New FATCA Regulations Solve Some Issues for Pension Plans, But Other Problems Remain Authors: James P. Klein, Susan P. Serota
For multinational companies, it is increasingly common to move key employees in and out of different countries – a practice that can trigger a variety of issues. New regulations proposed in February offer some relief for companies with an international workforce, as they indicate that most non-U.S. pension plans will be treated by the U.S. as “deemed compliant” with Foreign Account Tax Compliance Act (FATCA). But multinational employers still have reasons to look closely at pension-based U.S. tax liabilities affecting mobile employees.
There are many issues around a “mobile” workforce, including pay levels, immigration status, moving families and career planning. One small, but increasingly troublesome aspect of a company’s international operations and employee mobility problems involves pensions and retirement plans. The issues in this area have existed for a long time, but will not go away, notwithstanding treaty changes and favorable regulatory developments. But in at least one area, the application to pension and retirement plans of the Foreign Account Tax Compliance Act seems to have settled on a reasonable approach for some entities, based on the proposed regulations that came out in early 2012 under this Act. While this is a development to be applauded, other issues will remain. This advisory looks at the developments in this area from the perspective of financial institutions supporting pension plans, as well as from the perspective of the individuals participating in these plans and the multinational companies sponsoring them.
Background on U.S. Tax Laws and Non-U.S. Pension Plans
The U.S. takes a very parochial view of pensions under U.S. tax law. It starts with the internationally unusual position that U.S. citizens and residents (resident either by physical presence in the U.S. or though immigration status – holding a “green card”) are taxable on worldwide income, without regard to source or residence. The U.S. then applies its domestic tax laws to other countries’ pension and deferred compensation plans. What this means is that a U.S. citizen or resident who works outside the U.S. and is covered by a non-U.S. pension or a supplemental executive retirement plan or “SERP” (a type of nonqualified deferred compensation plan) has to apply U.S. tax laws to the taxation of that pension. For unfunded pensions and SERPs, there are a number of important exceptions under U.S. tax law for foreign plans (for example, under section 409A of the Internal Revenue Code of 1986, as amended (“IRC”) and the regulations). But unfunded plans are not the only retirement plans found in those countries that are the major trading partners to the United States.
For funded plans, the rules are very harsh: the U.S. views all foreign pension plans, including ones registered or approved by the local tax authority, as “nonqualified” for favorable U.S. taxation. This means that if the employee has a “vested” (nonforfeitable) interest in the plan, then the employee has current income while earning the pension, taxable well before anything is paid out. This rule has extremely complicated tax aspects to it, and for many years was not diligently enforced by the IRS. There are some U.S. income tax treaties that reduce, or in some cases eliminate U.S. tax, but these treaty provisions require careful analysis, as well as intricate procedural hurdles for both the employee and the employer in order to get the favorable tax results. The result is that the employees participating in non-U.S. pension plans may well face current tax without any cash and the employer may have reporting and withholding requirements.
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