Amplifying its efforts to crack down on U.S. taxpayers’ use of Malta pension funds to attempt to achieve federal income tax savings, the IRS recently has issued proposed regulations identifying these funds as listed transactions and appears to have launched criminal investigations into these plans.
Background
Some U.S. taxpayers have been taking the position that a combination of the income tax treaty between the United States and Malta and local Maltese law regarding person retirement schemes provides them with an exemption from federal income tax for income associated with pension funds that they establish in Malta.
Here’s a brief explanation. The U.S.-Malta income tax treaty prohibits each state from taxing a pension plan established in the other state that is beneficially owned by an individual resident of the first state if the pension plan would be exempt from taxation in that other state.[1]
Some examples of U.S. pension plans where this provision could apply include an individual retirement account (IRA) under section 408 or a Roth IRA under section 408A of the Internal Revenue Code with an individual beneficiary who is Malta resident.[2] Generally, amounts in an IRA are not taxed until there is a distribution.[3] Likewise, a Roth IRA generally is not taxed on its earnings, and certain distributions from a Roth IRA may be exempt from tax.[4] There are certain limitations, however, on what constitutes and IRA and Roth IRA. Non-cash contributions are prohibited, and such contributions must be limited to the individual’s earned income.[5]
U.S. taxpayers have argued that Malta’s Retirement Pension Act of 2011 should entitle them to a similar exemption from U.S. federal income tax under the treaty with respect to earnings in and distributions from these schemes. The IRS has provided an example of this fact pattern:
[T]he taxpayer (Taxpayer A), a U.S. citizen or a U.S. resident alien, establishes a personal retirement scheme under Malta’s Retirement Pension Act of 2011. In Year 1, Taxpayer A transfers cash, appreciated property (annuities, securities, digital assets, partnership interests, etc.), or a combination thereof, to the scheme without recognizing gain on the transfer . . . . In Year 2 or later, Taxpayer A takes the position on a U.S. income tax return that the income earned by the scheme (including gain on the sale or other disposition of appreciated property initially transferred to the scheme) is exempt from U.S. tax under . . . the Treaty because the scheme is a ‘‘pension fund’’ for purposes of the Treaty. In Year 3 or later, Taxpayer A receives a distribution from the scheme and takes the position on a U.S. income tax return that such distributions are exempt from U.S. tax by reason of . . . the Treaty. Additionally, Taxpayer A may not comply with U.S. information reporting requirements related to these transactions, including under section 6048.[6]
Prior IRS Responses
The IRS contends that the positions taken by these taxpayers is incorrect and the income for which these taxpayers are claiming exemptions from tax is in fact taxable. The IRS notes that many U.S. taxpayers who have made use of Maltese pensions have no connection to Malta.[7] The IRS also identifies certain differences between Maltese pensions and those under U.S. law, such as an IRA or Roth IRA, which qualify for exemptions from federal income tax:
Maltese law does not condition the tax benefits it provides for these arrangements upon reasonably analogous requirements of U.S. law. Those requirements include that an individual’s contributions to an individual retirement arrangement (other than qualified rollovers from a pension or retirement arrangement that is tax-favored under the same country’s laws) must be made in cash and must be based on income earned from employment or self-employment activities.[8]
The IRS has sent out warnings regarding U.S. taxpayers’ use of Maltese pensions over the last couple of years. In 2021, the IRS included Maltese pensions in its “Dirty Dozen” list of tax schemes for that year.[9]
Later that year, the competent authorities of the United States and Malta reached an arrangement regarding the definition of the term “pension fund” in the income tax treaty between the two countries. Under this arrangement, “pension fund” is defined as:
any person established in a Contracting State that is:
i) in the case of pension funds established in the United States, generally exempt from income taxation, and in the case of pension funds established in Malta, a licensed fund or scheme subject to tax only on income derived from immovable property situated in Malta; and
ii) operated principally either:
A) to administer or provide pension or retirement benefits; or
B) to earn income for the benefit of one or more persons meeting the requirements of subparagraph i) and clause A) of this subparagraph.[10]
The competent authorities also agreed that a fund or scheme established in either state that, except in the case of a qualified rollover from a pension fund established in the same state, is allowed to accept non-cash contributions from a participant or doesn’t limit contributions by reference to earned income from the personal services of the participant or the participant spouse isn’t operated principally to administer or provide pension or retirement benefits and is therefore not a “pension fund” within the meaning the treaty.[11] The purported takeaway from the competent authorities’ arrangement is that U.S. taxpayers cannot claim treaty benefits with regard to Maltese pensions under the typical fact pattern identified by the IRS.[12]
In 2022, the IRS again included Maltese pensions in its “Dirty Dozen” list of tax schemes for that year.[13]
Recent IRS Responses
The proposed regulations making Maltese pensions a listed transaction would apply to any transaction that is substantially similar to one in which:
(i) A U.S. citizen or U.S. resident alien, directly or indirectly—
(A) Transfers . . . cash or other property to a personal retirement scheme established under Malta’s Retirement Pension Act of 2011 (a ‘‘Malta personal retirement scheme’’), or
(B) Receives a distribution from a Malta personal retirement scheme, and
(ii) A U.S. citizen or U.S. resident alien described [above] takes a position on a U.S. Federal income tax return that—
(A) Income earned or gain realized by the Malta personal retirement scheme is not includible on a current basis in income for U.S. Federal income tax purposes by reason of the income tax treaty between the United States and Malta, or
(B) A distribution received from the Malta personal retirement scheme attributable to earnings or gains that have not been included in income for U.S. Federal income tax purposes is exempt from U.S. taxation by reason of the income tax treaty between the United States and Malta.[14]
As a result of being named a listed transaction, taxpayers must disclose to the IRS whether they have participated in a Malta personal retirement scheme.[15] A taxpayer’s failure to report these transactions can lead to hefty penalties. For example, natural persons who fail to report a listed transaction face a minimum penalty of $5,000 and a maximum penalty of $100,000, plus accuracy-related penalties relating to any understatement of federal income tax attributable to the listed transaction.[16] The IRS has also indicated that Malta personal retirements schemes could be required to file certain international information reports such as the Form 3520 (Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts, and Form 3520–A, Annual Information Return of Foreign Trust With a U.S. Owner (Under section 6048(b)) and the Form 8938 (Statement of Specified Foreign Financial Assets).[17]
Material advisors also are required to report Malta personal retirement schemes as listed transactions and/or to keep a list of all such transactions with respect to which they were a material advisor.[18] A material advisor’s failure to adequately report listed transactions could result in a penalty in an amount equal to the greater of $200,000 or 50% of the gross income derived by the material advisor from aiding, assisting, or advising which is provided in connection with the listed transaction, with the percentage being increased to 75% for an intentional failure or act.[19] A material advisor who fails to provide a list of reportable transactions to the IRS within 20 days of receiving a request for such information may face a penalty of $10,000 for each day such failure occurs after the 20th day.[20] Additional penalties also could apply.
Recently, taxpayers who have participated in Malta personal retirement schemes also reportedly have been approached by IRS criminal agents, further increasing the pressure on the use of these schemes by U.S. taxpayers.
[1] Convention Between United States and Malta for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income, arts. 17(1)(b), 18.
[2] Dep’t of Treas. Technical Explanation for the Convention Between the United States and Malta, art. 17(1); 88 Fed. Reg. 37189 (June 7, 2023).
[3] See I.R.C. §§ 408(d)(1), (e)(2).
[4] See I.R.C. §§ 408(d)(1), (e)(2), 408A(a), (d).
[5] See I.R.C. §§ 219(b)(1)(A), 408(a)(1), 408A(b), 7701(a)(37)(A).
[6] 88 Fed. Reg. 37190.
[7] 88 Fed. Reg. 37190.
[8] 88 Fed. Reg. 37191.
[9] IRS Wraps up its 2021 Dirty Dozen Scams List with Warning About Promoted Abusive Arrangements.
[10] United States and Malta Competent Authority Arrangement Regarding Pension Funds.
[11] Id.
[12] XXXXX
[13] IRS Warns Taxpayers of Dirty Dozen Scams for 2022.
[14] 88 Fed. Reg. 37194 (proposing Treas. Reg. § 1.6011-12(a), (b)).
[15] See I.R.C. §§ 6011(a); Treas. Reg. § 1.6011-4(a).
[16] See I.R.C. §§ 6707A(b)(2), (3), 6662A.
[17][17] 88 Fed. Reg. 31790.
[18] I.R.C. §§ 6111(a), 6112.
[19] I.R.C. § 6707(b).
[20] I.R.C. § 6708(a).
