Introduction – A small step for forms, one giant leap for “formkind”

It’s true. Many Americans abroad may no longer be required to file Form 3520 and Form 3520A to report their lives abroad! Early indications appear that many Americans will (assuming their retirement vehicle does qualify as a trust) not be required to report on Form 3520. This new initiative from Treasury a positive step in the right direction.

I have long thought that Treasury could solve many of the problems experienced by Americans abroad. Here is a wonderful example of Treasury taking the initiative to clarify the obvious:

Americans abroad do NOT use non-U.S. pension plans and non-U.S. tax-advantaged investing accounts to evade U.S. taxes. Hence, there is NO reason for the Form 3520 reporting requirement. This is an example of the tax compliance industry sitting down with Treasury, explaining a problem and getting a resolution. I suggest (and hope) that the same can be done for PFIC (Form 8621), Small Business Corporations (Form 5471) and other penalty-laden forms.

Yes, this announcement from Treasury in the form of RP 20-17 is a great achievement. Although it certainly doesn’t solve all the problems, it’s:

A small step for forms, one giant leap for “formkind”

The background to this problem – It starts in 1996 (same year as the beginning of the Exit Tax)…

Since 1996 Internal Revenue Code 6048 has required extensive reporting of almost any interaction with a foreign trust. Treasury has required that the reporting take place on Forms 3520 and 3520A. The forms are complex and subject to the draconian penalty regime described in Internal Revenue Code Section 6677. In order for an entity to be a foreign trust, it must be a trust. A “trust” for IRS purposes is defined by the Treasury Regulations as:

(a) Ordinary trusts. In general, the term “trust” as used in the Internal Revenue Code refers to an arrangement created either by a will or by an inter vivos declaration whereby trustees take title to property for the purpose of protecting or conserving it for the beneficiaries under the ordinary rules applied in chancery or probate courts. Usually the beneficiaries of such a trust do no more than accept the benefits thereof and are not the voluntary planners or creators of the trust arrangement. However, the beneficiaries of such a trust may be the persons who create it and it will be recognized as a trust under the Internal Revenue Code if it was created for the purpose of protecting or conserving the trust property for beneficiaries who stand in the same relation to the trust as they would if the trust had been created by others for them. Generally speaking, an arrangement will be treated as a trust under the Internal Revenue Code if it can be shown that the purpose of the arrangement is to vest in trustees responsibility for the protection and conservation of property for beneficiaries who cannot share in the discharge of this responsibility and, therefore, are not associates in a joint enterprise for the conduct of business for profit.

Americans abroad generally do (1) their retirement planning and (2) participate in pensions in other countries. In the same way that the United States has rules pertaining to retirement planning and pensions, other countries have their own systems, governed under their own laws. Because, Americans abroad are subject to taxation in both the United States and their country of residence, their retirement and pension plans are subject to both sets of laws. The application of the U.S. Internal Revenue Code has been an absolute nightmare for Americans abroad. They (and their tax preparers) don’t understand how the Internal Revenue Code applies to these “foreign” investment vehicles. This problem was accentuated in 2019 when the IRS levied a large number of $10,000 penalties (presumably by computer) on Americans who – by filing a Form 3520 and 3520A – were doing their level best to comply with U.S. laws. This problem was discussed at Tax Connections, in numerous (brilliant) posts by U.S. CPA Gary Carter. You will find Mr. Carter’s “Form 3520A Penalty Fundraiser Posts” (my quotes not his) here.

When faced with a non-U.S. retirement account or a tax advantaged savings/investment account it’s important to consider whether it’s a trust at all.

In simple terms, many Americans abroad filed Form 3520 to report their non-U.S. pensions and tax advantaged investment accounts. A Form 3520 includes a correlative Form 3520A requirement – the penalties were levied in relation to Form 3520A. In any event, a massive effort: publicized by Kat Jennings of Tax Connections and spearheaded by Gary Carter (and others) led to the IRS reversing the Form 3520A penalties. Credit goes to all involved AND to U.S. Treasury for recognizing it’s mistake and reversing the penalties. In other words, this success on behalf Form 3520A victims was the result of publicity, education and recognition of the root of the problem.

What was/is the root of the problem?

The problem was the combination of Internal Revenue Code 6048 (mandating the reporting requirements for Foreign Trusts) coupled with the IRS lack of guidance. In my view, certain tax advantaged investment plans (TFSA in Canada or ISA in the U.K.) were not trusts to begin with and therefore (although the income is taxable) there is no 3520 requirement. But, (like most things applying to Americans abroad) the law was/is not clear. Some tax preparers were taking (what they thought was) a conservative stance and filing Form 3520. What a mess. Some commenters suggested the obvious: Many Treasury should just make it clear that normal investment vehicles in the lives of Americans abroad were either not trusts or were subject to Form 3520.

Treasury does the “right thing”: Announces that Form 3520 (and From 3520A) will not not be required for many foreign pensions and for many foreign tax advantaged accounts!

What follows is an “over simplification” and you should consult your tax advisor, but in general Revenue Procedure 20 – 17 establishes the following

1. The first step is ALWAYS to consider whether the tax advantaged account or pension qualifies as a trust. If no trust then no 3520.

2. For certain (many) foreign pensions and tax advantaged financial accounts (which qualify as trusts) Form 35320 reporting will no longer be required

3. The end of the Form 3520 reporting has no bearing on the Income Tax aspects and other reporting aspects of these plans. Example: With or without a Form 3520 requirement TFSA income is still reportable as income to the U.S. taxpyayer. TFSAs and Foreign Pensions are still reportable on Form 8938. Obviously this has no impact on FBAR obligations. It means ONLY that Form 3520 and Form 35320A would not be required. (Frankly this is huge. It will save tax filers money and removes the threat of the draconian penalties.)

4. Those who have been assessed penalties under Internal Revenue Code Section 6677 will be able to apply for a refund of those penalties.

I will update these principles as necessary.

The devil is in the details – we need to read the text of Revenue Procedure 20-17. The full text of the Revenue Procedure is here:

rp-20-17

Here are the most relevant details supporting the conclusions above:

SECTION 4. SCOPE

Sections 3 and 6 of this revenue procedure apply to any eligible individual who,
but for this revenue procedure, is (or was) required to report a transaction with, or
ownership of, an applicable tax-favored foreign trust under section 6048.

SECTION 5. DEFINITIONS

.01 Applicable tax-favored foreign trust. For purposes of this revenue procedure,
an applicable tax-favored foreign trust means a tax-favored foreign retirement trust as
defined under section 5.03 of this revenue procedure or a tax-favored foreign nonretirement savings trust as defined under section 5.04 of this revenue procedure.

.02 Eligible Individual. For purposes of this revenue procedure, an eligible
individual means an individual who is, or at any time was, a U.S. citizen or resident
(within the meaning of section 7701(a)(30)(A)) and who, for any period during which an
amount of tax may be assessed under section 6501 (without regard to section
6501(c)(8)), is compliant (or comes into compliance) with all requirements for filing a
U.S. federal income tax return (or returns) covering the period such individual was a
U.S. citizen or resident, and to the extent required under U.S. tax law, has reported as
income any contributions to, earnings of, or distributions from, an applicable tax-favored
foreign trust on the applicable return (including on an amended return).

.03 Tax-Favored Foreign Retirement Trust. For purposes of this revenue
procedure, a tax-favored foreign retirement trust means a foreign trust for U.S. tax
purposes that is created, organized, or otherwise established under the laws of a
foreign jurisdiction (the trust’s jurisdiction) as a trust, plan, fund, scheme, or other
arrangement (collectively, a trust) to operate exclusively or almost exclusively to
provide, or to earn income for the provision of, pension or retirement benefits and
ancillary or incidental benefits, and that meets the following requirements established by
the laws of the trust’s jurisdiction.

(1) The trust is generally exempt from income tax or is otherwise tax-favored
under the laws of the trust’s jurisdiction. For purposes of this revenue procedure, a trust
is tax-favored if it meets any one or more of the following conditions: (i) contributions to
the trust that would otherwise be subject to tax are deductible or excluded from income,
are taxed at a reduced rate, give rise to a tax credit, or are otherwise eligible for another
tax benefit (such as a government subsidy or contribution); and (ii) taxation of
investment income earned by the trust is deferred until distribution or the investment
income is taxed at a reduced rate.

(2) Annual information reporting with respect to the trust (or of its participants or
beneficiaries) is provided, or is otherwise available, to the relevant tax authorities in the
trust’s jurisdiction.

(3) Only contributions with respect to income earned from the performance of
personal services are permitted.

(4) Contributions to the trust are limited by a percentage of earned income of the
participant, are subject to an annual limit of $50,000 or less to the trust, or are subject to
a lifetime limit of $1,000,000 or less to the trust. These contribution limits are
determined using the U.S. Treasury Bureau of Fiscal Service foreign currency
conversion rate on the last day of the tax year (available at
https://www.fiscal.treasury.gov/reports-statements/treasury-reporting-rates-exchange).

(5) Withdrawals, distributions, or payments from the trust are conditioned upon
reaching a specified retirement age, disability, or death, or penalties apply to
withdrawals, distributions, or payments made before such conditions are met. A trust
that otherwise meets the requirements of this section 5.03(5), but that allows
withdrawals, distributions, or payments for in-service loans or for reasons such as
hardship, educational purposes, or the purchase of a primary residence, will be treated
as meeting the requirements of this section 5.03(5).

(6) In the case of an employer-maintained trust, (i) the trust is nondiscriminatory
insofar as a wide range of employees, including rank and file employees, must be
eligible to make or receive contributions or accrue benefits under the terms of the trust
(alone or in combination with other comparable plans), (ii) the trust (alone or in
combination with other comparable plans) actually provides significant benefits for a
substantial majority of eligible employees, and (iii) the benefits actually provided under
the trust to eligible employees are nondiscriminatory.

A trust that otherwise meets the requirements of this section 5.03 will not fail to
be treated as a tax-favored foreign retirement trust within the meaning of this section
solely because it may receive a rollover of assets or funds transferred from another taxfavored foreign retirement trust established and operated under the laws of the same
jurisdiction, provided that the trust transferring assets or funds also meets the
requirements of this section 5.03.

.04 Tax-Favored Foreign Non-Retirement Savings Trust. For purposes of this
revenue procedure, a tax-favored foreign non-retirement savings trust means a foreign
trust for U.S. tax purposes that is created, organized, or otherwise established under the
laws of a foreign jurisdiction (the trust’s jurisdiction) as a trust, plan, fund, scheme, or
other arrangement (collectively, a trust) to operate exclusively or almost exclusively to
provide, or to earn income for the provision of, medical, disability, or educational
benefits, and that meets the following requirements established by the laws of the trust’s
jurisdiction.

(1) The trust is generally exempt from income tax or is otherwise tax-favored
under the laws of the trust’s jurisdiction as defined in section 5.03(1) of this revenue
procedure.

(2) Annual information reporting with respect to the trust (or about the beneficiary
or participant) is provided, or is otherwise available, to the relevant tax authorities in the
trust’s jurisdiction.

(3) Contributions to the trust are limited to $10,000 or less annually or $200,000
or less on a lifetime basis, determined using the U.S. Treasury Bureau of Fiscal Service
foreign currency conversion rate on the last day of the tax year (available at
https://www.fiscal.treasury.gov/reports-statements/treasury-reporting-rates-exchange).

(4) Withdrawals, distributions, or payments from the trust are conditioned upon
the provision of medical, disability, or educational benefits, or apply penalties to
withdrawals, distributions, or payments made before such conditions are met.

A trust that otherwise meets the requirements of this section 5.04 will not fail to
be treated as a tax-favored foreign non-retirement savings trust within the meaning of
this section 5.04 solely because it may receive a rollover of assets or funds transferred
from another tax-favored foreign non-retirement savings trust established and operated
under the laws of the same jurisdiction, provided that the trust transferring assets or
funds also meets the requirements of this section 5.04

You and your tax prepare will have to assess what this means for you.Like many aspects there will be winners and losers. You and your tax preparer will have to analyze whether your pension plans. It will be interesting to see how helpful this is for Americans abroad.

How does Revenue Procedure 20 – 17 apply to the Australian Superannuation?

An early report from Dr. Karen Alpert of Fix The Tax Treaty includes:

Thanks for your post on Revenue Procedure 20-17. This will, indeed, help many Americans Abroad. However, the requirements that Treasury has imposed on what they will consider a “qualified retirement trust” are too restrictive. Other countries don’t necessarily follow the US practice of severely limiting tax advantaged savings.

Superannuation does not meet their definition of “Tax-favored foreign retirement trust” because contributions can be made that are not connected with income from personal services (even though the vast majority of contributions are the required employer contribution of 9.5% of earnings) and annual contribution limits exceed USD50,000 (non-concessional contributions can be AUD100,000 per year). There is no lifetime limit on super, though the maximum benefit of tax free earnings in retirement can only be claimed for the first AUD1.6 million in the account. A lifetime limit of USD1million seems quite low to me, though it is contributions, not balance. Many countries have higher limits for those over 50 to allow them to catch up – will those higher limits mean that the whole system doesn’t qualify under this RevProc, even though the specific individual may not be old enough to use them?

So, while many countries’ retirement accounts may qualify, the US is deciding what they deem to be an appropriate tax concession and penalizing US citizens for living in countries that are more generous. Furthermore, defining limits in USD means that any country where the limits are close will qualify some years but not others due to currency fluctuation. It seems to me that the requirements of section 5.03 or 5.04 depend on the rules in the foreign jurisdiction, not taxpayer-specific facts. The IRS should issue an annual list of qualifying plans/jurisdictions to reduce taxpayer uncertainty.

John Richardson – Follow me on twitter @Expatriationlaw