Disclosing foreign pension plans on IRS information reporting forms is one of the most complex tasks related to U.S. tax and reporting requirements. Most importantly, foreign pensions must be reported on multiple information reporting forms required by the IRS.
The reporting requirements placed on you will depend on what type of pension plan you have. Because foreign pensions are generally made up of different types of contributions, knowing which forms to file can be difficult. Further, your employer might also be required to report the pension plan to the IRS. Having a seasoned tax attorney on your side can help ensure that you report your pension plan accurately.
For a free review of your case, speak with our foreign pension tax attorneys at McCormick Tax Law today by calling us at (215) 630-0861.
What Are the Reporting Requirements for Foreign Pension Taxes?
Reporting foreign pensions on your U.S. tax return can be complex due to additional requirements beyond reporting employer contributions and pension income. Fortunately, our foreign pension tax attorneys have the knowledge to ensure you meet your reporting requirements. Depending on your specific situation, you might need to use specific forms to report your foreign pension income.
Form 3520
If you engage in any dealings with a foreign trust, it is mandatory for you to file Form 3520. This includes pensions and retirement plans, which are commonly categorized as trusts.
Form 3520-A
If you have a foreign pension, the company managing it needs to file Form 3520-A. However, if they fail to do so, it becomes your responsibility to file this form. It is a legal requirement, and failure to comply can result in penalties.
Form 8621
If you are subject to the Passive Foreign Investment Company (PFIC) rules, it is mandatory to file Form 8621. Many U.S. individuals who own foreign mutual funds and equity funds might need to fill out Form 8621 for their PFIC. This is a common requirement, as foreign pension plans often include different types of investment funds.
Form 8938
If you possess foreign financial assets, including foreign pensions, and meet the filing threshold, you are required to report them using Form 8938. This form is necessary for the disclosure of all such assets.
Do Foreign Pensions Have to Be Reported on the FBAR?
If you are an American and have $10,000 or more deposited in a non-U.S. financial account, you are required to file FinCEN Form 114, also known as a Foreign Bank Account Report (FBAR). The FBAR was created to prevent tax evasion by making it difficult for U.S. citizens to conceal money in offshore accounts.
According to the FBAR instructions, you must report all financial accounts. In most cases, pensions are considered financial accounts. However, the requirements will vary depending on whether the foreign pension plan is a defined benefit plan or a defined contribution plan.
Defined Benefit Plans
A defined benefit plan is a retirement or death benefit plan funded by an employer or government, which provides a fixed benefit to the beneficiary. The plan participants do not have ownership rights and cannot direct investments or withdraw funds before retirement. Additionally, it might be difficult to determine the current value of the plan until retirement.
Reporting defined benefit plans on FBAR might not be necessary, according to some financial experts. However, it is safer to report it using a reasonable estimate, especially if the plan provides for a residual cash benefit payable to the beneficiaries in case of the participant’s death before retirement.
In such cases, the amount of the residual benefit might be used as the balance to report on FBAR. If you are currently receiving benefits from this plan, you can report the total annual payments as the FBAR balance.
Defined Contribution Plans
Employers and employees fund defined contribution plans, and employees control the investments within the plan. These plans always have a clear value or balance and must be reported on the FBAR.
In Switzerland and some other countries, a three-pillar retirement scheme is implemented. The first pillar is a welfare program that provides benefits for old age and disability. These plans do not require FBAR reporting. The second pillar is an employer-funded pension plan, which must be reported on the FBAR. The third pillar is a private retirement plan that must also be reported on the FBAR.
Though some foreign governments offer retirement plans similar to social security that do not require FBAR reporting, some foreign retirement plans combine social security aspects with a foreign pension plan, as well as bank and financial accounts. These plans are usually mandatory, government-run funds with contributions from both the employer and employee. Despite their similarities with social security-type programs, these types of foreign pension plans require FBAR reporting.
How Are Foreign Pensions Taxed?
Foreign pension plans are subject to U.S. taxation. For U.S. tax purposes, a foreign pension can be divided into three parts: your contributions, your employer’s contribution, and the pension’s investment income. Each of these three parts might be taxed immediately or later, depending on various factors, including the pension’s terms and conditions and any applicable tax treaties.
When you receive your pension, a portion of it might be taxed, and the remaining portion might not be taxed. As a general rule, whatever is taxed now by the U.S. will not be taxed later, and whatever is not taxed now by the U.S. will be taxed later. Thus, each part of your pension will be taxed at some point, whether it is all now, all later, or a portion now and the rest later.
Foreign Pension Contributions Tax
Contributions made by employees to foreign pensions are not considered as reducing their taxable U.S. income since such pensions are not qualified plans. Additionally, contributions made by employers to foreign pension funds are viewed as increasing the taxable income of the employee.
Foreign Pension Withdrawals Tax
If your contributions to a foreign pension were not deducted from your tax returns, your withdrawals from it will not be taxed. However, if your employer’s contributions to your pension plan were included as taxable income on your tax return, and all annual investment income was also included as taxable income on your tax returns, then your withdrawals will be taxed.
It is crucial to maintain detailed records of what was and was not included as taxable income on your tax returns since withdrawals from a foreign pension might not occur for many years or even decades. Failure to keep good records could result in the IRS treating all pension distributions as taxable income.
Annual Foreign Pension Investment Income Tax
Qualified pensions provide the benefit of tax-free income accrual. However, foreign pensions are considered as the participant’s income and, therefore, subject to annual taxes. This could be detrimental in situations where the foreign plan fund invests in foreign mutual funds or exchange-traded funds, which are classified as passive foreign investment companies or PFICs by the IRS.
Our Foreign Pension Tax Attorneys Can Help
Contact McCormick Tax Law today at (215) 630-0861 to receive a free case evaluation with our international tax attorneys.