How the Australian superannuation fund impacts US tax returns
Superannuation funds (“super funds”) are the Australian version of a pension or retirement plan, where your employer puts at least 9.5% (10% from 1 July 2021) of your salary annually into a super fund, which you can then access upon your retirement.
Super funds held by Americans living in Australia can be quite difficult to account for on US tax returns, leaving many American expats confused about what to do.
Why do super funds complicate my tax return?
Under the Foreign Account Tax Compliance Act (“FATCA”), Americans who hold financial assets outside of the US must report these assets to the IRS on form 8938, although there are other forms that may also need to be filed. The term ‘financial assets’ includes the majority of super funds.
A super fund is different to a 401(k) plan (the US company sponsored retirement plan scheme) because one of the rules of a 401(k) plan is that the retirement plan must be created in the US. This means that super funds can never be qualified plans in the eyes of the IRS and the Double Tax Agreement is of little help.
What does a super fund do? Is it a trust?
The purpose of a super fund is to help save for retirement. These super funds are not held in the name of the recipient but rather with a fiduciary, and, as this is a third party taking partial or full responsibility and/or control of the funds, this will make the super fund a foreign trust in the eyes of the IRS.
Is my super fund a foreign grantor trust?
If you are unsure as to whether your super fund meets the criteria of a foreign grantor trust, the IRS has set out a list of rules in Internal Revenue Code sections 671 through 679. These sections look at who has control of the super fund and who is the owner. If you are the owner or have control of the super fund, this status brings with it burdensome US tax filing requirements as the IRS say you have a foreign grantor trust.
I want more information about Australian Superannuation
Why doesn’t everyone with a foreign trust have to fill in forms 3520 and 3520-A?
Forms 3520 and 3520-A are forms that must be submitted separately to your tax return if you are the owner of a foreign grantor trust. These forms show the transactions, ownership and income of a foreign trust.
The reason that not everyone has to file forms 3520 and 3520-A for their super fund is that there are different types of super fund, with the most common being a retail super fund and a self-managed super fund. These types of super fund have different levels of control attached to them.
Retail super funds
If you are in a situation where your employer is contributing more than you to your super fund, your super fund is with a large custodian (e.g. AustralianSuper) and you have little power or control over your fund (typical of retail funds), then you can probably take advantage of the exemption from filing foreign trust returns, however there is still a liability to income tax under section 402(b). This is why the majority of Americans in Australia do not have to file forms 3520 and 3520-A for their super funds.
Self-managed super funds
Self-managed super funds (“SMSF”) almost always create US tax problems as they are usually foreign grantor trusts. This is because SMSFs allow for a much broader investment strategy, generally under the control of the US owner. For example, the trust deed may allow you to buy specific shares and trade on the stock market, as well as even purchase properties within the SMSF. While you cannot take money out of the SMSF, and use it as a standard bank or brokerage account, the IRS will tax you on the gains as the SMSF is not a qualified foreign retirement plan in the eyes of the IRS. If you have a SMSF then you will have to file forms 3520 and 3520-A, but you may not actually end up paying more tax to the IRS due to the operation of the foreign tax credit regime.
Contributions to a super fund
In Australia, there are generally two ways that money can be put into a super fund. Usually it is through the employer, however individuals can also contribute on a pre or post-tax basis subject to contribution limitations. The pre-tax contributions generally reduce your Australian taxable income but not your US taxable income. However, there is usually no US tax due because of the foreign tax credit regime.
Excess foreign tax credit
Because Americans living in Australia pay so much Australian tax, they usually end up with excess foreign tax credits. This is because the US tax due on the same sources of income is generally less than the Australian tax payable on that income.
You can use these foreign tax credits to offset the US tax that would otherwise be due in relation to your super fund to avoid being double taxed. This is why in practice most Americans will not pay US tax in relation to their super funds when your tax returns are prepared by an international tax expert. Any foreign tax credits not utilized (the foreign tax credit carryover) are essentially a dollar-for-dollar credit against future US taxes, which are good for up to 10 years.
What if I haven’t been filing US tax returns?
If you haven’t been filing US tax returns, or you haven’t been handling your super fund correctly on your US tax returns, there is a way to fix this.
You can rectify this using the Streamlined Filing Compliance Procedures, which allows you to file tax returns and clean-up your IRS reporting. While the IRS may not currently know about your super fund, and this is why you haven’t been penalized, when you start to take distributions in retirement the IRS will know and, unfortunately, all of the income will be taxable. This is a big problem as Australia does not tax retirement distributions from super funds in most instances, so there is no foreign tax credit available to offset the US tax.
What happens if I don’t file properly?
Although FATCA may exclude super funds from Australian Central Bank/Government reporting, this doesn’t mean that you do not have to include the information on your US tax return and file forms 3520 and 3520-A if applicable. The IRS is getting better and better every day at detecting foreign income and assets and generally the penalties are the greater of $10,000, 5% of the value of the super fund or 35% of the value of the distributions.
How can I get professional help?
Because the rules covering tax returns for American expats are so complex, it is recommended that you consult a professional before you file your taxes. This is because it can be difficult to know exactly which laws apply to you and what you need to file. There are large financial penalties if you submit your information to the IRS incorrectly, and professionals can help you at every step of the way, so contact a professional before filing your taxes.