Malta Retirement Plans – The Jig is Really Up!

Things are looking worse and worse for Americans who invested in Malta personal retirement plans. Not only has the Internal Revenue Service (IRS) listed them twice on its Dirty Dozen tax scams list, it has now proposed rules that will require taxpayers and material advisers to specially put the IRS on notice about their use.  Under these rules, the Malta personal retirement plan would be treated as  a “listed transaction”  which is a kind of transaction the IRS believes likely involves tax avoidance.  The taxpayer must identify and report the listed transaction on a special tax form with his or her tax return.  No way the IRS will miss it! It’s clear that the IRS is adamantly pursuing persons who have used these plans.

I have seen a number of these retirement schemes. How a taxpayer may wish to address the ugly tax issues will depend on the precise plan in which he has invested.  Some are foreign trusts, others may be annuities; some may be so-called PFICs… so much depends on the precise parameters of the product.  Careful analysis is required and it is not child’s play.

My latest article on the Malta retirement schemes is written with Jimmy Sexton, LLM,  copied below in full, as published by Bloomberg Tax, June 12, 2023 in Tax Insights, reproduced with permission, link here.  The Bureau of National Affairs, Inc. (800-372-1033) www.bloombergindustry.com

Malta’s Retirement Plans Too Good to Be True for US Taxpayers

When things sound too good to be true, they usually are. That is certainly the case with the Malta personal retirement plans that were marketed to US taxpayers, which have appeared twice on the IRS’s “Dirty Dozen” scams list.

Promoters of the retirement plans promised US taxpayers they could use the US–Malta income tax treaty to receive substantial tax benefits, including the ability to contribute cash or appreciated property tax-free, no limitation on contribution amounts, no immediate taxation on income accumulated within the plan, and substantial tax-free distributions starting at age 50.

Under US tax law, contributions by an employer or employee to a qualified plan, as well as earnings accumulating within the plan, generally aren’t taxed. There also are no information reporting requirements for the taxpayer on investments within the plan, even if it includes foreign income or assets. There is generally no tax due until the taxpayer receives a distribution from the plan.

Foreign retirement plans generally aren’t qualified plans, and their treatment under US tax law is complex. Depending on how they are structured, they can be treated under US tax law as passive foreign investment companies, foreign financial accounts, foreign annuity or other type of contractual arrangements, or foreign trusts. Tax usually isn’t deferred, and there may be punitive taxation and cumbersome international information reporting.

The standard treatment of foreign retirement plans can be modified by an applicable tax treaty. Promoters of the Malta retirement plan claimed the Malta–US tax treaty allowed US taxpayers to contribute cash as well as appreciated property to the plans without triggering tax; permitted earnings within the plan to accumulate tax-free; and provided tax-free distributions after age 50.

The promoters’ interpretation of the treaty allowed plan holders various tax-free withdrawals. Initially, a tax-free lump-sum distribution of 30% of the plan’s value was available at age 50; several years later, further tax-free withdrawals could be taken annually if the plan had “sufficient retirement income.”

Sufficient retirement income was to be computed on a lifetime basis and based on annual national minimum wage in the country where the plan holder was resident. Based on this treaty interpretation, most of the plan’s value could be withdrawn tax-free.

To illustrate how this purportedly worked, consider the following example. Joe, age 54, owns appreciated stock with a fair market value of $120 million and a basis of $20 million. Rather than selling the stock and paying tax, Joe could contribute it to a Malta retirement plan. The plan sells the stock and recognizes a $100 million capital gain, and there’s no tax on this amount because income accumulates tax-free within the plan.

Because Joe is over 50, he can take an initial tax-free distribution of $40 million (30% of the plan’s balance). After four years, Joe can take out another tax-free distribution of 50% of the plan’s remaining balance—$40 million in Joe’s case. He then can take tax-free distributions of 50% of the plan’s remaining balance each year. This example assumes the plan has sufficient retirement income, and there are no accumulated earnings beyond the capital gain from the sale of the appreciated stock.

Unsurprisingly, the IRS wasn’t happy with such tax-free contributions of appreciated property and “retirement” distributions. The hype surrounding the aggressive marketing of such plans resulted in an unexpected turn of events.

In December 2021, the competent authorities of the US and Malta signed an agreement clarifying that the Malta retirement plans were not “operated principally to administer or provide pension or retirement benefits” under the treaty and, as a result, the plans aren’t pension funds and can’t provide tax deferral under the treaty. They further clarified that distributions from the plans were not made in consideration of past employment.

Given the US–Malta agreement and the IRS’s announcement that it will be auditing taxpayers who have invested in the Malta retirement schemes, US taxpayers may find they’re liable for US tax on income generated within the plans. Additional penalties may apply for failure to file international information returns that could include the FBAR, Form 8938, Form 5471, Form 3520, Form 3520-A, and Form 8621.

Very significantly, on June 6, IRS issued proposed Treasury Regulations that, if adopted, would classify such Malta personal retirement schemes and similar transactions as listed transactions, which material advisers and participants must specially report to the IRS. Listed transactions are of a type that are the same as (or similar to) a kind of transaction that the IRS has determined may involve improper tax avoidance.

Accordingly, the IRS requires the taxpayer to identify and report the listed transaction on Form 8886 when filing the tax return. Failure to disclose can result in financial penalties.

US taxpayer participants in such plans now need to consider taking corrective action. This could include a so-called quiet disclosure—filing amended returns, paying late-payment penalties, and paying interest. The danger of a quiet disclosure is that such filings aren’t part of an IRS sanctioned program and don’t provide any protection from audit or punitive penalties.

Streamlined filing compliance procedures are another option for US taxpayers whose use of the pension schemes was the result of non-willful conduct. These IRS-sanctioned programs aim to regain tax compliance and are available to taxpayers who can certify that their failure to report foreign financial assets and pay all tax due in respect of those assets did not result from “willful” conduct on their part. Under the streamlined procedures, US taxpayers would be subject to a maximum penalty of 5% of the balance of the retirement plan and would need to pay tax and interest on any unreported income.

Taxpayers whose noncompliance was willful could come clean via the IRS’s voluntary disclosure program, under which US taxpayers would need to file amended returns and pay any back taxes, plus penalties and interest. The downside is that taxpayers have no protection against punitive penalties. They do, however, avoid an IRS recommendation of criminal prosecution.

A taxpayer could also do nothing, but that hardly seems prudent given the Malta plans’ inclusion in the Dirty Dozen and the IRS’s avowed audit campaign for those who have used the plans. A tax professional with experience in understanding the Malta plans can assist the taxpayer in making the right decision to regain compliance.

 

Posted June 13, 2023

All the US tax information you need, every week –

Named by Forbes, Top 100 Must-Follow Tax Twitter Accounts @VLJeker

Named by Bloomberg, Tax Professionals to Follow on LinkedIn

Subscribe to Virginia – US Tax Talk  to receive my weekly US tax blog posts in your inbox. My blog specializes in foreign and US international tax issues.

You can access my papers on the Social Science Research Network (SSRN) at https://ssrn.com/author=2779920