BI EDITED BY

DEPARTMENT
INTERNATIONAL

Alarming U.S. Tax

Rules and Information-
Reporting Duties for
Foreign Retirement
Plans: Problems and
Solutions
HALE E. SHEPPARD

The IRS generally taxes contributions to foreign plans, the accumulated yet
undistributed income in foreign plans, and distributions from foreign plans.
If the lack of tax deferral is not enough to get your attention, the long list of
information-reporting duties and the steep penalties for violations should.

More Americans than ever before will tributions to foreign plans, the accu-
have the chance to work abroad at mulated yet undistributed income in
some point in their careers. The re- foreign plans, and distributions from
sponsible ones will gain valuable pro- foreign plans. If the lack of tax deferral
fessional experience, learn the local is not enough to get your attention,
language, and save for the future, likely the long list of information-reporting
by participating in a foreign workplace duties and the steep penalties for vi-
retirement plan, which they believe olations should. Based on a recent
to be similar to a Section 401(k) plan study by the U.S. Government Ac-
in the United States. Putting money countability Office (“GAO Report”)
aside for old age can have unexpected criticizing the IRS and Congress for
downsides in the international context allowing the perpetuation of a com-
because most U.S. taxpayers, and way plex, obscure, and inconsistent system,
too many U.S. tax advisors, make the this article analyzes the surprising
crucial mistake of thinking that the rules for U.S. individuals with interests
IRS treats foreign retirement plans in foreign workplace retirement plans
just like domestic ones. It does not. and proposes solutions for solving un-
Indeed, the IRS generally taxes con- intentional violations. 1

HALE E. SHEPPARD, M.A., LL.M., LL.M.T., is a Shareholder in the Tax Controversy Section of
Chamberlain Hrdlicka and Chair of the International Tax Group. He specializes in tax audits, appeals,
and litigation, and international tax compliance and disputes. Mr. Sheppard is a frequent contributor
to the Journal. He can be reached at (404) 658-5441 or hale.sheppard@chamberlainlaw.com.

14 i J O U R N A L O F TA X AT I O N l O C TO B E R 2 0 1 8
Background income from the foreign savings account free. e U.S. accountant is concerned
on Schedule B; (4) claiming the foreign about a malpractice lawsuit, of course,
How does one get into a mess with the earned income exclusion on Form 2555 but is smart enough to comprehend that
IRS with respect to a foreign retirement (Foreign Earned Income); and (5) filing he should not compound his problems
plan? Here is a typical scenario. electronically an annual FinCEN Form so he contacts Ernie, explains the situ-
Expat Ernie, a U.S. citizen by birth, 114 (Report of Foreign Bank and Fi- ation, and recommends that he hire U.S.
gets a new job in and moves to a foreign nancial Accounts) (FBAR) to notify the international tax attorneys to analyze
country. On securing his first job there, IRS about the foreign savings account. the options for rectifying matters on the
he inquires about the company’s retire- e U.S. accountant believes mistak- best terms possible.
ment plan, arranges to contribute the enly that the foreign retirement plan is
maximum allowed each year to the similar to a Section 401(k) plan in the
plan, and opens a local savings account United States, such that Ernie will not Summary of Information-
to squirrel away yet more funds for his have any U.S. tax or reporting issues Reporting Duties
old age. until he starts receiving distributions U.S. individuals generally have three
Ernie retains tax advisors in the for- upon retirement. e accountant ex- main duties when they hold a reportable
eign country to confirm that the accu- plains this to Ernie, who, equally ignorant interest in a foreign financial account:
mulated yet undistributed income that about U.S. international tax matters, (1) check the “yes” box in Part III (For-
the plan generates is not subject to an- does nothing to reveal the foreign re- eign Accounts and Trusts) of Form 1040
nual taxes in the foreign country and tirement plan to the IRS for many years. Schedule B to disclose the existence
that he is generally not permitted to Ernie continues to make the maximum and location of the foreign account; (2)
withdraw funds from the plan until he annual contribution to the plan and the report the account on Form 8938 (State-
reaches the specified retirement age. e amount in the plan continues to grow ment of Specified Foreign Financial
local tax advisors verify his understand- thanks to contributions and gains on Assets), which is enclosed with Form
ings and help him file all necessary forms passive investments. 1040; and (3) file an FBAR electroni-
and make all necessary payments, either Ernie receives news that his parents cally.2 If the U.S. person holds an interest
directly or through withholding, to en- have serious medical problems and de- in a foreign workplace retirement plan,
sure full tax compliance in the foreign cides to return to the United States. He he likely will need to file additional in-
country. resigns from the foreign company, closes ternational information returns with
Intent on maintaining U.S. tax com- his foreign account and transfers the the IRS.
pliance while abroad, Ernie also consults funds back to a U.S. account, and as- Below is an overview of the main in-
with his accountant back in the United sumes that he can simply move the large formation-reporting duties of U.S. in-
States and provides him with all the rel- balance in the foreign retirement account dividuals with foreign workplace
evant data about his new job, retirement as a tax-free transfer (rollover) to an ex- retirement plans. is initial information
plan, and savings account. e U.S. ac- isting Section 401(k) plan or IRA. Ernie is important because one must under-
countant lacks extensive experience with consults with his U.S. accountant to val- stand these duties before appreciating
international tax matters but does his idate his understanding about the U.S. the problems and solutions discussed
best to help Ernie adhere to all U.S. rules tax effect of the proposed transfer. in this article.
by (1) filing timely Forms 1040 (U.S. In- is question is novel to the U.S. ac-
dividual Income Tax Return) reporting countant so he does some research and Form 1040—duty to report foreign
the wages from the foreign company; aer a few clicks realizes that Ernie has accounts and related income
(2) disclosing the existence and location violated U.S. tax law inadvertently with Part III of Form 1040 Schedule B con-
of the foreign savings account on Form respect to his foreign retirement plan tains an FBAR inquiry and a cross-ref-
1040 Schedule B (Interest and Ordinary and that he cannot transfer the funds erence. e IRS has modified and
Dividends); (3) reporting the interest to a Section 401(k) plan or an IRA tax expanded this language slightly over the
NOTES
years, with the 2017 Schedule stating
1
U.S. Government Accountability Office (GAO), Report Foreign Financial Assets on Form 8938: the following:
“Workplace Retirement Accounts: Better Guid- Demystifying the Complex Rules and Severe At any time during 2017, did you
ance and Information Could Help Plan Partici- Consequences of Noncompliance,” 38(3) Int’l Tax have a financial interest in or a signa-
pants at Home and Abroad Manage Their Re-
J. 11 (2012); Sheppard, “Form 8938 and Foreign ture authority over a financial
tirement Savings,” GAO-18-19 (1/31/2018),
www.gao.gov/products/GAO-18-19 (“GAO Re- Financial Assets: A Comprehensive Analysis of account (such as a bank account,
port”). See also Murthy, “Selected Cross-Border the Reporting Rules After IRS Issues Final Reg- securities account, or brokerage
Equity and Deferred Compensation Issues With ulations,” 41(2) Int’l Tax J. 25 (2015); Sheppard, account) located in a foreign country?
Fund Foreign Plans,” 42 Comp. Planning J. 67 “Specified Domestic Entities Must Now File Form See instructions.
(April 2014); Chastang and Yeager, “Foreign 8938: Section 6038D, New Regulations in 2016,
Pensions and Florida Practitioners,” Florida CPA
and Expanded Foreign Financial Asset Report- If “Yes,” are you required to file Fin-
Today (May/June 2013); Blum, “Migrants with
Retirement Plans: The Challenge of Harmoniz- ing,” 42(3) Int’l Tax J. 5 (2016); and Sheppard, CEN Form 114, Report of Foreign
ing Tax Rules,” 17(1) Florida Tax Review (2015). “Unlimited Assessment Period for Form 8938 Vi- Bank and Financial Accounts
2
For a detailed analysis of the Form 8938 filing olations: Ruling Shows IRS’s Intent to Attack (FBAR), to report that financial inter-
requirement, see Sheppard, “The New Duty to Multiple Tax Returns,” 95(5) Taxes 31 (2017). est or signature authority? See Fin-

I N T E R N AT I O N A L O C TO B E R 2 0 1 8 l J O U R N A L O F TA X AT I O N i 15
 CEN Form 114 and its instructions reasonably necessary” to enforce the For Form 8938, an SP generally holds
for filing requirements and excep- FBAR rules. 7 an interest in an SFFA if any income,
tions to those requirements. Congress enacted new FBAR penalty gains, losses, deductions, credits, gross
If you are required to file a FinCEN provisions in 2004.8 e IRS may now proceeds, or distributions attributable
Form 114, enter the name of the for- penalize any U.S. person who fails to file to the holding or disposition of the SFFA
eign country where the financial an FBAR when required, period. 9 For are (or should be) reported, included,
account is located. non-willful violations, the maximum or otherwise reflected on the SP’s annual
penalty is $10,000, but the IRS cannot tax return.14 e Regulations clarify that
FBAR—duty to report assert this penalty if the violation was an SP has an interest in the SFFA even
foreign financial accounts due to “reasonable cause.”10 Higher penal- if no income, gains, losses, deductions,
Congress enacted the Bank Secrecy Act ties apply when willfulness exists. Specifi- credits, gross proceeds, or distributions
in 1970. 3 One purpose was to require cally, when a taxpayer deliberately fails are attributable to the holding or dis-
the filing of certain reports, like the to file an FBAR, the IRS can assert a position of the SFFA for the year in
FBAR, when doing so would help the penalty equal to $100,000 or 50% of the question.15 e Regulations also indicate
U.S. government carry out criminal, balance in the account at the time of the that an SP must file a Form 8938 even
tax, and regulatory investigations.4 e violation, whichever is larger. 11 Given though none of the SFFAs that must be
relevant statute, in conjunction with the astronomical balances in some un- reported affect the U.S. tax liability of
the corresponding regulations and reported accounts, FBAR penalties can the SP for the year. 16
FBAR instructions, generally require be enormous. For purposes of Section 6038D, SFFA
the filing of an annual FBAR when (1) includes two major categories: foreign
a U.S. person, including U.S. citizens, Form 8938—duty to report financial accounts 17 and other foreign
U.S. residents, and domestic entities, foreign financial assets financial assets that are held for invest-
(2) had a direct or indirect financial in- Section 6038D, which mandates the fil- ment purposes.18 e concept of “finan-
terest in, or signature or some other ing of Form 8938, was enacted as part cial account” for purposes of Form 8938
type of authority over, (3) one or more of the Foreign Account Tax Compliance is complicated for several reasons, one
financial accounts (4) located in a for- Act (FATCA).12 e general rule can be of which is that the definition is not
eign country (5) the aggregate value of divided into the following parts: (1) any found in the applicable statute, Section
which exceeded $10,000 (6) at any point specified person (SP), which term now 6038D, or the corresponding Regula-
during the year at issue. 5 includes U.S. citizens, U.S. residents, tions. Instead, it is in the Code’s inter-
Concerned with widespread FBAR certain domestic entities, and others (2) national tax withholding provision,
noncompliance, the U.S. government who/that holds an interest (3) during Section 1471, and its ultra-dense Reg-
has taken action in recent years. No- any portion of a tax year (4) in a specified ulations.19 For purposes of this article,
tably, Treasury transferred authority foreign financial asset (SFFA) (5) must it suffices to confirm that the tax-favored
to enforce FBAR duties to the IRS in attach to a timely tax return (6) a com- foreign retirement accounts and foreign
2003. 6 The IRS has been empowered plete and accurate Form 8938 (7) if the pension accounts are generally treated
since then to investigate potential total value of all SFFAs (8) is more than as “financial accounts” on Forms 8938.20
FBAR violations, issue summonses and the applicable filing threshold.13 Notably, even if these retirement items
administrative rulings, assess civil Holding an interest in an asset means have been excluded from the definition
penalties, and take “any other action different things in different contexts. of “financial account” under an inter-
NOTES
3 12
P.L. 91-508, Title I and Title II (10/26/1970). P.L. 111-147, Hiring Incentives to Restore Employ- created; (2) the transferor in cases involving a
4
Id. section 202. ment Act (3/18/2010), section 511. “reportable event,” other than a transfer by rea-
13
5
31 U.S.C. section 5314; 31 C.F.R. section Section 6038(a). son of death; and (3) the executor of a dece-
1010.350(a).
14
Reg. 1.6038D-2(b)(1). dent’s estate.
26
6
68 Fed. Reg. 26489 (May 16, 2003).
15
Id. Section 6048(c)(1).
16 27
7
31 C.F.R. section 103.56(g), 68 Fed. Reg. 26489 Reg. 1.6038D-2(a)(8). Section 6677(a).
17 28
(May 16, 2003). Section 6038D(b)(1); Reg. 1.6038D-3(a)(1). Section 6677(d).
8 18 29
American Jobs Creation Act. P.L. 108-357 Section 6038D(b)(2); Reg. 1.6038D-3(b)(1). Section 6048(b)(1). The grantor trust rules are in
(10/22/2004). 19
Reg. 1.6038D-1(a)(7). Sections 671-679.
9 30
31 U.S.C. section 5321(a)(5)(A). 20
Regs. 1.1471-5(b)(2)(i)(A), (B), and (D); See also Section 678(a)(1).
10
31 U.S.C. section 5321(a)(5)(B)(ii). Reg. 1.6038D-3(a)(7). 31
Section 679(a)(1).
11 21
31 U.S.C. section 5321(a)(5)(C)(i). As of May 2018, See Reg. 1.1471-5(b)(2)(vi); Reg. 1.6038D-1(a)(7); 32
Section 6677(b).
there was uncertainty regarding the maximum Preamble, 76 Fed. Reg. 73819-73820 (12/12/2014); 33
Section 6677(d).
FBAR penalty, as a district court issued an opin- instructions to Form 8938 (October 2015), page 5. 34
ion stating that the willful FBAR penalty was 22 Section 6114(a); Regs. 301.6114-1(a)(1), (d)(1).
Section 6038D(d)(1); Reg. 1.6038D-8(a). 35
capped at $100,000 per violation because the 23 Section 6712(a); Reg. 301.6712-1(a).
Section 6038D(d)(2); Reg. 1.6038D-8(c).
IRS failed to update the operable Regulations 36
24
Section 6038D(g); Reg. 1.6038D-8(e)(1). Id.
after Congress amended the law to increase 37
penalties. See Colliot, Cause No. AU-16-CA-
25
Sections 6048(a)(1) and (4). “Responsible party” Section 6712(b); Reg. 301.6712-1(b).
38
01281-SS (DC TX, 5/16/2018). means (1) the grantor when an inter vivos trust is GAO Report, page 3.

16 i J O U R N A L O F TA X AT I O N l O C TO B E R 2 0 1 8 I N T E R N AT I O N A L
governmental agreement between the reportable amount,” whichever is larger.27 existed during 2017, you may have
United States and a foreign country to However, the IRS will not assert penalties to file Form 3520. Don’t attach Form
implement FATCA, they will still be when there is “reasonable cause” for the 3520 to Form 1040. Instead, file it at
the address shown in its instruc-
considered “financial accounts” for pur- violation.28 tions. If you were treated as the own-
poses of Form 8938. In other words, er of a foreign tr ust under t he
while certain foreign governments and Form 3520-A. Form 3520-A normally grantor trust rules, you are also
financial institutions are not required must be filed if, at any time during the responsible for ensuring that the for-
to provide data to the IRS pursuant to relevant year, a U.S. person is treated as eign trust files Form 3520-A. Form
FATCA about certain retirement-type the “owner” of any portion of the foreign 3520-A is due on March 15, 2018,
accounts, U.S. individuals holding these trust under the grantor trust rules.29 A for a calendar year trust. See the
instructions for Form 3520-A for
accounts will not benefit from such an person other than the grantor is treated more details.
accommodation.21 as the owner of any portion of a trust
If an SP fails to file the Form 8938 with respect to which he has “a power
timely, the IRS generally will assert a exercisable solely by himself ” to vest the Form 8833—duty to report
penalty of $10,000 per violation.22 The assets or income from the trust in positions taken pursuant to treaty
penalty increases to a maximum of himself.30 Moreover, a U.S. person who Taxpayers taking a position that a U.S.
$50,000 if the SP does not rectify the transfers property, directly or indirectly, tax treaty overrules or otherwise mod-
problem quickly after contact from to a foreign trust will generally be treated ifies U.S. tax law generally must reveal
the IRS. 23 An SP who unintentionally
fails to file a timely, accurate, complete
Form 8938 can avoid penalties if the
SP can demonstrate that the violation
was due to reasonable cause and not
willful neglect. 24
i IRS may now penalize any U.S. person
who fails to file an FBAR when required,
period—given the astronomical balances
in some unreported accounts, FBAR
Forms 3520 and 3520-A: penalties can be enormous.
duty to report foreign trusts
Taxpayers must file a Form 3520 (Annual
Return to Report Transactions With as the owner during the year of the such position to the IRS on Form 8833
Foreign Trusts and Receipt of Certain transfer for his portion of the trust (Treaty-Based Return Position Disclo-
Foreign Gis) or Form 3520-A (Annual attributable to such property if there is a sure).34 Corporate taxpayers that fail to
Information Return of Foreign Trust U.S. beneficiary of any portion of such disclose treaty-based return positions
With a U.S. Owner), or both, in certain trust.31 are subject to a penalty of $10,000 for
situations involving foreign trusts. e normal penalty for Form 3520- each violation. 35 e penalty for indi-
A violations is the higher of $10,000 or vidual taxpayers is lower, at $1,000 per
Form 3520. In the context of foreign 5% of the “gross reportable amount.”32 omission.36 However, the IRS will waive
trusts, Form 3520 generally must be Penalties will not be asserted when there the penalty if the taxpayer shows that
filed in two circumstances. First, the is “reasonable cause” for the violation.33 there was reasonable cause, the taxpayer
responsible party generally must file a acted in good faith, and the failure was
Form 3520 within 90 days of certain Foreign trust issues on Form 1040. Part not due to willful neglect.37
“reportable events,” such as the creation III to Form 1040 Schedule B presents
of any foreign trust by a U.S. person; the following question about foreign
the transfer of any money or other trusts: GAO Report
property (directly or indirectly or During 2017, did you receive a distri- Identifies Numerous
constructively) to a foreign trust by a bution from, or were you the grantor Reporting Problems
of, or transferor to, a foreign trust? If
U.S. person; and the death of a U.S. e U.S. tax and information-reporting
“Yes,” you may have to file Form 3520.
person if the decedent was treated as See instructions on back. problems of U.S. persons with foreign
the “owner” of any portion under the retirement instruments are well docu-
grantor trust rules, or if any portion of e instructions to Schedule B ex- mented in the GAO report issued in
the foreign trust was included in the pand on the foreign trust concept: January 2018.38
decedent’s gross estate.25 Second, a U.S. If you received a distribution from a
person ordinarily must file a Form 3520 foreign trust, you must provide addi- Distinct U.S. tax treatment
tional information. For this purpose,
if he receives during a year (directly or of domestic and foreign plans
a loan of cash or marketable securi-
indirectly or constructively) any ties generally is considered to be a e GAO Report starts by underscoring
distribution from a foreign trust.26 distribution. See Form 3520 for the size of the problem: there are nearly
e penalty for not filing a Form 3520 details. If you were the grantor of, or nine million U.S. citizens living abroad,
is equal to $10,000 or 35% of the “gross transferor to, a foreign trust that many of whom have interests in local

I N T E R N AT I O N A L O C TO B E R 2 0 1 8 l J O U R N A L O F TA X AT I O N i 17
 retirement instruments. It then describes confirms the IRS positions that foreign foreign financial accounts on FBARs
the distinct way that the U.S. tax system workplace retirement plans are not gen- and Forms 8938, while still others suggest
treats domestic versus foreign retirement erally considered “qualified” plans for that they should be treated as foreign
plans. e GAO Report says that, in the U.S. tax purposes and thus are not en- trusts and reported on Forms 3520 and
United States, contributions by employ- titled to the corresponding tax benefits. 3520-A.44
ees, contributions by employers, and e GAO Report says in this regard: To exacerbate matters, the GAO Re-
passive earnings (such as interest, div- IRS officials told us that U.S. tax law port, citing warnings from the National
idends, and capital gains) within a “qual- generally does not recognize foreign Taxpayer Advocate, says that the IRS
retirement plans as tax-qualified and
ified” retirement plan generally are not might abate penalties related to erro-
IRS does not recognize any retire-
taxed until the employee receives actual ment accounts outside the United neous treatment of foreign plans in sit-
distributions from the plan.39 States as having tax-qualified status. uations involving reasonable reliance
By contrast, the GAO Report says IRS officials we spoke to said that by a taxpayer on a qualified, informed,
that foreign workplace retirement plans only plans meeting the specific U.S. tax professional. However, “receiving
are not ordinarily considered “qualified” requirements of [Section] 401(k) or incorrect tax advice from a foreign tax
plans under the Internal Revenue Code, other requirements describing retire- preparer may not be a sufficient miti-
ment plan qualification may achieve
so American expatriates working as em- tax-qualified status in the United
gating circumstance to avoid penalties
ployees do not receive the same benefits States. As a result, according to IRS for reporting a foreign retirement ac-
as their counterparts with “qualified” guidance, U.S. individuals participat- count incorrectly on a tax return [be-
domestic plans. Depending on several ing in foreign workplace retirement cause] tax preparers in other countries
factors, including the characteristics of plans generally cannot deduct contri- are usually not considered qualified pre-
the plan, local law, and the provisions butions to their account from their parers by IRS.”45 e GAO Report also
in the applicable bilateral treaty, U.S. in- income on their U.S. tax return. is says that the IRS sticks to its normal
is true even if the retirement account
dividuals who participate in foreign re- is considered a tax-deferred retire- mantra when it comes to international
tirement plans might be taxed currently ment account in the country where tax issues, which is that taxpayers are
on (1) contributions to the plans, by the individual works, and even if the ultimately liable for getting things right,
themselves or their employers; (2) the account is similar in nature to those notwithstanding the complexity of the
accrued-but-undistributed earnings in found in a U.S.-type retirement plan, issues, lack of IRS guidance, and the
the plans; and (3) distributions from the such as a [Section] 401(k) plan.43 confusion among tax professionals about
plans that they have not actually received, how to treat foreign retirement plans:
such as transfers of assets between or Everybody has an opinion, and this “IRS officials told us that individual tax-
among various foreign plans.40 is certainly true in the tax community, payers are responsible for understanding
fueled too oen by unfounded theories their filing requirements and for deter-
IRS guidance is insufficient and unclear posted on endless blogs, chat rooms, mining how to correctly file their tax
e GAO Report acknowledges that the webpages, client alerts, and the like. Such returns, regardless of whether they live
IRS has provided some limited guidance a high rate of information dissemination, in a foreign country or the United
about foreign workplace retirement plans, coupled with the lack of clarity from the States.”46
such as the International Tax Gap Series IRS, has created disagreement among
and Publication 54 (“Tax Guide for U.S. U.S. tax practitioners about how to treat Transfers generally trigger
Citizens and Resident Aliens Abroad”). foreign plans. According to the GAO immediate taxation
However, the GAO Report says that nei- Report, some practitioners advise their A major issue that the GAO Report ad-
ther of these “describes in detail how tax- clients to report them as passive foreign dressed, but one unknown to many U.S.
payers are to determine if their foreign investment companies (PFICs) on Forms individuals and tax practitioners, is that
workplace retirement plan is eligible for 8621 (Return by U.S. Shareholder of a changing jobs and transferring (“rolling
tax-deferred status, or how to account for Passive Foreign Investment Company). over”) savings from one foreign workplace
contributions, earnings, or distributions Others recommend disclosing them as retirement plan to another likely triggers
on their annual U.S. tax return, particularly
NOTES
whether and when contributions and 39
Id. pages 11-12.
50
Id.
earnings should be taxed as income.”41 40
Id. pages 12-14. 51
Id. page 50.
e GAO Report also indicates that, while 41
Id. page 37. 52
Id.
the IRS directs taxpayers to review the 42
Id. 53
Id. page 51.
relevant bilateral tax treaties for any pro- 43
Id. pages 38-39. 54
Id. page 52.
visions related to foreign pensions, even 44
Id. 55
Id.
45
IRS officials admit that “these treaties can Id. page 39. 56
Id. page 53.
46
vary from country to country and … can Id. pages 39-40. 57
Id. pages 55-56.
47
be difficult for nonexperts to understand.”42 Id. page 46. 58
See “Foreign Retirement Account Is Subject to
48
Consistent with IRS rulings discussed Id. pages 47-48. OVDP Penalty,” 2017 WTD 224-26 (Tax Ana-
49
elsewhere in this article, the GAO Report Id. page 49. lysts), 11/21/2017.

18 i J O U R N A L O F TA X AT I O N l O C TO B E R 2 0 1 8 I N T E R N AT I O N A L
immediate U.S. taxation.47 e IRS ac- cials said, there is no way that the plan that the IRS provide clear guidance about
knowledges that such movements of money can structure the transfer to prevent U.S. tax and information-reporting re-
generally do not undermine tax-deferred the U.S. individual who is transferring quirements to minimize the compliance
assets within or between foreign plans
status in the foreign country where the from receiving a distribution and
burden and avoid unintentional
plan is located, but this does not alter that being subject to tax liability. Even in violations.54 Second, it proposed that the
the U.S. tax system views it differently: cases where a tax treaty is in place, the IRS conduct a systematic analysis of data
IRS officials told us the [Internal Rev- treaty may not provide special treat- about foreign retirement plans now dis-
enue Code] does not recognize for- ment for the transfer of retirement closed on Form 8938 to determine
eign retirement plans as tax-qualified assets. is would be the case in at whether it would be appropriate to waive
plans, and because these plans are not least two of the five case study loca-
able to meet the criteria for qualifica- such information-reporting duty in the
tions we examined, where despite a
tion, tax-deferred transfers or tax treaty in place, we were unable to future.55 ird, it suggested that Congress
rollovers may not be possible, unless identify any provisions that address consider assisting U.S. individuals who
a tax treaty provides otherwise. IRS these types of transfers. In these cases, participate in foreign workplace retirement
generally considers routine adminis- according to IRS, the U.S. individual plans by allowing them to be treated as
trative transfers of retirement assets must fall back on the [Internal Rev- “qualified” retirement plans in the United
that occur between or within foreign enue Code], which does not provide
retirement plans to be distributions to
States, such as a Section 401(k) plan.56
tax-deferral on such transfers. As a
the participant and therefore taxable e IRS did not agree with everything
result, a U.S. individual who partici-
income…. [T]he transfers would gen- in the GAO Report but there were some
erally constitute a “constructive receipt
of funds” by the participant and would
be reportable and taxable. As a result,
a U.S. individual who participates in
a foreign retirement plan could owe
U.S. tax on the entire amount of their
i The concept of “financial account”
for Form 8938 purposes is complicated
for several reasons, one of which is that
the definition is in Section 1471 and its
retirement savings when they separate
from their employer and their ultra-dense Regs.
account is transferred to another
account within the plan or to a differ-
ent workplace retirement plan.48 pates in a foreign workplace plan positive signs for taxpayers, perhaps the
would lose any tax-deferrals on the most important of which is the following:
e GAO Report says that Treasury transfer.51 IRS also stated that U.S. individuals par-
officials have been aware of this issue for ticipating in foreign retirement plans
oen do not know how to correctly
many years, raised it during treaty nego- Solutions are sparse, at least in the
report foreign retirement accounts and
tiations with other countries, and included short term. e GAO Report points out associated income due to complex fed-
in the most recent U.S. model income that renegotiating a tax treaty is a slow eral requirements and treaty provisions
tax treaty a clause that would generally process and generally will not occur to governing the taxation of foreign retire-
exempt from immediate U.S. income tax rectify just one issue, such as the U.S. ment accounts …IRS agreed with our
transfers between foreign workplace re- tax treatment of foreign workplace re- recommendation to clarify how U.S.
tirement plans, provided that such trans- tirement funds.52 It suggests that the best individuals are to report their foreign
retirement accounts, which could
fers preserve tax-deferred status under way to provide “more immediate relief ” include how the taxpayer should report
local law.49 Positive news indeed, but the would be to have Congress enact appro- contributions, earnings, and distribu-
reality remains that, as of today, many priate legislation. Unless and until that tions made from the account.57
countries lack tax treaties with the United occurs, the Report says that “U.S. indi-
States or they have outdated treaties that viduals who participate in foreign work-
do not address specifically the impact on place retirement plans must follow
U.S. individuals of making transfers current law, which does not provide tax Examples of IRS Treatment
among retirement plans.50 e GAO Re- deferral for transfers within or between of Foreign Retirement Plans
port contains more detail about the U.S. foreign plans, even those that may be e GAO Report painted a bleak picture
tax effects under current law lest anyone eligible for tax-deferred contributions for U.S. individuals with foreign work-
be unclear about the harshness: and earnings in the foreign jurisdiction.”53 place retirement accounts. Lest anyone
IRS officials told us that if no treaty think that hyperbole was involved, a
exists between the United States and Suggestions and future actions couple of examples are examined below.
the country where the U.S. individual
e GAO Report contained several sug-
is participating in a foreign workplace
retirement plan, or the treaty does not gestions, three of which focused on the Swiss retirement plans
specify how to treat these transfers, complexity of international tax compliance e IRS released a legal memo in No-
there is generally no form of transfer and the perceived unfairness of U.S. tax vember 2017 dealing with retirement
that will receive U.S. income tax- treatment of foreign workplace retirement instruments in Switzerland.58 e tax-
deferral. In these situations, IRS offi- plans. First, the Report recommended payer in the memo:

I N T E R N AT I O N A L O C TO B E R 2 0 1 8 l J O U R N A L O F TA X AT I O N i 19
 • Worked in the United States and cludes that “[t]he facts of this case are of Australian superannuation funds
had an employer-established U.S. sympathetic in that the rules relating to by the United States amounts to dou-
pension. foreign pension accounts are not intu- ble taxation; Australian superannua-
tion funds are already taxed, albeit at
• Was terminated from her job and itive, and we anticipate that the taxpayer’s different intervals and different time
accepted a new position and representatives will not be pleased with frames than retirement funds in the
moved to Switzerland. the conclusion in this memorandum.” United States.60
• Transferred the funds from the
U.S. pension to a Swiss “libre pas- Australian retirement plans Based on the available data, it appears
sage” account (which she argued U.S. individuals with Australian retire- that neither Congress nor the IRS is
was analogous to a tax-deferred ment plans have fared no better than heeding the call for change. In 2017, the
IRA in the U.S.). those in Switzerland. Taxpayers and IRS was obligated to release a portion
• Did not report on Forms 1040 any practitioners have sought guidance and of the written guidance that it provides
accumulated but undistributed a remedy from the IRS for many years to personnel tasked with answering calls
gain within the Swiss retirement with respect to a common retirement from taxpayers on the “voluntary dis-
account or any distributions from vehicle, the Australian Superannuation closure hotline.”61 e IRS guidance in-
the account. Fund (ASF), by sending letters under- structs personnel to say the following
• Presumably did not report the ac- scoring the inconsistent tax treatment with respect to ASFs: (1) unlike certain
count on all necessary U.S. inter- by the U.S. and Australian tax authorities, retirement plans in Canada, ASFs are
national information returns and the lack of specific language in the not covered by a favorable treaty pro-
including Form 8938 and FBAR. U.S.-Australia treaty to correct the issue.59 vision; (2) the IRS’s voluntary disclosure
e IRS concluded the following in One letter from the American Chamber programs do not have special provisions
the memo: of Commerce in Australia sums up the for ASFs; (3) the highest value of ASFs
1. e transfer from the U.S. pension issues (and the outrage) nicely: that are not compliant with U.S. tax or
to the Swiss libre passage account I have recently been advised that information-reporting obligations will
was not a tax-free, qualified rollover, under current treaty arrangements be subject to the “offshore” penalty; and
the annual income of my Australian
such that the taxpayer should have (4) ASFs must be reported on various
superannuation funds is subject to
been taxed on the total amount re- 39.6% U.S. tax (in excess of $21,000 international information returns in-
located. AUS for my 2013 return). As Aus- cluding, but not limited to, Forms 3520
2. e taxpayer should have reported tralian taxpayers are not able to draw and 3520-A related to foreign trusts.
on her annual Forms 1040 all accu- on their superannuation funds to pay
mulated but undistributed gains U.S. tax before they reach preserva-
within the account and all distribu- tion age, this can cause significant Ability to Standardize U.S.
tions from the account.
financial hardship. In addition to U.S. Tax Treatment of Foreign
3. e U.S.-Switzerland tax treaty “pro-
taxation of the annual income of Aus-
tralian superannuation funds, there Retirement Plans
vides no exceptions or relief.” is U.S. taxation on the transaction e situations above involving Switzer-
4. Because the Swiss libre passage ac- when they roll over into an allocated land and Australia illustrate what can
count was not in compliance with pension stream and taxation on the happen when a U.S. individual has an
U.S. law, the taxpayer must include annual annuity/pension, thus causing interest in a workplace retirement plan
the highest value of the account in further financial strain. e treaty in a foreign country that does not have
does not recognize that Australian
the “offshore” penalty calculation as superannuation funds meet Aus- a favorable treaty with the United States.
part of her participation in a volun- tralian regulatory requirements and It is critical, though, that when the United
tary disclosure program with the IRS. are similar in purpose and structure States and a foreign country put their
In what tax practitioners might label to American retirement funds which collective minds to it, they are capable
as one the biggest understatements in are not similarly taxed. Nor does it of inserting provisions in a treaty that
recent memory, the legal memo con- account for the fact that the taxation essentially standardize U.S. tax treatment
of workplace retirement plans, foreign
NOTES

59 64
and domestic. One example is the treaty
“Remedy Sought for Taxation of Retirement Section 6501(c)(8)(B) contains a limitation—the
Funds in Australia,” 2016 Tax Notes Today 178-29 assessment period will remain open only with re-
with the United Kingdom, the relevant
(Tax Analysts), 8/26/2016. spect to “the item or items” related to the late in- aspects of which are summarized below.62
60
“Dual Citizen Concerned about Australian Su- ternational information return if the taxpayer can Article 18 of the treaty deals with is-
perannuation Funds,” 2014 Tax Notes Today 166- demonstrate that the delinquency was due to
14 (Tax Analysts), August 11, 2014. reasonable cause and not willful neglect.
sues related to “pension schemes.” Before
61
“IRS Releases OVDP, Streamlined Program Hot- 65
This article discusses only the five main methods
analyzing the substantive rules in Article
line Guide,” 2017 WTD 160-16 (Tax Analysts), Au- that the IRS has approved publicly. Taxpayers 18, it is first necessary to define the key
gust 21, 2017. use other techniques, such as making a “quiet term. e definition of “pension scheme”
62
See Treasury Technical Explanation of the U.S.- disclosure” with the IRS, doing nothing, and be-
UK treaty and related report by the Joint Com- ginning U.S. tax compliance in future years only.
is in Article 3(1)(o):
mittee on Taxation (JCS-4-03), March 3, 2003. The author does not endorse these and other e term “pension scheme” means
63
JCS-4-03, supra note 62, page 43. techniques. any plan, scheme, fund, trust or other

20 i J O U R N A L O F TA X AT I O N l O C TO B E R 2 0 1 8 I N T E R N AT I O N A L
 arrangement established in [the The proposed treaty provides that provides a benefit to U.S. citizens or U.S.
United States or the United King- neither country may tax residents residents holding an interest in an ac-
dom] which is (i) generally exempt on pension income earned through ceptable “pension scheme” in the United
from income taxation in [the United a pension scheme in the other coun-
States or the United Kingdom]; and try until such income is distributed.
Kingdom. e savings clause in Article
(ii) operated principally to adminis- For purposes of this provision, roll- 1(4) ordinarily takes away that benefit
ter or provide pension or retirement overs to other pension plans are not because the IRS has reserved the right
benefits or to earn income for the treated as distributions. When a res- to tax U.S. citizens and U.S. residents as
benefit of one or more such arrange- ident receives a distribution from a if the treaty did not exist. But Article
ments. pension plan, such distribution is 1(5)(a) revives the tax-deferral benefit
generally subject to residency coun- rooted in Article 18(1), acting as an ex-
tr y taxation in accordance with
e general rules regarding the tax- Article 17 (Pensions, Social Security, ception to an exception. Any doubt re-
ability of accumulated but undistributed Annuities, Alimony, and Child Sup- maining on this point is resolved by the
earnings in retirement plans are in Ar- port).63 Treasury Technical Explanation to Ar-
ticle 18(1), which provides the following ticle 18:
guidance: e apparent benefits of certain pro- [Article 18(1)] is not subject to [the
Where an individual who is a resi- visions of a treaty, like Article 18(1), are savings clause] by reason of the
dent of [the United States or the exception in [Article 1(5)(a)].
oen trumped by other provisions in
United Kingdom] is a member or Accordingly, a U.S. citizen who is a
the same treaty, such as the infamous resident of the United Kingdom will
beneficiary of, or participant in, a
pension scheme established in the “savings clause.” Many U.S. accountants not be subject to tax in the United
other Contracting State, income and attorneys who do not regularly deal States on the earnings and accretions
earned by the pension scheme may with international tax issues oen fail of a U.K. pension fund with respect
be taxed as income of that individual to consider the impact of the clause. to that U.S. citizen.
only when, and … to the extent that,
it is paid to, or for the benefit of, that
individual from the pension scheme
(and not transferred to another pen-
sion scheme).

e Treasury Technical Explanation

i Until there is parity in tax treatment
for domestic and foreign retirement
plans and IRS clarifies all applicable
tax and information-reporting rules,
of Article 18(1) gives additional clarity unintentional violations will abound.
regarding the concept of current or de-
ferred taxation:
[Article 18(1)] provides that if a resi- Below is an analysis of the savings clause Everyone loves a multi-step analysis,
dent of [the United States or the Unit- in the treaty and its impact on the tax- requiring review of domestic tax laws
edKingdom]participatesinapension
deferral benefits that Article 18(1) grants. in two countries, the potential for su-
scheme established in the other Con-
tracting State, the State of residence The treaty savings clause is in Ar- perseding tax treatment by a treaty, and
will not tax the income of the pension ticle 1(4). It says generally and omi- the interplay between a general rule, an
scheme with respect to that resident nously that the United States and the exception, and exception to an excep-
until a distribution is made from the United Kingdom may each tax their tion!
pension scheme. Thus, for example, own residents and citizens as if the
if a U.S. citizen contributes to a U.S. treaty had never come into effect. For
qualified plan while working in the
U.S. citizens residing in the United Potential Solutions
UnitedStatesandthenestablishesres-
idenceintheUnitedKingdom,[Arti- Kingdom, the savings clause normally Many U.S. retirement plans are tax de-
cle 18(1)] pre vents t he United would have the effect of subjecting ferred. Taxpayers who have worked
Kingdom from taxing currently the them to annual U.S. income taxes on abroad (either before or after becoming
plan’s earnings and accretions with all worldwide income, including the U.S. persons) often do not distinguish
respect to that individual. When the accumulated but undistributed income between U.S. “qualified” retirement
resident receives a distribution from in a workplace retirement plan in the plans and foreign “nonqualified” plans.
thepensionscheme,thatdistribution
maybesubjecttotaxintheStateofres- United Kingdom. Only a few bilateral treaties offer fa-
idence, subject to paragraphs 1 and 2 Fortunately, there are certain excep- vorable treatment to U.S. persons with
of Article 17 (Pensions, Social Secu- tions to the harshness of the savings foreign plans and, as the GAO Report
rity, Annuities, Alimony, and Child clause for U.S. persons and one of these confirms, the IRS has not developed
Support). preserves the tax-deferral benefits on or published clear guidance regarding
retirement plans. Article 1(5)(a) of the the U.S. tax treatment of, and infor-
e Joint Committee on Taxation re- treaty says expressly that the savings mation-reporting duties related to,
port also contributes to the guidance, clause will not affect Article 18(1). In foreign workplace retirement plans.
explaining the taxation concepts in plain short, the treaty functions in the follow- This is a recipe for widespread non-
English: ing complicated manner: Article 18(1) compliance.

I N T E R N AT I O N A L O C TO B E R 2 0 1 8 l J O U R N A L O F TA X AT I O N i 21
 Violations keep previously reported all income and foreign assets. e OVDP occupies the
assessment periods open paid all taxes related to foreign ac- lowest rung on the ladder for most tax-
Why must U.S. individuals with viola- counts but failed inadvertently to file payers because it requires filing Forms
tions related to their foreign workplace FBARs. 1040X for eight years (as opposed to
retirement plans approach the IRS proac- 5. Filing late information returns (other three years); the IRS obligates the tax-
tively to resolve them? One of the biggest than FBARs) penalty free according payer to pay taxes, penalties, and interest
reasons is that they cannot simply put to the Delinquent International In- with respect to the Forms 1040X (instead
their head in the sand, as they say, and formation Return Submission Pro- of just taxes and interest); and the “off-
run out the clock on the IRS. cedures (DIIRSP), which is open only shore” penalty is either 27.5% or 50% of
A relatively obscure procedural pro- to taxpayers who reported all income the highest value of the noncompliant
vision, Section 6501(c)(8)(A), contains and paid all taxes related to foreign foreign assets (instead of 5%).
a powerful tool for the IRS. It says gen- entities and assets but neglected to
erally that when a taxpayer fails to file file information returns, such as
timely a long list of international in- Forms 5471 (for foreign corpora- Conclusion
formation returns (e.g., Forms 926, tions), 8865 (for foreign partner- e GAO Report describes the current
3520, 3520-A, 5471, 5472, 8621, 8858, ships), 8938 (for foreign financial situation as follows:
8865, and 8938) the assessment period assets), or 3520 (for foreign trusts). 1. For decades, Treasury has been aware
remains open “with respect to any tax Importantly, the IRS announced that of the problems that U.S. tax treat-
return, event, or period” to which the the OVDP would end permanently ment of foreign workplace retirement
information return relates, until three in September 2018, thereby warning plans causes but it can only rectify
years after the taxpayer ultimately files taxpayers with outstanding interna- matters very slowly, if at all, as existing
the return.64 Thus, for example, if a tax- tional issues to rectify them quickly treaties are renegotiated or new
payer never files the information returns or lose the chance.66 To create more treaties are implemented.
that might apply to foreign workplace urgency and public anxiety, the IRS 2. Congress is capable of rectifying mat-
retirement plans, such as Forms 8938 reminded everyone in the relevant ters swily but it has not yet enacted
and 3520, the general three-year as- news release that it intends to con- appropriate legislation.
sessment period never starts. This tinue using a long list of enforcement 3. e IRS claims that its hands are tied,
would allow the IRS to gather infor- tools aer the close of the OVDP and such that it must enforce current U.S.
mation about the taxpayer and later that it has criminally indicted more tax and information-reporting ob-
audit at its leisure, assured of its ability than 1,500 taxpayers for international ligations regardless of how unjust
to assess additional taxes, penalties, violations since the OVDP began in they might seem in some cases.
and interest related to the foreign re- 2009.67 Until there is parity in tax treatment
tirement plan. Dozens of articles have been written for U.S. individuals with domestic and
about the preceding five options, and foreign retirement plans (either through
Main options available there is no need to get into that level of bilateral treaties or changes in U.S. law),
to taxpayers now detail here. It is enough for purposes of and until the IRS fulfills its promise to
What options are available for taxpayers this article to underscore the order in clarify for the public all applicable tax
with foreign plans who have uninten- which taxpayers likely would choose to and information-reporting rules, un-
tionally violated the rules? As of the resolve their matters, if they were to intentional violations related to foreign
writing of this article, there are five main meet the relevant eligibility criteria. plans will abound. Taxpayers who dis-
options acceptable to the IRS:65 Most taxpayers would prefer to settle cover the problem before the IRS con-
1. Participating in the Streamlined For- things through the SFOP, DFSP, or DI- tacts them will likely attempt to resolve
eign Offshore Procedure (SFOP). IRSP because each of these options calls matters proactively on the most favor-
2. Participating in the Streamlined Do- for penalty-free treatment. able terms available, through one of
mestic Offshore Procedure (SDOP). If these top three choices are unfea- the voluntary disclosure programs de-
3. Participating in the 2014 Offshore sible, taxpayers would logically attempt scribed above. On the contrary, tax-
Voluntary Disclosure Program to conclude matters through the SDOP payers who get caught by the IRS must
(OVDP). because participants are only required present their strongest possible case,
4. Filing late FBARs penalty free pur- to file Forms 1040X (Amended U.S. In- first to the IRS and later to a court,
suant to the Delinquent FBAR Sub- come Tax Returns) for the past three about how their violations were “non-
mission Procedure (DFSP), which is years; the IRS does not assert penalties willful” and due to “reasonable cause.”
generally limited to taxpayers who on the additional tax liabilities shown Either way, taxpayers with unreported
NOTES on the Forms 1040X; and the one-time foreign retirement plans should seek
66
IR-2018-52, “IRS to End Offshore Voluntary Dis- “offshore” penalty that the IRS imposes assistance from tax professionals with
closure Program; Taxpayers With Undisclosed
Foreign Assets Urged to Come Forward Now,”
to sanction broadly all past international experience in international compliance,
March 13, 2018. tax violations is set at just 5% of the high- treaties, IRS disclosure programs, and
67
Id. est aggregate value of the noncompliant tax litigation. l

22 iB J O U R N A L O F TA X AT I O N l O C TO B E R 2 0 1 8 I N T E R N AT I O N A L