Overview

In the early 1990’s while attending the University of Miami School of Law, aka Harvard of the South, I worked in the Miami Agency of the National Life of Vermont (NLV). The Company always had a strong propensity towards advanced planning.

In my view, life insurance salesman are the best salesmen in the financial services sector or any industry for that matter. After all, it is a difficult proposition to sell a product to a prospect that requires a discussion about an event that the prospect has no interest in discussing - dying. As a result, life insurance salesmen have been infinitely more creative than other financial salesmen in order to sell “big ticket” life insurance policies.

One of the advanced planning strategies to emerge around that time centered around the charitable remainder trust. As I remember, a former Manulife general agent, Elton Brooks, created Renaissance Trust, a trust specialized in the administration of charitable trusts. The company marketed charitable remainder trusts through life insurance agents who could sell life insurance policies to replace trust property ultimately passing to charity.  Fast forward 25 years or so, and the current configuration of Renaissance Trust has approximately $20 billion of charitable trust assets under administration.

The question arises as to how and where Malta Pension Plans and Charitable Remainder Trusts intersect. The Malta Pension Plan can serve as an alternative to the Charitable Remainder Trust for many taxpayers. This article outlines how the Malta Pension Plan for taxpayers that are not driven by their philanthropic motivation which is to say most taxpayers, can use the Malta Pension Plan to dispose of capital assets without tax consequence and reinvest the proceeds on a tax-favored basis.

The Tax Doctrine of “Me, Myself and I”

In making the observation that most taxpayers are driven by their own self-interest rather than their philanthropic interest, I would not consider myself to be the modern day Plato. To test that observation, all I would need to do is look in the mirror.

In my personal experience of working with financial service professionals and their clients, most people who set up a charitable remainder trusts are not looking to donate significant amounts to charity but instead are motivated by the tax incentives of the charitable remainder trust. At the time the taxpayer created the charitable remainder trusts, the taxpayer most likely had not been considering a large gift to charity.

The charitable remainder trust and other planning giving strategies have been heavily marketed by the not-for-profit sector for decades. Financial service professionals through their professional and personal involvement with these charitable organizations have promoted the charitable cause. The charity needs the funds while the investment advisor can manage the assets. The life insurance agent can sell life insurance to replace the assets lost to the taxpayer’s family.

Nevertheless, the taxpayer facing a large tax realization event such as the sale of a company, real estate or some other capital asset, who is motivated by minimizing the tax consequences of the sale, is frequently presented with the charitable remainder trust, as a planning solution to minimize the tax consequences associated with the sale. In many cases, the amount of the size of the donation may still be more than the taxpayer originally intended based on the minimum requirement that the remainder interest must be at least equal to ten percent of the gift.

The decision-making matrix is usually guided by the tax doctrine of “Me, Myself, and I,” e.g. which strategy produces the most money for the taxpayer. In the taxpayer’s defense, the philanthropic option is not a question of being non-existent, but rather a question of “not now”, or “not that much.”  As a result, the Malta Pension Plan presents itself as an excellent option for taxpayers when facing a large tax realization event such as the sale of a company.

The Malta Pension Plan as An Alternative to a Charitable Remainder Trust

In order to understand and appreciate the benefits of a Malta Pension Plan as an alternative to a Charitable Remainder Trust (CRT), we need to summarize and appreciate the CRT. The Charitable Remainder Trust (CRT) is an irrevocable agreement in which the taxpayer/donor transfers assets to a trust in exchange for an income interest. 

The trust is known as a split interest trust. The trust is "split" between an income interest and a remainder interest which passes to one or more charities. The charitable remainder trust is exempt from income taxation and allows the donor to claim an income tax charitable deduction based on the value of the remainder interest. The value of the remainder interest needs to be at least ten percent of the gift.  

The arrangement permits the tax-free sale of appreciated assets and irrevocably designates the remainder portion between one or more charitable beneficiaries. The charitable beneficiary can be a single beneficiary, donor-advised funds, and private foundations.

The donor enters into a trust agreement with the trustee to transfer certain assets to be managed and maintained by the trustee. In accepting the assets, the trustee agrees to pay an income stream to one or more designated income beneficiaries for the rest of their lives or a designated period of time (term of years). At the expiration of the trust term, the trustee of the charitable remainder trust delivers the remaining trust assets to the charitable remainder beneficiary.

CRT distributions to income beneficiaries are taxed using a unique four-tier system of accounting. This system utilizes a "worst -in-first-out" method for characterizing income distributions in the hands of the income beneficiaries. Each item of income earned by the trust must be separately tracked according to type (e.g. interest, dividends, capital gains, tax-exempt interest, etc.). Then each type of income is "used up" starting with items taxed at the highest rate moving to items that are taxed at the next lower rate. The end result is that ordinary income items, such as interest, are passed out first (Tier I), followed by short-term capital gains, then long-term capital gains (Tier II), tax­ exempt interest (Tier Ill), and finally trust principal (Tier IV).

Any CRT earnings in excess of the income beneficiary distributions are retained in the trust in a tax-free environment and combined with future transactions for characterizing future income beneficiary distributions. Note that while the CRT avoids taxation on capital gains realized from the sale of appreciated assets, such gains may be used to characterize future income beneficiary distributions.

The taxpayer may use several forms of a charitable remainder trust. The principal distinction between the various forms of charitable remainder trust is the manner in which the trust agreement defines the income interest. The trust must specify that the income interest will be paid as: (a) a fixed amount (annuity) k n o w n as a Charitable Remainder Annuity Trust, or CRAT) or (b) a fixed percentage of the trust's assets revalued annually (a Charitable Remainder Unitrust, or CRUT).

The longer the charity must wait, and the greater the income payments to the income beneficiaries, the lower the amount of the charitable deduction. This computation is complex and is generally performed using specialized software. The amount of the deduction of the gift of the charitable remainder interest is generally limited to thirty percent of the donor's adjusted gross income for most long term capital gain property for public charities and twenty percent to private foundations. Deductions that are denied because of the deduction limitations, may be carried over for the next five tax years.

One major limitation of the CRT are the rules dealing with self-dealing and unrelated business taxable income (UBTI). The UBTI rules are designed to prevent tax-free treatment to investment income that is unrelated to the charitable purpose of the public charity. The consequences of UBTI treatment are severe for a charitable remainder trust. Previously, even a dollar of UBTI within a charitable remainder trust would disqualify the trust. IRC Sec 664(c) now imposes a 100 percent excise tax on any UBTI within a charitable remainder trust.

Overview of Malta Pension Plans (PLAN)

The Malta Pension Scheme is a surrogate to the Roth IRA. The taxpayer is able to make an unlimited contribution to the Malta Pension Plan. Unlike the Roth IRA, the taxpayer may make in kind contributions to the PLAN through the contribution of the asset or an interest in an entity holding the asset.

All of the income within the Malta Pension Plan is tax-deferred. The Plan is not subject to unrelated business taxable income (UBTI). The Plan is treated as a grantor trust from a federal income tax perspective. As a result, the contribution of an appreciated asset will not trigger any tax consequences on the transfer of an asset.  As a result, of the foreign grantor status treatment, the Plan will avoid UBTI treatment of debt financed real estate and business income within the PLAN. This is significant advantage in favor of the PLAN over the Roth or traditional IRA.

Malta law permits distributions to be made from such plans as early as age 50.The rules allow an initial lump sum payment of up to 30% of the value of the member’s pension fund to be made free of Maltese tax. Based on treaty provisions, distributions that are non-taxable for Malta tax purposes are also non-taxable in the United States. Under Malta law, three years must pass after the initial lump sum distribution before additional lump sum distributions could be made to a resident of Malta tax-free. In Year 4, the PLAN may distribute additional funds to the participant. Lump sum distributions in excess of a minimum annuity amount may be made every year. Fifty percent of the distribution in excess of the annuity amount is tax-exempt, and fifty percent is taxable.

U.S. Tax Compliance Requirements

Participation in the PLAN requires compliance with the FinCEN reporting requirements for foreign bank and financial accounts. FinCEN Form 114 (Report of Foreign Bank and Financial Accounts) must be filed annually with the Financial Crimes Enforcement Network (FinCEN), a bureau of the Department of the Treasury.

Code Section 6038D, also enacted as part of FATCA, requires that any individual who holds any interest in a “specified foreign financial asset” must disclose such asset if the aggregate value of all such assets exceeds $50,000 (or such higher dollar amounts as may be prescribed).

IRS Form 8938 is used to report specified foreign financial assets if the total value of all the specified foreign financial assets in which you have an interest is more than the appropriate reporting threshold. As a foreign grantor trust, the taxpayer will most likely be required to file Form 3520.

Summary

The Malta Pension Plan is a powerful vehicle designed to provide for substantial tax deferral in a manner similar to the Roth IRA. The PLAN advantage with respect to real estate investment is much greater due to the ability to use debt-financing without subjecting the plan to the UBTI rules. The Plan has no contribution limits. The taxpayer may contribute real estate assets. At distribution a substantial portion of the deferred income may be distributed without taxation in Malta or the United States. Taxpayers looking for a long-term tax deferral without contribution limitations and complicated tax hurdles such as UBTI, should consider the Plan as a planning structure for real estate investments.

Similar to the CRT, the Plan provides the opportunity to dispose of appreciated assets without the necessity of leaving a minimum of ten percent of the value of the asset to charity. Investment income within the Plan avoids current taxation. The taxation of distributions from the Plan is more favorable than the CRT without any fear of adverse taxation related to UBTI.