Taxation Task Force's Response to IRS Comment Period on "Foreign Trust" Reporting Requirements


Below is a copy of the submission the Democrats Abroad Global Taxation Task Force submitted to the Internal Revenue Service for the public comment period on Foreign Trust reporting requirements.

Click here to download a pdf of DA's submission to the IRS in full.

In preparation for this comment for the record, Democrats Abroad spoke to IRS officials on June 12 regarding these proposed regulations. Slides from the meeting are available to view here.

Be sure to submit your comment to the IRS before July 8! Click here for instructions.

Dear Commissioner Werfel,

Democrats Abroad appreciates the opportunity to comment on the proposed regulations on “Transactions With Foreign Trusts and Information Reporting on Transactions With Foreign Trusts and Large Foreign Gifts” proposed by the Internal Revenue Service (the “Proposed Regulations”). As the largest Americans abroad organization in the world with hundreds of thousands of members, Democrats Abroad is the official Democratic Party arm for the estimated 9 million Americans living outside the United States.

Our recommendations on the Proposed Rules are summarized here and detailed further below:

  • Suspend Foreign Trust reporting requirements for non-U.S. pension and retirement accounts, where the U.S. has no significant tax interest; 
  • Align exemption from Foreign Trust reporting with FATCA IGA Annex II; 
  • Clarify which accounts do and don’t need to be reported by issuing a list of country-specific account types.

We also provide detailed suggestions for modifying the proposed definition of tax-favored foreign trusts.

Background:

The legislative history provided in the Background section preceding the Proposed Regulations demonstrates that the legislative intent of Congress was to combat abusive tax schemes in which U.S. resident taxpayers were using foreign trusts to transfer large amounts of assets to offshore tax havens. It is abundantly clear that the legislation was never intended to regulate or penalize foreign pensions and retirement accounts in which Americans abroad might participate in their country of residence and employment.

Americans abroad need access to pensions and retirement plans where they live and work. In many cases, these non-U.S. retirement savings are the only option for Americans living and working abroad to save for retirement since their income is foreign-sourced. Many government and employer pension plans don’t provide for an opt-out, and relocating retirement savings to the U.S. or incorporating U.S.-based investment products is generally not legally possible due to local statutes and regulations. In a recent survey by Democrats Abroad, 47% of respondents stated they do not plan to return to the U.S. for retirement, therefore demonstrating that it doesn’t make sense for them to be restricted to U.S.-based retirement products.

Saving for retirement is essential, but IRS rules on how non-U.S. retirement plans are taxed and reported are often a major obstacle for Americans abroad seeking to achieve financial security in their senior years. Americans abroad need to comply with the tax systems in their country of residence and also file and pay U.S. federal taxes. Due to the incompatibility of these systems, attempts at responsible financial / retirement planning in their countries of residence are frustrated by the need to comply with U.S. tax laws. The most significant problem, affecting many of the estimated 9 million Americans residing overseas, is the increasing difficulty accessing and retaining savings vehicles and retirement plans.

It is quite common for Americans working abroad to have foreign retirement accounts without knowing they may be subject to complex reporting requirements, such as filing IRS forms 8938 (“Statement of Specified Foreign Financial Assets”), 3520 (“Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts”), 3520-A (“Annual Information Return of Foreign Trust With a U.S. Owner”) and/or 8621 (“Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund”), and potentially also FinCEN Form 114 (the “Report of Foreign Bank and Financial Accounts,” or “FBAR”). The issues are summarized well by the GAO in “Workplace Retirement Accounts” (GAO-18-19), pp.12-15. IRS rules on how these plans are taxed and need to be reported don’t take into account the reality of retirement planning for Americans abroad and are often opaque and difficult to understand. Due to the diversity of international pension plans, U.S. tax professionals have little guidance on how to report them, and bad advice abounds. As noted in the Proposed Regulations, penalties for lack of compliance are significant. 

These issues were also highlighted in the National Taxpayer Advocate’s 2024 Report to Congress in Most Serious Problem #9: Compliance Challenges for Taxpayers Abroad. In accordance with the National Taxpayer Advocate’s first administrative recommendation to the IRS in response to this problem, Treasury should issue guidance covering the pension plans non-resident citizens may participate in in their country of residence, and provide straightforward instructions for the tax-reporting rules that apply.

Information reporting requirements which may apply to foreign pensions and retirement plans are complex and duplicative. At issue in the Proposed Regulations is whether reporting on Forms 3520 and 3520-A is also required. The IRS estimates the time burden for completing Form 3520 to be 54.5 hours, and we hear from tax practitioners that individual taxpayers are typically unable to complete this form on their own. Therefore filers are forced to pay a professional to complete the forms, and reports from Americans abroad confirm that tax professionals charge $250-$600 to prepare just this form, not including the rest of the taxpayer’s return.

All FATCA Inter-Governmental Agreements (“IGA”s) include an Annex II listing account types which are exempt from institutional reporting by Foreign Financial Institutions due to Treasury’s belief that they are tightly regulated and pose a low risk of abuse. These Annex II lists include most foreign pension plans which were in existence as of the timing of IGA signing, but have unfortunately not been updated for new programs established since then. Regardless of whether listed on Annex II or not, individuals generally must report foreign pensions and retirement plans on Form 8938 and possibly also on FBAR. Any additional disclosure on Forms 3520 / 3520-A is clearly duplicative, and these forms are ill-suited to reporting ordinary pensions and retirement plans since the forms are designed to collect detailed information about bespoke trust arrangements. 

 

Recommendations:

With respect to information reporting on transactions with foreign trusts, the Treasury Secretary is authorized under 26 USC §6048(d)(4) — Modification of Return Requirements — to suspend or modify the requirements of §6048 — Information with Respect to Certain Foreign Trusts — where the United States has no significant tax interest in obtaining the information. 

We further note that the latest provisions related to foreign pension plans in the 2016 U.S. Model Income Tax Convention provide that the U.S. may not tax an American citizen resident in the treaty country on income earned inside a pension fund in the treaty country unless it is paid out to the individual taxpayer, and then only to that extent. To ensure equitable treatment among overseas Americans in various countries, we recommend that IRS regulations applicable to foreign pensions be aligned with Treasury’s latest position in the model treaty.

Even with the exclusions in the Proposed Regulations, uncertainty will remain whether a foreign pension or retirement plan is a trust in the first place, and whether it may benefit from the proposed exclusions. The uncertainty inherent in the statute and Proposed Regulations is a major issue for taxpayers, professional preparers, and for the IRS itself. We recommend that the IRS clarify which foreign pension and retirement plans are considered to be qualified pensions and therefore not subject to foreign trust reporting or Passive Foreign Investment Company (“PFIC”) taxation. IRS regulations should state the general presumption that trust reporting and PFIC taxation is not required for foreign pensions and retirement accounts. The IRS can reserve the right to specify any particular schemes (e.g. Malta pensions) which are deemed to be problematic and should be reported.

An alternative would be to exempt from trust reporting and PFIC treatment any pension plans which are described in the section entitled “Specific Treatment of Retirement Plans” in the FATCA IGAs (typically Article 4.3 in the Model 1 IGAs and Article 3.3 in the Model 2 IGA), or specifically listed as Exempt Accounts in Annex II of the IGAs. However, please note that relying on Annex II alone is insufficient because the IGAs have not been updated since 2014, and many countries have enacted legislation creating new types of tax-favored foreign retirement trusts since then or changed the statutes under which the accounts are organized. If the IRS refers to the FATCA IGAs in its foreign trust regulations, then the United States should engage in a periodic exercise to ensure that each IGA is updated to reflect the latest retirement programs in effect in each counterparty country. An illustrative list of major foreign pensions and retirement plans is included in the Appendix.

While we sincerely hope that the IRS will scrap the Proposed Regulations in favor of the general presumptions described above, we would like to provide the following additional detailed comments in case the IRS moves forward with an exclusion for certain tax-favored foreign trusts defined in a way substantially similar to the six criteria listed in the Proposed Regulations:

  • § 1.6048-5(b)(2)(ii): Please clarify that annual reporting of deductible or excludable contributions to the trust, as described in § 1.6048-5(b)(2)(i)(a), is sufficient to meet this criterion.

  • § 1.6048-5(b)(2)(iii): This criterion would exclude many legitimate pension plans, as different countries may employ a wide range of factors for determining eligibility to participate in a tax-favored foreign retirement trust. For example, permitted contributions should include those made by:
    • People employed by a company that does not have a corporate pension plan
    • Self-employed people
    • A homemaker who is dependent on the spouse’s employment income
    • A person who is temporarily unemployed, but elects to continue making contributions
  • § 1.6048-5(b)(2)(vi)(B): The requirement that a “significant majority” actually participate in an employer-maintained trust is too high a bar for a voluntary plan offered by an employer because it ignores the possibility that the trust is made available to all employees, but some elect not to participate. We believe that the key issue the IRS is trying to control here is to exclude retirement plans which are only made available to a narrow class of employees, such as senior executives. What about the case if a certain pension plan is made available only to employees who were acquired as part of an M&A transaction, but not the entire employee base? This might also fail to meet the criteria in item (B).

  • For the Value Thresholds and Contribution Limitations defined in § 1.6048-5(b)(2)(iv), § 1.6048-5(b)(3)(iii) and § 1.6048-5(b)(4)(iii), the phrase “limited to no more than” is ambiguous as to whether it describes the actual value contributed to or contained in the taxpayer’s trust, or whether it is referring to a regulatory limitation in the country of the trust’s jurisdiction. We propose that this language should be clarified to refer to the actual value contributed to or contained in the taxpayer’s trust, without regard for the regulatory limitations that may or not be in place in the trust’s jurisdiction. We further note that foreign currency fluctuations versus the U.S. dollar may result in a particular trust qualifying for the exemption in some years and not in other years. This is another argument for why the IRS should create a list of foreign pensions and retirement plans which always qualify for the exemption.

  • § 1.6048-5(b)(5) — Certain Rollovers and Transfers: Please consider the case where the other trust from which the assets or funds were transferred did not meet all of the requirements in paragraphs (b)(2) or (b)(3), but the rollover is treated under local law as a tax-exempt contribution as defined in § 1.6048-5(b)(2)(i), and the aggregate contributions still fall under the annual and lifetime limits provided in item § 1.6048-5(b)(2)(iv). We believe that this should not disqualify the trust from qualifying as a tax-favored foreign retirement trust.

  • Eligible Individual, as defined in § 1.6048-5(b)(1): The requirement, in order to benefit from the exceptions for certain tax-favored foreign trusts in § 1.6048-5(b), that an individual must be compliant with all tax obligations, is on its face logical. However, given the complexity and opacity of the regulations as they may apply to foreign pensions and retirement plans, and the fact that few tax preparers are capable of advising Americans abroad on the tax treatment of foreign pensions and retirement plans, we believe reporting exceptions should be provided in cases in which an American abroad was unable to correctly report any contributions to, earnings of, or distributions from their foreign pension or retirement plan. Imposing confiscatory penalties of up to 35% of the total balance of the pension or retirement plan is draconian in the case of non-willful errors or where there was reasonable cause. The IRS should not assess these penalties against Americans abroad for honest errors related to the reporting of pensions or retirement plans.

In conclusion, we would like to reiterate our request that the IRS take this opportunity to modify the Proposed Regulations in a way that will ensure Americans abroad can save for retirement, by eliminating the burden of complex reporting and punitive treatment of pensions and retirement plans outside the United States.

Sincerely,

Martha McDevitt-Pugh
International Chair
Democrats Abroad
[email protected]

Rebecca Lammers
Chair, Taxation Task Force
Democrats Abroad
[email protected]