The Internal Revenue Service is under tremendous pressure to justify the funding increases it has received from Congress. We expect the IRS will deploy much of the additional funding that is earmarked for enforcement in the high wealth space, and mainly (at first) on promoted transactions that the IRS finds abusive. One of the first will apparently be the Malta pension plan.
In a recent quarterly press call, IRS Commissioner Daniel Werfel was quoted as saying that one of the "swift and aggressive action[s]" the agency is taking to strengthen enforcement efforts against high-income individuals is escalating enforcement efforts around Malta pension plan transactions.
The IRS's actions back that up. Over the past several weeks, its Criminal Investigation division served summonses on multiple entities and people whom it believes were involved with such plans and has proposed making the transaction a "listed" transaction. Either action would be noteworthy on its own, but that combined activity tells a story of deep IRS scrutiny. This article discusses that activity, and provides some high-level options for affected advisors and taxpayers.
Treaty and benefits
The U.S. and Malta signed a tax treaty on Aug. 8, 2008. One of the purposes was to alleviate double taxation. If Malta-based income is taxed in Malta, the U.S. generally will not tax that income a second time.
The treaty contains what is known as a "savings clause," which allows the U.S. to tax its citizens on any income. As this savings clause would otherwise serve to undermine the "no double taxation" portion of the treaty, there are exceptions.
First, "pensions and other similar remuneration" arising in Malta are exempted to the extent that pensions or remuneration would be exempt from tax under Maltese law if the beneficial owner were a resident of Malta.
Second, income earned by a "pension fund" established in Malta is exempted until the income is distributed. These exemptions allow U.S. citizens the option of participating in Malta Pensions, which have different rules than U.S. retirement plans, such as IRAs.
Some have described the combined treaty and the Maltese definition of "pension" as something like a "supercharged" Roth IRA. Most notably, the Maltese pension allows contributions of almost any asset, such as appreciated securities, business interests or real estate. Further, there is no limit on the amount of annual or total contributions. There is no taxation on income earned within the pension, and distributions are taxed under the more favorable Malta scheme, which allows certain lump sums to be distributed tax free.
Maltese pensions allow distributions to begin as early as age 50, as opposed to 59 ½ for a U.S.-based Roth IRA. When taxpayers do finally take that first distribution, they may receive up to 30% of the total fund on a tax-free basis. From then on, the taxpayer receives minimum annual distributions — the "pension." These minimum distributions are taxed as ordinary income. Three years after that first 30% distribution, the taxpayer may begin taking tax-free distributions of 50% of the amount in excess of the corpus required to fund the minimum distributions.
IRS response
In July 2021, the IRS added the Malta pension to its "Dirty Dozen" list. According to the IRS announcement: "Some U.S. citizens and residents are relying on an interpretation of the U.S.-Malta Income Tax Treaty (Treaty) to take the position that they may contribute appreciated property tax free to certain Maltese pension plans and that there are also no tax consequences when the plan sells the assets and distributes proceeds to the U.S. taxpayer. Ordinarily gain would be recognized upon disposition of the plan's assets and distributions of the proceeds. The IRS is evaluating the issue to determine the validity of these arrangements and whether Treaty benefits should be available in such instances and may challenge the associated tax treatment."
Notably, the IRS said the transaction was "potentially" abusive and that the IRS "is evaluating the issue." It is clear that the IRS had not yet reached a conclusion as of the date of this statement, which could, at a minimum, constitute a strong rebuttal to any penalty that the IRS might propose. Importantly, the IRS also advised U.S. taxpayers who were considering such a transaction "to show caution" and advised those who had already participated "to consult independent counsel about coming into compliance."
A few months later, on Dec. 27, 2021, the U.S. and Malta executed a Competent Authority Arrangement. The CAA explains that it "has come to the attention of the competent authorities that U.S. citizens and residents are establishing personal retirement schemes in Malta under the Retirement Pensions Act of 2011 with no limitation based on earnings from employment or self-employment and are making contributions to these schemes in forms other than cash (e.g., securities). Questions have arisen in the United States about whether these personal retirement schemes are 'pension funds' for purposes of applying the Treaty." The CAA answered that they are not. The purported effect is to remove the Maltese Pension from any exception to the treaty savings clause, subjecting U.S. citizens to U.S. tax on any income therefrom.
The IRS again included the transaction on the 2022 Dirty Dozen list in June of that year. This time, however, the IRS warned the public that it had determined that the transaction was improper and that participating taxpayers were "misconstruing" the treaty.
Maltese pensions
On June 7, 2023, the Treasury Department issued Proposed Treasury Regulation 1.6011-12 to designate what the IRS calls the "Malta Personal Retirement Scheme" as a listed transaction. The IRS solicited comments over the following 60 days, and will hold a public hearing on the proposed regulation on Sept. 21. The proposed regulation will not be effective until after the public has this opportunity to comment.
According to the preamble, a listed transaction is a transaction that is the same as or substantially similar to a transaction that the IRS has identified as an abusive transaction and identified by notice, regulation or other form of published guidance as a listed transaction, which is a long way of saying that the IRS has determined the Malta Pension to be an abusive transaction. Notably, however, the proposed regulations expressly limit their application to Malta pension plans, and not to similar plans in any other country (yet).
The proposed regulation also sets out some IRS arguments against the perceived tax benefits: "First, the Treaty benefits claimed with respect to personal retirement schemes established in Malta are not available because these schemes are not 'pension funds,' and their distributions are not 'pensions or other similar remuneration,' as explained in the CAA," it said. "Second, under Article 3(2) of the Treaty, the undefined terms 'pension' and 'retirement' are interpreted according to the tax law of the United States, which is the country that is applying the Treaty. Under U.S. law applicable to individual retirement arrangements, Malta personal retirement schemes are neither 'pensions' nor do they provide 'retirement benefits' for purposes of the Treaty…"
Effect on taxpayers
Assuming the proposed regulation is finalized, U.S. participants in Malta pensions will have no choice but to disclose their participation to the IRS, unless the participant's statute of limitations is closed, lest they risk significant escalated penalties. The proposed regulations provide that anyone who filed a tax return reflecting a Malta pension prior to the date of the final publication of the regulations must disclose that transaction for any tax return where the period of limitations has yet to expire prior to the final publication of the regulations.
A taxpayer's statute of limitations could be three years, six years or forever, depending on whether the taxpayer filed all the required forms, whether the IRS asserts fraud, and whether the taxpayer adequately disclosed the transaction on a return if the transaction caused the taxpayer to omit more than 25% of gross income. Moreover, the structure of the transaction would likely affect multiple tax years, meaning that the statute of limitations could be closed in some years, but open in other years.
Regarding required forms, the preamble to the proposed regulation explains that U.S. taxpayers must annually report information regarding a U.S. person's transfers of money or other property to, ownership of, and distributions from, foreign trusts. The Treasury Department and IRS have, however, relieved most U.S. taxpayers from these reporting requirements in
If a taxpayer's statute of limitations for any period is open when the regulation is finalized, the taxpayer will have to report the transaction to the IRS, and the IRS will have one year to assess any tax with respect to the transaction from that date (unless a material advisor provides the information to the IRS on an earlier date).
Listing the Malta pension may result in stiff penalties for some participants. Failure to disclose a transaction results in a penalty of 75% of the decrease in tax shown on the return as a result of the reportable transaction (with a minimum amount of $5,000 per "natural person" or $10,000 in other cases and a maximum amount of $100,000 for a natural person and $200,000 in other cases.
The Internal Revenue Code also imposes a 20% accuracy-related penalty on any understatement that is attributable to a listed transaction (although the actual computation is complicated). However, if a taxpayer is required to but does not disclose a listed transaction, the penalty rate jumps to 30 percent of the understatement.
And those are just the penalties that are specific to listed transactions. The IRS can pursue other, more general penalties, such as negligence, substantial understatement, or civil fraud, which can be as much as 75% of the amount of any understatement (although the IRS cannot "stack" most penalties).
Effect on material advisors
Once the regulation is finalized, "material advisors" will also have certain disclosure requirements. A person is a material advisor with respect to a listed transaction if the person provides any material aid, assistance or advice with respect to organizing, managing, promoting, selling, implementing, insuring or carrying out the transaction, and directly or indirectly derives gross income in excess of certain threshold amounts for the material aid, assistance, or advice. For listed transactions where substantially all the tax benefits are provided to natural persons, the threshold is $10,000.
Material advisors must disclose transactions on Form 8918, which must be filed with the Office of Tax Shelter Analysis by the last day of the month that follows the end of the calendar quarter in which the advisor becomes a material advisor with respect to a listed transaction (or in which the circumstances necessitating an amended disclosure statement occur).
The IRS will then issue the material advisor a "reportable transaction number" with respect to the disclosed reportable transaction. Material advisors must provide the reportable transaction number to all taxpayers and material advisors for whom the material advisor acts as a material advisor. The reportable transaction number must be provided at the time the transaction is entered into, or, if the transaction is entered into prior to the material advisor receiving the reportable transaction number, within 60 calendar days from the date the reportable transaction number is mailed to the material advisor.
Failure to file a timely disclosure, or filing an incomplete or false disclosure, can lead to stiff penalties, the greater of either $200,000 or 50% of the gross income derived by a person with respect to aid, assistance or advice provided with respect to the listed transaction until the disclosure is filed.
Additionally, material advisors must prepare and maintain lists identifying each person with respect to whom the advisor acted as a material advisor, to be provided to the IRS if requested. A material advisor who does not provide the list upon written request within 20 business days can be liable for a $10,000 per day penalty unless there is reasonable cause.
What's a taxpayer to do?
First and foremost, taxpayers need to confirm they are in compliance with all foreign reporting. Suffice it to say there may effectively be no limitations period for assessments due to a failure to file a foreign information reporting return. Said another way, if the taxpayer did not file the appropriate forms to report foreign holdings, the IRS could have forever to assess tax and penalties.
Aside from any reporting issues, taxpayers need to consider whether they want to "get out" before the IRS really turns up the heat. The IRS has not "listed" many transactions recently, but if past history is any guide, it will audit all (or close to all) participants, resources permitting. From the IRS perspective, that makes complete sense — if it knows (via a disclosure) that a taxpayer has engaged in a transaction that the IRS has determined is abusive, the IRS would almost certainly prioritize that transaction for audit.
If taxpayers are not yet under audit, they may have the option of filing a qualified amended return. If the taxpayer is eligible to file such a return, then the taxpayer can essentially "undo" the transaction and avoid most civil penalties. Eligibility depends on various timing rules, so taxpayers who want to consider this option should speak with their tax advisors.
Criminal investigations
On June 30, the IRS Criminal Investigation Division served summonses on multiple persons and entities whom it believes were involved in Malta pension plan transactions. The summonses seek information from the recipients about U.S. investors. Some summons were served on persons who CI believes provided advice or facilitated participation, and some summons were served on persons who CI believes were participating taxpayers.
Although most taxpayers who participated in these plans should have no reason to fear criminal prosecution, sometimes witnesses misspeak or misremember, documents tell a story different from reality, and government agents and prosecutors simply get it wrong. Consequently, even if a taxpayer has nothing to hide, it is still a dangerous game for them to approach a criminal investigation alone. To that end, taxpayers who are contacted by IRS criminal investigators should consider politely declining interviews unless and until they have spoken with an attorney experienced in sophisticated criminal tax matters.
The same holds true for advisors. There is nothing criminal about providing advice on a technical interpretation of a treaty (provided of course, that the advisor did not willfully provide false advice). Advisors are also being put in a precarious position because the summons may direct the advisor to produce documents pertaining to the advisor's clients. This, obviously, is particularly sensitive, given the advisor may have a duty of confidentiality to the client, and the client may have certain privileges to protect. Once again (and we hope this is stating the obvious) any advisor who receives a summons from IRS Criminal Investigation regarding the advisor or the advisor's clients should immediately retain tax counsel for advice.
Additional taxpayer options
Taxpayers who are proactive are likely to have more options to help themselves avoid potentially adverse consequences than those who are not.
Time is of the essence. Even if they have yet to be contacted by IRS criminal investigators, taxpayers who claimed tax benefits from Malta pension plans would be well served to expeditiously seek out attorneys experienced in sensitive tax matters to assess their exposure. There are a number of events that could occur during the course of the Malta pension plan criminal tax investigation that could restrict taxpayers' ability to "undo" their plans and eliminate their penalty exposure by filing qualified amended returns. For example, to the extent the IRS uses the information it learns to open a Section 6700 civil investigation into the advisors that promoted their particular plan, the initiation of said investigation would foreclose all future qualified amended returns with respect to that plan. The IRS's use of a special type of summons called a John Doe summons or a visit by IRS criminal investigators could similarly foreclose a taxpayer's ability to proactively extinguish his or her penalty exposure.
The IRS has repeatedly warned taxpayers that have participated in a Malta pension plan to consult a tax advisor. Those that don't may soon live to regret it. By ensuring their particular plan is expeditiously analyzed by an attorney with experience handling the types of issues referenced above and by taking appropriate action to either remediate or begin mounting a defense, taxpayers can favorably position themselves to survive the coming IRS scrutiny of these transactions.
