Australian Superannuation US tax treatment: Separating fact from (wishful) fiction
by: Anthony Parent
US persons are taxed on their worldwide income, even if there is income generated in a tax-deferred account in another country. This is especially a problem for US Expats in Australia, and for Australian immigrants to the US who still have assets that earn income overseas. We recently came across an article claiming that the entire US tax industry is treating all Australian Superannuation funds incorrectly. And the writer of the article claims he has the best solution. No doubt the entire US tax treatment of Australian Superannuation Funds held by US persons is complicated and can be onerous. However, some cases are actually pretty simple. In this article we analyze the claims made and help clarify the issues so that the US holder of an Australian Superannuation can be empowered to make up their own minds if they have a big issue or not.
Some background. Why you want your Superannaution to be an Employee’s Trust and not A Grantor’s Trust
The number one concern of an Australian Superannuation, whether Self-Managed Superannuation Fund (SMSF) or not, is whether it is classified for US tax purposes as a Grantor Trust or an Employee Trust. We always hope for a Employee Trust. Why? Because if it is classified as an Employee’s Trust the reporting is relatively easy and there no tax is due until the date of distribution (which still isn’t great, but it is better than being taxed on its growth).
The reasons we hope our clients aren’t dealing with a Grantor Trust is that:
Taxes will likely be due on growth in the fund year over year even though it is a tax -deferred vehicle in Australia.
The Test for Determining Employee’s Trust or Grantor Trust
What is the test to determine if an Australian Superannuation Fund is an Employee Trust or Grantor Trust? The IRS’s test is based on contributions. If an employee’s contribution is equal or less than the employer’s then it is an employee trust. For example, if you contirubte nothin of your own or up to 9.5% a year, and your employer contribute its mandated 9.5% a year, and you put no more money in, you have an Employees' trust. This could be true even if you have a SMSF.
Once you go over the 50% contribution you are really taking a chance claiming it is an Employee’s trust; but I'm not saying that a challenge to this rule can’t prevail. The first issue with the article is the inaccurate claim about ignoring the primary inquiry of determining if a Superannuations is Grantor or Employee’s trust. The second sentence reads:
“The problem is that nearly every accounting firm in the U.S. is treating Australian Superannuation as a taxable foreign grantor trust.”
I cannot think of one US tax practitioner that claims that all Australian Superannuation Funds are Grantor trusts. Assuming that all tax practitioners are behaving this way can lead to problems —because if it is an Employee’s Trust there is not that much of an issue.
The claim that Australian Superannuation Funds are a Social Security analogue, thus non-taxable, falls apart upon closer inspection.
The meat of the claim by the article’s author, John Castro, is that the US-Australian tax treaty states Australian social security is exempt from US taxation. This part is true. Yet, where the train derails is where Mr. Castro makes a leap and claims that Superannuation Funds are actually Australian Social Security and not a private pension.
Granted, like Social Security, Australian Superannuation Funds are both mandated and are for retirement. But that’s about where the similarity ends. Consider:
Social Security is a pooled investment, Superannuations are personalized
Social Security has no account number. A Superannuation fund does.
Social Security checks are written by the government. Superannuation Fund check are not. This is an important distinction as the treaty defines Social Security as something the government pays.
A Superannuation Fund holder has control over the investments. A social security participant has none.
Superannuation funds can be left to heirs. It is the fund owners actual assets. Social Security benefits end with the death of the recipient.
There is actually Social Security in Australia, along with a law mandating Superannuation Funds. In the Treaty, Social Security referenced actually refers to Social Security.
The reasonable interpretation of the laws and treaties would indicate the “Social Security” that the US-Australia Tax Treaty references is the actual Australian Social Security program. Overcoming the obvious language is an unlikely, if not impossible, task. It is a tax position no other practitioner I know would ever take.
File properly or not at all
As Circular 230 practitioners we always advise tax compliance. If I could give the tax advice that it is better to do nothing, than something you know is incorrect, I would. The problem with incorrect filings and submissions is two-fold. First, you alerted the IRS that you exist. Second, whatever you submittedt is a roadmap to audit you. Worse, the advice of an incompetent practitioner is not a basis for penalty mitigation or abatement. Ultimately, as the taxpayer, you are primarily responsible for every tax form you sign. As crazy as it may sound, you can not delegate your duty of care to a tax practitioner.
If you are thinking of making a disclosure about an unreported Superannuation Fund, or already have made a submission are are worried it might be incorrect, feel free to contact us for a first or second opinion. Call us at 888-727-8796 or email firstname.lastname@example.org. Any information you share with us will be kept confidential.