, under certain circumstances, be required to pay Social Security taxes to both the United States and Spain for the same work.

      • Under the agreement, if you work as an employee in the United States, you normally will be covered by the United States, and you and your employer will pay Social Security taxes only to the United States. If you work as an employee in Spain, you normally will be covered by Spain, and you and your employer pay Social Security taxes only to Spain.

      • On the other hand, if your employer sends you from one country to work for that employer or an affiliate in the other country for five years or less, you will continue to be covered by your home country and you will be exempt from coverage in the other country. For example, if a U.S. company sends an employee to work for that employer or an affiliate in Spain for no more than five years, the employer and the employee will continue to pay only U.S. Social Security taxes and will not have to pay in Spain.

      • If you are self-employed and reside in the United States or Spain, you generally will be covered and taxed only by the country where you reside.”

Second Pillar Occupational Pension (Employment)

The Occupational Pension is provided by the employer.  In general, pillar 2 in Spain is funded through the employer and is limited to about $10,000 per year. If the insured is self-employed, they can establish their own pension through a local bank or financial institution.

Third Pillar Private Pension (Private)

The third pillar pension is a private and voluntary pension. There is no obligation for an employee to submit to the voluntary pension for Pillar 3.

Spain & US Tax Treaty Analysis

Let’s take a brief look at the tax treaty analysis:

1st Pillar Distributions

As provided by Article 20 of the U.S. Spain Tax Treaty, presuming that the 1st pillar is social security equivalent:

      • Subject to the provisions of Article 21 (Government Service):

      • (a) pensions and other similar remuneration derived and beneficially owned by a resident of a Contracting State in consideration of past employment shall be taxable only in that State; and

      • (b) social security benefits paid by a Contracting State to a resident of the other Contracting State or a citizen of the United States may be taxed in the first-mentioned State.

Presuming that the First Pillar is social security, then only the country paying the social security benefit can take the benefit (with an additional clarification for U.S. Citizens).

2nd Pillar: Occupational Pension

The 2nd Pillar is managed by the employer or by the self-employed, if applicable. The 2nd Pillar is equivalent to a 401K. It is not social security, as it is in addition to the 1st Pillar, and benefits can be paid out as a lump sum or annuity. In Switzerland, the pension it is mandatory, whereas the equivalent in the U.S. such as a 401K is not mandatory.

Are 2nd Pillar Contribution Payments Deductible?

Based on the treaty, there is no carve-out for pension contributions as deductible from income as there is in the UK treaty for example.

Are 2nd Pillar Distributions Payments Taxable in the U.S.?

As with most tax treaties, the taxation of pension income will be based primarily on the residence of the taxpayer.

3rd Pillar: Private Pension

Pillar 3 is self-funded and designed to further supplement Pillar 1 and 2 and contributions are not deductible from gross income.

Are 3rd Pillar Contribution Payments Deductible?

Based on the treaty, there is no carve-out for pension contributions as deductible from income.

Are 3rd Pillar Distributions Payments Taxable in the U.S.?

As with the 2nd Pillar, the taxation of pension income will be based primarily on the residence of the taxpayer.

Spain Pension Plan & FBAR

The FBAR Is used to report foreign bank and financial accounts, including life insurance and investment accounts. Generally, while Pillar 1 (Social Security) is not considered FBAR reportable — since it is equivalent to U.S. Social Security and not technically an account — the same cannot be said for other pillars.  Pillar 2 (Occupation) or Pillar 3 (Private) are reported on the FBAR since they are segregated accounts for each person who contributes, and the accounts have a separate identifier and value based on the contribution amounts.

FATCA Form 8938 & Spain Pension Plans

The IRS Form 8938 (FATCA)  form is required for certain U.S. Taxpayers to report specified foreign financial assets.  The FATCA reporting (for U.S. Taxpayers) was introduced on the 2011 tax returns and is technically referred to as the Foreign Account Tax Compliance Act.  Foreign Pension & Retirement is considered a foreign asset for FATCA purposes and therefore would be reportable on Form 8938.  Generally, the same rules would apply as for the FBAR, insofar as Pillar 1 may escape reporting, but Pillars 2 and 3 are reportable.

Form 3520/3520-A & Spain Pension Plan

Form 3520-A/3520 is used to report Foreign Trusts. At its most basic, a pension such as a Spanish Pension is a foreign trust:

      • Government Trustor (Pillar 1),

      • Employer Trustor (Pillar 2)

      • Investor/Employee (Pillar 3)

And, each trust has an Administrator, along with the employee beneficiary.

Thus, technically, the Spanish Pension is a Trust but Revenue Procedure 2020-17 may negate the filing requirement.

Form 8833

Form 8833 is used by Taxpayers who want to take a Treaty Position on issues involving the applicability of tax rules when it involves the pension (and other tax-related matters).

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.