Relief from Filing Forms 3520a/3520 for Certain Tax-Favored Foreign Trusts
IRS exempts certain plans from onerous trust reporting
Rev. Proc. 2020-17 exempts from section 6048 information reporting an eligible individual’s transactions with, or ownership of, an applicable tax-favored foreign trust. As a result, the penalties under section 6677 do not apply to eligible individuals who fail to report transactions with, or ownership of, these trusts under section 6048.
An eligible individual is a person who is or was a U.S. citizen or resident and who is compliant (or comes into compliance) with all requirements for filing U.S. federal income tax returns and has reported any contributions to, earnings of, or distributions from, an applicable tax-favored foreign trust.
The revenue procedure will apply to all open tax years, subject to the limitations of section 6511.
How to interpret relief requirements
SECTION 3 outlines six qualifying conditions for a foreign tax-favored retirement plan to qualify for the relief from filing Forms 3520a/3520 (see Sep 2019 article: New Compliance Campaign - IRS Going after Non-US Trusts).
Section 03(4) Contributions to the trust are limited by a combination of the below
- a percentage of earned income of the participant
- are subject to an annual limit of $50,000 or less to the trust,
- are subject to a lifetime limit of $1,000,000 or less to the trust.
P.03(4) enlists the requirements that are hard to overcome because the contribution limts set above (requirement 1&2 or requirements 1&3) are very difficult to meet in tandem. If it was only requirement 1, requirement 2, or requirement 3 - the qualifications would be far more lenient.
SECTION 4 outlines six qualifying conditions for a foreign non-retirement saving trust to qualify for relief. First, a qualifying trust, plan, fund, scheme, or other arrangement should operate exclusively or almost exclusively to provide, or to earn income for the provision of, medical, disability, or educational benefits.
There are tax-favored saving arrangements of this type that can meet 5 of 6 conditions.
However, P.04(4) sets the $ limit that narrows the list further down.
P.04(4) Contributions to the trust are limited to
- $10,000 or less annually or $200,000 or less on a lifetime basis
What this means for expats
Occupational (employer) plans always set a limit to the percentage of earned income (meeting requirement 1), yet annual or a lifetime monetary limit is less common (failure to meet requirement 2 or 3). Many occupational retirement plans do not qualify for the exemption under the Rev. Proc. 2020-17 for that reason. However, since those are mainly employer (non-grantor) trusts, they are exempt from filing the form 3520a/3520 regardless of this procedure (see Kiwisaver example below).
Individual (non-occupational) retirement plans usually set an annual limit to the contribution amount (meeting requirement 2). Percentage of earnings may not be set (failure to meet requirement 1) . Further, the qualifying limit of $50K is low (even US plans have a higher limit of $57K). Note that the limit indicates the maximum allowed contribution. This reads incredibly onerously as an individual (non-occupational) retirement plan participant who contributes $10 to the plan would have to file form 3520a/3520 because the allowed amount of contributions (on the plan level) is greater than $50K.
The limit amounts are determined using the U.S. Treasury foreign currency conversion rate on the last day of the tax year. Defining limits in USD means that any country where the limits are close will qualify some years but not others due to currency fluctuation.
Despite relief, potential increased reporting requirements for some
Section 5.04 regarding non-retirement savings accounts creates another challenge. The indicative list of what constitutes a trust for the purposes of this section appears to be far wider than the statutory definition. Although the statutory definition should take precedence, the risk exists that foreign medical, disability, or education savings plans or accounts that were not previously considered to be trusts could now be considered to be reportable trusts.
Examples of retirement plans this concerns
Australian Self managed mutual funds do not qualify for filing relief from 3520/3520-A. Contributions are not linked to the percentage of earnings (failure to meet requirement 1), the annual allowed limit is $100,000 (failure to meet requirement 2), with a lifetime limit of $1.6M (may or may not meet requirement 3 depending on the currency fluctuation in a given year)
New Zealand KIWISAVER
New Zealand Kiwisaver plans do not qualify under this relief procedure. Contributions are limited to 8% (meets requirement 1), however there is no annual or lifetime limit (failure to meet requirement 2 or 3). They are, however, exempt from filing 3520/3520-a as a non-grantor employer trust.
Hong Kong Mandatory Provident Fund (MPF)
Hong Kong MPF funds qualify for relief. Employer and employee each contribute 5 per cent (a sum equal to 10%, meeting requirement 1) of the salary with the total contributions capped at HK$1,500 a month (meets requirement 2).
Swiss Pillar 3
Swiss Pillar 3 plans qualify for relief. Contributions are limited to 20% of annual earnings (meets requirement 1) , with a limit of CHF 33,840 per annum (meets requirement 2)
For United Kingdom self-invested personal pension plans, it depends. The percentage limit is 100% of earned income (meets requirement 1). Those who earn under 150K GBP do not qualify unless they earn less than $USD 50K.
Whereas high earners are subject to “tapered” contributions similar to ROTH contributions in the US, thus staying under the $ amount limit. I.E, those who make more than £210,000 per annum, have a SIPP contribution limit of £10,000 a year.
Two examples = one does qualify for relief, the other does not.
Taxpayer who earns 150k GBP and may put in 150k GBP (fails to meet requirement 2)
Taxpayer who earns 210k GBP may only put in 10k GBP per year (meets requirement 2)
Ireland Personal Pension Plan PRSA
For Irish Personal pension plans, relief qualification depends on the participant age and currency rates.
Percentage of earnings varies from 15% to 40% depending on the participants age (meeting requirement 1). The maximum amount of earnings taken into account for calculating tax relief is €115,000 . Therefore, the annual $ limit is met for younger participants (meeting requirement 2). Although a 60-years old is allowed to contribute up to 40%, thus the contribution limit is €46,000. This translates into $52K as of Jun 30, 2020 (fails to meet requirement 2) but may meet requirement 2 if the Euro appreciates vs $USD.
Canadian Registered Education Savings Plans (RESPs) are clear beneficiaries, perfectly matching the definitions of Section 4 relief. This is a foreign grantor trust set up exclusively to provide for the provision of educational benefits. The lifetime limit of contributions is 50K CAD per beneficiary. Those who previously filed 3520/3520-A for Canadian RESP no longer need to.
Other retirement plans need to be reviewed against their tax treaty or special arrangements that may lead to requirement (or lack thereof) of filing form 3520/3520-A.
Income from funds & financial accounts still require reporting
While this revenue procedure may exempt some accounts from filing form 3520/3520-A (see RESP above), the income generated in the account should still be reported on form 1040, accounts must be reported on FBAR FinCEN 114 and FATCA (both if applicable) and the presence of the foreign trust should still be identified on your Form 1040. In addition, filing of Form 8621 for accounts invested in non-US mutual funds required if the balance exceeds the exception threshold.
Requesting Abatement of Section 6677 Penalties
With the spread of information about Rev. Proc. 2020-17 in the media, we expect an influx of requests for abatement or refund of Sec 6677 Penalties from the clients who have been previously assessed penalties for the failure to file forms 3520a/3520.
It is important to note that the plan must meet all conditions outlined in Section 3 & 4. If the plan meets those conditions (i.e. the taxpayer was assessed penalties for failure to timely report RESP or Pillar 3) TFX can assist with requesting the penalty abatement.