Foreign asset reporting—including the reporting of foreign retirement plans—is a high priority for the IRS, which in 2019 listed the “failure to report offshore funds” as one of its “Dirty Dozen Tax Scams,” and has done so for several years running. Individuals with assets in foreign retirement plans, as well as their tax advisors, should become familiar with the various U.S. information reporting forms that may need to be filed to report those plans. This article provides information about different types of foreign retirement plans, the Department of Treasury forms used to report them, and the consequences of failing to do so.
Foreign Retirement Plan Basics
There are various reasons why a U.S. person may have a foreign retirement plan. For example, a U.S. citizen living abroad may work for a foreign company and have a workplace retirement plan provided by that company. Alternatively, a citizen and resident of a foreign country working for a foreign company may be assigned to work in the United States while continuing to be the beneficiary of the foreign company’s retirement plan. Another common situation is that of a U.S. resident alien working for a U.S. employer who came to the United States with an existing retirement plan from a former employer in a foreign country.
Just as there are many different situations in which a U.S. person may have a foreign retirement plan, there are also many different types of foreign retirement plans. The four basic types of foreign retirement plans are 1) a retirement plan involving a segregated foreign retirement account for the employee, which is created by the employer and funded by the employer, the employee, or both (i.e., a defined contribution plan); 2) a retirement plan created by the employer that does not result in a segregated retirement account for the employee, but instead consists solely of an agreement to pay the employee certain periodic payments upon retirement, such as an employer-created pension (i.e., a defined benefit plan); 3) a personal pension plan created and funded by the individual; and 4) a government-sponsored retirement plan, such as a foreign equivalent of Social Security.
Forms, Requirements, and Penalties
A U.S. person may need to report a foreign retirement plan on one or more information reporting forms. The United States has several different information reporting forms relating to foreign assets, including the Report of Foreign Bank and Financial Accounts (FBAR), Form 8938 for reporting various “specified foreign assets” (e.g., foreign accounts, contracts with foreign counterparties, interests in foreign entities), and Form 3520 for reporting interests in foreign trusts, gifts, and estates.
The monetary thresholds that must be met before an individual is required to submit one of these forms differ depending upon the form and, in certain cases, the individual’s status. For example, the obligation to file an FBAR is triggered when an individual has foreign bank accounts with an aggregate high balance of $10,000 at any point during the tax year. The obligation to file Form 8938, however, depends on the filing status of the individual (because Form 8938 is attached to, and part of, a Form 1040 income tax return) and whether the individual resides in the United States or abroad. An unmarried individual living in the United States will have an obligation to file Form 8938 if her total specified foreign assets exceed $50,000 on the last day of the tax year or $75,000 at any point during the tax year, while a married individual filing jointly and living abroad will only have to file Form 8938 if his total specified foreign assets exceed $400,000 on the last day of the tax year or $600,000 at any time during the tax year. Within this range are additional reporting thresholds for single taxpayers residing abroad and married taxpayers residing in the United States. Finally, Form 3520 has different reporting triggers depending on the nature of the foreign asset. A U.S. person must file Form 3520 to report a foreign gift or distribution from a foreign estate that exceeds $100,000. Form 3520 must also be filed by a U.S. person to report the creation of a foreign trust, ownership of a foreign trust, transfers of money or property to a foreign trust, or distributions from a foreign trust.
In addition, there are different monetary penalties that may apply if an individual fails to timely submit a required information reporting form related to foreign assets. The penalty for failure to file an FBAR is $10,000 for each nonwillful violation, and the greater of $100,000 or 50% of the account value for each willful violation. The penalty for failure to file a required Form 8938 is $10,000 for each 30-day period during which the Form 8938 is not filed, with a maximum continuing failure-to-file penalty of $50,000. There is also a 40% underpayment penalty for any tax deficiencies relating to foreign assets that were not properly reported on Form 8938. The penalty for failing to report an interest in a foreign trust on Form 3520 is the greater of $10,000 or 35% of the gross value of any property transferred to the foreign trust or any distributions from the trust.
Reporting Different Types of Plans
Reporting a foreign retirement plan will differ depending upon the type of plan and form. A foreign retirement plan is only reportable on an FBAR if it is associated with a segregated foreign retirement account, since it is the foreign account—not the plan itself—that triggers the obligation to file the FBAR. Assuming that the aggregate $10,000 reporting threshold has been met, an individual with a foreign retirement account will need to report the highest balance in the retirement account at any point during the tax year. Neither a foreign employer-created pension (which involves only a right to receive payments on retirement) nor a foreign equivalent of Social Security would qualify for reporting on an FBAR, however, as there is no foreign account to report in those situations.
In contrast, Form 8938 requires the reporting of all manner of foreign assets (assuming the appropriate monetary reporting thresholds are met), and a foreign retirement plan is reportable on Form 8938 regardless of whether the plan is associated with a segregated foreign retirement account or is simply a foreign pension. A foreign equivalent of Social Security, however, is exempt from reporting on Form 8938.
There is also the issue of which monetary values must be reported on Form 8938 with respect to a foreign retirement plan. If the plan is in the form of a foreign retirement account, the taxpayer should receive periodic statements identifying the value of the retirement account and can use the values on those statements when reporting the maximum value on Form 8938. With respect to a foreign pension, the general rule is that the individual must report on Form 8938 the fair market value of her beneficial interest in the pension plan as of the last day of the tax year. If, however, the individual does not know (or have reason to know based on readily accessible information) the fair market value, then she must instead report on Form 8938 the fair market value of the cash and other property distributed during the tax year as a beneficiary of the pension. If she received no distributions during the tax year, and does not know or have reason to know the fair market value of the beneficial interest—which will often be the case with an employer-created pension plan when the participant is not yet receiving retirement benefits—then she must still report the pension on Form 8938, but should report the maximum value of the asset as zero.
A foreign retirement plan may also trigger an obligation to file a Form 3520, which is used, among other things, to report transactions related to a foreign trust. A self-created foreign personal pension plan may be viewed as a foreign grantor trust, and thus reportable on Form 3520, since a U.S. person must file Form 3520 to report ownership of a foreign trust. An employer-created foreign pension may also trigger an obligation for a U.S. resident alien who is of retirement age to file Form 3520. The foreign pension may be viewed as a foreign trust with the resident alien as its beneficiary, and any retirement distributions from the pension would then trigger a Form 3520 filing obligation, since distributions from a foreign trust to a U.S. person also trigger the filing requirement. An employer-created foreign retirement account may also result in a U.S. person needing to file Form 3520, since the account may be viewed as a foreign trust for the benefit of the employee. If the employee is a U.S. person, then his periodic contributions from his wages to the foreign retirement account (i.e., the foreign trust) may trigger an obligation to file Form 3520, since Form 3520 must be filed when a U.S. person transfers money or property to a foreign trust. It appears, however, that an employer’s periodic contributions to an employer-created foreign retirement plan will not trigger a Form 3520 reporting requirement, since the instructions to Form 3520 expressly provide that the form does not have to be filed to report “transfers to foreign trusts described in [Internal Revenue Code] sections 402(b), 404(a)(4), or 404A,” all of which relate to employer contributions to retirement plans.
Complicating matters is the fact that there may be special rules that apply to certain foreign retirement plans. For example, Canadian Registered Retirement Savings Plans (RRSP) do not have to be reported on Form 3520, as the instructions to that form expressly provide that “Form 3520 does not have to be filed” to report transfers to, ownership of, and distributions from such plans. Until tax year 2014, however, RRSPs did have to be reported on Form 8891, U.S. Information Return for Beneficiaries of Certain Canadian Registered Retirement Plans. Thus, although RRSPs are exempt from being reported on Form 3520, that does not mean that they are exempt from being reported elsewhere. For example, there is no exemption from reporting RRSPs as an asset on Form 8938; rather, the 2014 instructions to Form 8938 expressly provide that RRSPs must be reported. In addition, there is no exemption from reporting RRSPs on the FBAR form; in fact, an IRS FBAR Reference Guide available on the IRS’s website expressly states that RRSPs—as well as similar foreign retirement accounts, such as the Canadian Tax-Free Savings Account (TFSA), Mexican individual retirement accounts (Fondos para el Retiro), and Mexican Administradoras de Fondos para el Retiro (AFORE)—are “foreign financial accounts reportable on the FBAR.”
Schedule B Requirements
In addition to the forms detailed above—and possibly others, such as Form 8621, which is used to report investments in a foreign mutual fund or passive foreign investment company (PFIC), and Form 3520-A, which must be filed by foreign trusts with a U.S. owner—a foreign retirement plan may also trigger a requirement to file Schedule B with a Form 1040 income tax return. Part III of Schedule B requires the taxpayer to check a box to report an interest in or signature authority over any financial account located in a foreign country; a segregated foreign retirement account arguably triggers this reporting requirement. Part III of Schedule B also requires the taxpayer to check a box to report whether they received “a distribution from, or were the grantor of, or transferor to, a foreign trust.” Many foreign retirement plans will trigger this reporting requirement, even if there is no obligation to file a Form 3520 because of an applicable exemption to that form. When such foreign assets exist, the failure to check “Yes” on Part III of Schedule B—or even worse, checking “No”—is often viewed in a negative light by the IRS, and may be asserted as evidence that the taxpayer is attempting to evade taxation.
Failure Carries Consequences
The Government Accountability Office (GAO) released a report in January 2018 (GAO-18-19) that discussed foreign retirement plans and noted that complying with U.S. information reporting requirements for such plans often results in “high tax preparation fees,” but that the failure to properly report such plans “may bring significant financial penalties.” The report also noted that “IRS officials expressed concern that unless U.S. individuals are required to report foreign retirement accounts via Form 8938, they will seek to avoid proper reporting on their tax returns when distributions are made.” In other words, the IRS views information return reporting with respect to foreign retirement plans as a vital tool in its tax compliance arsenal.
While an argument can be made that a foreign retirement plan is not the sort of vehicle used to evade taxes, such plans are nonetheless looked at closely by the IRS, and there are significant monetary consequences for failing to properly report such plans on U.S. information reporting forms such as the FBAR, Form 8938, and Form 3520. U.S. persons who are beneficiaries of foreign retirement plans should consult their tax professionals in order to properly report those assets.