UNITED STATES IRC 402(b) LAW (1986) UNLEASHES TAX OFFSHORE
The U.S. Tax system is generally hostile to foreign financial structures if there is a U.S. taxpayer or U.S. beneficiary involved. The hostility is understandable-foreign structures interfere with government ability to impose or collect tax. Avoiding international tax pitfalls can be best achieved, both foreign and domestic, by means of an IRS and internationally recognized 402(b) foreign retirement fund. Pension law is recognized in Common, Civil and Sharia law countries is regulated by government and registered by governance in mutual respect to provide citizens safety, security and survivorship which are all protected by law.
This article highlights the basics in pension law internationally and that is specifically mentioned in the Foreign Account Tax Compliance Act (FATCA), Double Tax Treaties (DTA) and Tax Information Exchange Agreements (TIEA) none of these acts, treaties or agreements mention Trusts, Life Insurance Companies nor other financial intermediaries or structures.
The 402(b) Foreign Government Regulated, Registered, and Recognized Retirement fund is FATCA Compliant. The 402(b) is not subject to FATCA withholding. FBAR is filed at highest annual value and IRS Form 8938 is filed as ”Zero Value”.
There are no other filing forms required which means simplified tax reporting that you can complete yourself. The further benefit is tax deferral is achieved because the contributions, the accumulations of income and gains on the contributions, together or separately, are never vested in the member, not by contract nor by US law, the result will be tax deferral. This specific IRC 402(b) is excluded from probate, inheritance and estate tax and has statutory legal asset protection that is not subject to claims, counter-claims, new parties joined, summons, discover, depositions, interrogatories, nor court judgments.
This foreign investment account is all laid out for you in the law. (IRS Code, Rulings and Guidelines and also if you look at US Treasury commentary as well as the IRS and Treasury commentaries. Also, read FATCA, TIEA and Double Tax Agreements).
IRC 402(b) Solves Foreign Account Tax Compliance Act (FATCA) issues:
Foreign Financial Institutions, partnership, corporation, IBC, Trust, Estate, shares, funds, non-compliant life and annuity policy, stock in a foreign corporation and any pass thru entity may be subject to enforcement of up to 60% withholding on transfers.
The most consequential part of the FACTA legislation is the severe penalties that the law imposes on foreign financial institutions that are found not to be in compliance with new mandated reporting on financial activity of their U.S. clients. Foreign financial institutions not complying with the rigorous reporting requirements will be subject to a 30% withholding tax on all U.S. sourced payments. It is important to understand clearly what that implies: any financial institution anywhere in the world not voluntarily complying with FATCA will find that 30% of any U.S. sourced payment (e.g. Microsoft dividend, maturing principal payment from a U.S. corporate or government bond) will be withheld. Because U.S. stocks and bonds are so widely owned globally, virtually all financial institutions everywhere in the world receive substantial U.S. sourced payments, mostly on behalf of clients who have no connection to the U.S. Allowing 30% of these payments to be withheld will not be an acceptable option. Additionally 30% of any funds sent from the USA to a non-compliant financial institution will be withheld by the U.S. financial institution. That means a potential 60% withholding on to and from transfers.
IRC 402(b) Solves the Passive Foreign Investment Company (PFIC) issues:
A Passive Foreign Investment Company (PFIC) includes income, dividends, interest, gains from sale or exchange of investment property (including commodities), partnership, corporation, IBC, Trust, Estate, shares, funds, non-compliant life and annuity policy, stock in a foreign corporation and any pass thru entity. The income that the Trust derives from its sales of physical bullion is expected to be treated as passive income for this purpose. Since substantially all of the Trust’s assets will consist of physical bullion and the Trust expects to derive substantially all of its income from the sales of physical bullion, it is expected the Trust will be treated as a PFIC for each of its taxable years.
Indeed, enforcement of the PFIC tax regime on investments held outside the United States by persons subject to U.S. taxation has been close to non-existent, even though the PFIC tax rules have been around since the 1980s. That is because enforcement relied entirely on self-reporting. The IRS has had no independent way to verify the nature of off-shore investments held by Americans and therefore was severely limited in its ability to enforce PFIC reporting. PFIC reporting rules are an inch wide and a mile deep.
The new FATCA Law completely ”sledge hammers” the law on PFIC rules and made them subject to reporting not only on the existing IRS Form 8621, but also on the new IRS Form 8938. Clearly, Congress intends one of the effects of the new FATCA law to be enforcement of the PFIC rules.
PFIC Sledgehammers tax evasion:
There are IRS special tax filing forms required from Passive Foreign Investment Companies (PFIC) which are charged tax at the highest rate on any income from interest, dividend and capital gains realized within the company; foreign IBC and most trusts can be considered to be a PFIC. The cost of required accounting/record-keeping for reporting PFIC investments can easily run into the thousands of dollars per investment year. Form 8621 (PFIC) must be filed every year for each separate PFIC. Tax filing of a PFIC is extremely complicated, requires a tax specialist, and the IRS assumes you are guilty of tax evasion unless you can prove that you are not guilty.
If you file the Form 5471 for a foreign company, the foreign company could be exempt from PFIC rules; but that is only because the 5471 reports the same information as the PFIC and subject to current reporting at ordinary income rates. Sale of foreign LLC stock is also re-characterized as a dividend and taxed at ordinary rates.
What about a 402(b) guarantee:
By the way, I have heard people respond to our solution that ”this is too good to be true”,” why has my advisor never heard of it”, ”why have I never heard of it” and ”what about a guarantee”.
It’s been around since Reagan was in short pants; the only reason it has become relevant is because with FATCA and IRS 8938, the IRS has woken up to the fact that there is a big wide world out there. There are a lot of people who are involved with pensions plans these days that back in 1986 when the 402(b) became law, or indeed in 1974 when ERISA arrived, they just wouldn’t have dreamt of working outside of the USA…it was just not something that people did; but they do now.
The second question ”Why have my advisors never heard of it?” (it sounds a bit tricky) is that there is no reason for your advisor to have ever heard of it because by definition you don’t have to deal with foreign retirement plan law since a US advisor does not need to study this area of law at all. There are big firms around that have dealt with these laws for years and years. Finally, as to a guarantee, well it is all laid out for you in the law; you see by IRS Code, Rulings and Guidelines and also if you look at US Treasury commentary as well as the IRS and Treasury commentaries on FATCA and then read it in FATCA as it is specifically recognized – foreign regulated, registered and recognized retirement plans are exempt.
The noise made by the State Department, that the rest of the world is bad or loving, has no bearing on the technical side of a 402(b). If you want to have Americans in a 402(b) foreign plan with custodian in the USA that is also fine, it is exactly what these agreements are all about.
FATCA has changed the financial and tax environment for Americans abroad. These changes cannot be ignored. As a result of FATCA, many old and new rules regarding assets held by Americans outside the United States will be enforced to a far great degree than they ever have been before because the IRS for the first time will have easy access to information about these assets. The good news is that these changes will prompt many Americans abroad to take steps that answer their issues.