Superannuation Funds Taxation for US Taxpayers

superannuation-for-us-residents

Superannuation Funds are NOT so Super when You are a US Person

Australian Superannuation funds are similar to US retirement plans.  The funds in accounts accumulate tax-free in Australia, however, from a US perspective they are taxable to a US person. In general, superannuation income is not exempt income on your US return, nor is the foreign tax credits paid by the superannuation fund available to provide relief from double taxation.  US persons who are living in Australia or have contributed to Superannuation funds in the past face some complexity in preparing their US tax returns, you must usually also file a Foreign Bank Account Report (FBAR) on Form FinCEN 114, formerly known as TDF 90-22.1. Failure to file the FBAR can result in both civil and criminal tax violations. 

 If your superannuation fund is classified as a foreign grantor trust for US tax purposes it will be subject to the reporting requirements of Internal Revenue Code ("IRC") Section 6048. IRC Section 6048 provides that a responsible party must notify the service each time that a U.S person creates a foreign trust, transfers money to a foreign trust, or when a U.S. person dies if she owned a portion of the foreign trust. In addition, information about a distribution from a foreign trust must be reported to the IRS. Any U.S. person who is required to report must do so on Form 3520. Furthermore, under IRC Section 6048(b), a U.S. owner of a foreign trust is required to file Form 3520-A every year if not filed by the trustee.

 

The tax penalties for failure to file are almost as horrific as the penalties for the non-filing of FBARs. If a U.S. person fails to file the annual Form 3520-A a penalty is imposed under IRC Section 6677 of 5% each and every year for which the form isn’t filed. In addition, each time there is a deposit into the superannuation fund, or a withdrawal from the superannuation fund a penalty of 35% of the amount deposit or withdrawn is subject to the penalty. These penalties can only be excused if the taxpayer can demonstrate “reasonable cause" for failure to file the forms. Unfortunately, there is no statute of limitations on the failure to file the Form 3520, or 3520-A. So, the IRS may impose these penalties at any time, even many years later.

How to determine whether your Superannuation is a Grantor Trust or an Employee Trust

Is my Superannuation classified as a Grantor Trust?

The determination of whether a Superannuation should be treated as either an employee benefits trust or a foreign grantor trust can be a complicated analysis for anyone looking at these rules.  They are overly complicated and frankly difficult to understand because there is no bright line test.  Here is a basic overview:

Employee Benefits Trust

Generally, a large employer-sponsored Superannuation plan held at a large financial institution is considered to be an Employee Benefits Trust.  The majority of superannuation accounts are actually treated as an employee benefits trust, which requires the Superannuation investment income to be reported on Form 1040. Moreover, ownership of your account needs to also be reported on Form 8938, if you meet the filing requirements.    The good news is that if you indeed have an Employee Benefits Trust, then there is no requirement to prepare a Form 3520 and 3520-A. 

What exactly needs to be reported on Form 1040 can differ among taxpayers. Some taxpayers only need to report the contributions as taxable income, for others the growth (including contributions made in a year) in the fund is taxable. To make matters more complex, the taxpayer will need to keep a separate ledger of their investment in the fund for US tax purposes because the contributions and growth taxed on the US return become your US cost basis in the fund.  As such, at the time of distribution, this basis can be returned tax-free to the taxpayer and therefore is not taxable on the taxpayer's US return.

Foreign Grantor Trust

The key to determining whether a superannuation rises to the level of a foreign grantor trust, a taxpayer must assess the level of "control" it held over the Superannuation investments.  Although the IRS has not made any rulings on what constitutes control for Superannuation purposes, generally the power to make decisions around the actual investments in the fund – as is the case with a Self-Managed Superannuation Fund (SMSF) – or the ability to make contributions to the fund are usually indicative of control.  

Like an employee benefits trust, as a grantor trust, superannuation ownership and income will need to be reported on Form 1040, an FBAR and possibly Form 8938.  If the Superannuation is treated as a foreign grantor trust, this will require the US taxpayer to report the Superannuation on Forms 3520 and 3520-A. To make matters worse, if any investments within the foreign trust are considered a Passive Foreign Investment Company (PFIC), then the foreign trust will also need to file Form 8621.  This places tremendous reporting requirements and burdens on the Taxpayer.  If the returns are being prepared professionally could cost thousands of dollars to prepare since they are extraordinarily time-consuming and complex.

The Argument that the USA-AU Income Treaty Exempts Superannuation Income is Wrong

There are tax practitioners that believe the US-Australian tax treaty treats social security is exempt from US taxation.    While it is accurate that some social security payments are exempt from US taxation, unfortunately because Superannuation Funds  are not analogous to social security, they are not afforded the same treatment under the treaty.
Although Social Security and Australian Superannuation Funds are both mandated by the government and are for retirement, they are totally different animals for purposes of the treaty.  Here are some reasons why:
  • Social Security is a pooled investment, Superannuations are personalized
  • Social Security has no account number. A Superannuation fund does.
  • Social Security checks are written by the government. Superannuation Fund check are not. This is an important distinction as the treaty defines Social Security as something the government pays.
  • A Superannuation Fund holder has control over the investments. A social security participant has none.
  • Superannuation funds can be left to heirs. It is the fund owners actual assets. Social Security benefits end with the death of the recipient.
  • There is actually Social Security in Australia, along with a law mandating Superannuation Funds. In the Treaty, Social Security referenced actually refers to Social Security.

The reasonable interpretation of the laws and treaties would indicate the “Social Security” that the US-Australia Tax Treaty references is the actual Australian Social Security program not a Superannuation Fund.  Therefore, it is impossible, unfortunately, to interpret the treaty as exempting this income from taxation in the United States.

If you have never disclosed your Australian Superannuation on a FBAR, or need assistance in preparing the necessary tax forms to meet your tax compliance obligations, please contact Freeman Tax Law for a consultation to schedule a confidential consultation.