Malta Pension Plan Exploit: See IRS Warning To Taxpayers

If you frequently visit the IRS website and read through its news releases, you’re probably familiar with the IRS Dirty Dozen. Annually, the IRS releases a list of tax scams to watch out for, especially during tax season. If you have read this year’s Dirty Dozen, you know that the Malta pension scheme was one of the potential tax frauds on the list.

What is Malta Pension Plan?

When it comes to retirement planning, the 401k, traditional IRA, and Roth IRA are the most popular ones Americans use. Some of the account benefits may include contributions of before- and after-tax dollars and a penalty-free withdrawal after age 59 ½. The Malta Pension Plan, on the other hand, is not as widely recognized. However, it can provide high-income taxpayers an alternative option to the typical Roth IRA.

The Malta Pension Plan is a wealth planning tool that US taxpayers use to gain tax deferral and avoidance advantages. The U.S.-Malta Income Tax Treaty makes these benefits possible. The Treaty states that the US cannot tax income earned by a Maltese pension fund until a distribution is made to a U.S. resident.

In some ways, the Malta plan is comparable to a Roth IRA. Roth IRAs allow U.S. taxpayers to avoid taxes on retirement funds. While contributions to a Roth account are taxable, the accumulated interest and earnings on the account are tax-free.

Malta Pension vs Roth IRA

Roth IRAs can have frustrating limitations, especially for high-income taxpayers. For example, Roth IRA benefits are only available to taxpayers within a particular adjusted gross income range. In addition, these taxpayers may only deposit $5,500 annually to their accounts. A six percent excise tax is imposed annually on excessive contributions until the disparity is remedied. Most importantly, U.S. taxpayers cannot transfer assets to a Roth IRA account without incurring hefty tax consequences.

In contrast to the Roth IRA, the Maltese pension does not impose contribution limits, and users enjoy greater contribution freedom. This can include contributions made in the form of assets or an interest in a company holding the assets. The U.S.-Malta Treaty provides broad guidelines for setting up a Maltese pension fund. Thus, allowing some U.S. taxpayers to use the Treaty to protect non-Maltese income.

US-Malta Treaty Abuse

In December 2021, the IRS issued its Dirty Dozen list of tax scams for 2021. The potentially abusive use of the US-Malta tax treaty is among them. According to the IRS, some U.S. citizens and residents rely on an interpretation of the U.S.-Malta Income Tax Treaty (Treaty) to claim they can contribute appreciated property tax-free to certain Maltese pension plans and that there are no tax consequences when the plan sells the assets and distributes proceeds to the U.S. taxpayer. Normally, the gain is reported on plan asset sales and distributions. The IRS is investigating whether these agreements are valid and whether Treaty benefits should be provided, and may contest the accompanying tax treatment.

Earlier this year, the Maltese pension again made it to the IRS Dirty Dozen list as one of the potentially abusive transactions to watch out for. 

This perceived threat appears sufficient to prompt a reasonably quick response, as the United States and the Republic of Malta concluded a Competent Authority Agreement (CAA) addressing the term “pension fund.”

US-Malta Competent Authority Agreement (CAA)

In December 2021, the US and Malta signed a Competent Authority Agreement (CAA) to confirm their understanding of the “pension fund” under the US-Malta income tax treaty (Treaty). According to the CAA, a fund, scheme, or arrangement is not operated principally to provide pension or retirement benefits if:

• it permits participants to contribute non-cash assets and
• does not place restrictions on contributions based on income from employment and self-employment activities

Maltese personal retirement plans have these features, so you can’t properly treat them as pension funds for treaty purposes. You can also not treat the distributions from these funds as pension distributions for tax purposes and the application of Articles 17 and 18 of the US-Malta tax treaty.

The CAA prevents US citizens from unlawfully setting up and using personal retirement schemes in Malta to receive Treaty benefits. Typically, these US taxpayers had no ties to Malta. They misconstrued the pension provisions of the Treaty to evade income tax on personal retirement scheme profits and distributions.

Act Quickly

If you engage in a Malta pension plan, know that you are subject to active scrutiny by the IRS. We advise you to act quickly and seek the guidance of a qualified tax professional before filing your tax returns and take any necessary corrective action with respect to your earlier tax filings.