The Internal Revenue Code of 1986 (the “Code”),[1] generally requires annual information reporting of a U.S. person’s contributions to, ownership of, and distributions from, foreign trusts.[2] The Code imposes penalties for failure to comply with such requirement. As an exception, Code section 6048(a)(3)(B)(ii) provides, with respect to certain transfers to foreign compensatory trusts, a suspension or modification of such a reporting requirement if the United States has no significant tax interest in obtaining the required information. Such guidance (issued by the Secretary and the IRS) provides that reporting is not required with respect to distributions from certain foreign compensatory trusts, provided that the recipient of the distribution reports the distribution as compensation income.
Section 6038D of the Code, enacted in 2010, generally requires a U.S. person to report any interest in a specified foreign financial asset provided that the aggregate value of all such assets exceeds certain thresholds (Form 8938). Interest in a specified foreign financial asset includes interests in certain foreign retirement, pension, and non-retirement savings funds or accounts.
On March 2, 2020 the Treasury Department and the IRS releases a new procedure (Rev. Proc. 2020-17) (the “Procedure”), determined that, because applicable tax-favored foreign trusts (“Eligible Trusts”)[3] generally are subject to written restrictions (such as contribution limitations, conditions for withdrawal, and information reporting), under the laws of the country in which such trust is established, and because U.S. individuals with an interest in Eligible Trusts may be required to separately report information about their interests in accounts held by, or through, these trusts, it would be appropriate to exempt U.S. individuals from the requirement to provide information about these trusts.
Accordingly, the Treasury Department and the IRS are exempted from Section 6048 information reporting an eligible individual’s [4] transactions with, or ownership of, an Eligible Trust. As a result, penalties do not apply to eligible individuals who fail to report transactions with, or ownership of, these trusts. The better news is that the IRS allows the taxpayer to request abatement of penalties that have been assessed or for a refund of penalties that have been paid. This is in addition to any existing exemption from Section 6048 reporting with respect to distributions from certain foreign compensatory trusts.
It should be noted that the Procedure does not affect any reporting obligations under Section 6038D or under any other provision of U.S. law, including the requirement to file FBAR returns.
The Procedure provides guidance on the process for requesting abatement or refund of penalties, as mentioned above. It is effective as of the date it was released and applies to all prior open taxable years, subject to the limitations of Code Section 6511.
[1] IRC Section 6048.
[2] IRS Forms 3520, 3520-A.
[3] An Eligible Trust means:
- Tax-Favored Foreign Retirement Trust which is 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 (i.e. (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; 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.
(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 but 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.
(6) For 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, (ii) the Trust 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.
- Tax-Favored Foreign Non-Retirement Savings Trust which is a foreign trust for U.S. tax purposes that is created, organized, or otherwise established under the laws of the Trust’s Jurisdiction) as 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 complies with terms of (i)(1)-(2). (2) Contributions to the Trust are limited to $10,000 or less annually or $200,000 or less on a lifetime basis. (3) 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 sections (i) and (ii) will not fail to be treated as an applicable Eligible Trust solely because it may receive a rollover of assets or funds transferred from another tax-favored foreign retirement trust or a non-retirement savings trust, as applicable, established and operated under the laws of the same jurisdiction, provided that the trust transferring assets or funds also meets the requirements of these sections.
[4] Eligible Individual means generally an individual who is, or at any time was, a U.S. citizen or resident and who is compliant (or comes into compliance) with all requirements for filing a U.S. federal income tax 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 Eligible Trust on the applicable return.
