As most U.S. expats living in Australia already know, Australia has a unique retirement system that's quite different from the United States. The cornerstone of the Australian retirement system is superannuation, or a mandatory workplace pension plan created by a company to benefit its employees.
Americans working in Australia should expect to be given superannuation accounts when they begin work. Some common questions we've received from U.S. expats are:
- "What is a superannuation account?"
- "How are superannuations taxed in the U.S.?"
- "How do I report this on my U.S. income tax return?"
Understandably, international tax law can be confusing for many people. In this article, we'll focus on the basic structure of a superannuation account, how superannuations are reported and taxed in the United States, and important considerations that U.S. owners of a superannuation account should consider.
What is an Australian superannuation?
Superannuations ("supers" for short) are a type of retirement investment account that all Australian adults and their employers pay into. While Australian supers are similar in many ways to the U.S. Social Security system—and in other ways, to U.S. pensions and traditional retirement accounts—they are unique to Australia.
Each person receives a super account set up by the Australian government when they begin working. Their employer must contribute a percentage of the employee's earnings into the employee's super. Employees can also make voluntary contributions, subject to certain limitations.
Each individual can choose a management fund to handle the superannuation and invest on their behalf until they retire.
Types of superannuations
There are three main types of super funds Australian workers can select from:
- Private Funds:
- Corporate funds: Employer funds established by employers for their employees with a structure unique to the corporation. Generally, these are only available to people working for a particular employer or corporation.
- Industry funds: Multiemployer funds run by employer associations. You can join if you work within a specific industry, such as hospitality or construction, if your employer is enrolled in that industry.
- Retail funds: Funds managed by financial institutions for individuals. Unlike corporate funds, these are open to everyone.
- Public Funds: Funds are generally only available to employees working for the Australian federal, state, or territory governments.
- Self-Managed Super Funds (SMSFs): Works like any other super fund, but you manage it yourself. As "trustee," you are legally responsible for all investment decisions and for complying with the super and tax laws.
Almost anyone who works for an Australian employer will be eligible for a super fund because employers are required to contribute to the super for all their employees. This results in many U.S. citizens with dual Australian citizenship or permanent residency in Australia having to report their superannuation to the IRS on their annual tax return, potentially incurring U.S. tax liabilities on their super fund.
How are Australian superannuations taxed in the U.S.?
Most people with a foreign pension or retirement plan are concerned about how the IRS will tax their account. Unlike Australian tax law, the U.S. may treat superannuation accounts differently, often categorizing them as either foreign grantor trusts or pensions depending on the circumstances. This classification can have significant tax implications, impacting contributions, earnings, and withdrawals.
U.S. TAX ON SUPERANNUATION CONTRIBUTIONS
Contributions to an Australian superannuation fund can create tax issues for U.S. taxpayers. They do not receive the same favorable tax treatment as contributions to a U.S. retirement account.
Employer contributions:
Australian employers are required to contribute 9.5% of an employee's salary into a superannuation fund (the Superannuation Guarantee, or SG). Any amount above the mandated SG, including salary sacrifice and employer contributions that exceed the minimum, would generally be treated as taxable income in the U.S.
Some tax professionals interpret the SG portion as equivalent to U.S. Social Security contributions, meaning it could potentially be excluded from taxable income on a U.S. return. This interpretation draws on the U.S.-Australia tax treaty and considers the SG portion to function similarly to Social Security benefits. However, there's no clear-cut guidance from the IRS specifically addressing Australian superannuation contributions, which leads to differing interpretations.
Voluntary contributions:
Individuals can make voluntary contributions on a pre-tax or post-tax basis, subject to certain limits. Pre-tax contributions generally decrease your taxable income in Australia, but not in the United States. Nevertheless, U.S. taxes are often not owed due to the foreign tax credit system.
U.S. TAX ON SUPERANNUATION WITHDRAWALS
Withdrawals from an Australian superannuation account can trigger U.S. tax consequences, even though such distributions are often tax-free under Australian law once certain conditions are met. In Australia, individuals who are over 60 years of age or have reached their preservation age and retired can generally withdraw funds from their superannuation accounts without paying tax.
However, U.S. taxpayers must report and potentially pay taxes on these distributions under U.S. tax law. The IRS may tax these withdrawals as part of the taxpayer's worldwide income, regardless of the tax treatment in Australia.
The classification of the superannuation (whether as a pension or foreign trust) will impact how the distributions are taxed in the U.S. In some cases, if earnings within the account have already been taxed annually by the IRS, this may reduce the tax burden on the withdrawals. Currency exchange rates and timing of withdrawals can also affect U.S. tax liabilities.
FOREIGN TAX CREDITS
The foreign tax credit system operates to ensure that individuals are not paying taxes on the same income in both the United States and in a foreign country ("double taxation"). Generally speaking, tax rates in Australia are higher than the U.S., so American expats working in Australia generally pay enough tax that it "cancels out" or "satisfies" their U.S. tax obligation.
If this applies to you, you will likely end up with an excess foreign tax credit that you can use to offset future U.S. tax obligations. The IRS allows taxpayers to carry over the excess foreign tax credits for up to 10 years, essentially offering a credit against future U.S. tax bills.
FOREIGN TRUST REPORTING
To add another layer of complexity, your super account could be considered a foreign trust, a foreign grantor trust, or neither, depending on the taxation agreements between the U.S. and the country where the plan is based.
The IRS recognizes two types of foreign trusts for U.S. tax purposes: Foreign trusts and foreign grantor trusts. The difference is based on ownership and the amount of control you have over the trust.
Foreign trusts are not maintained in the name of the recipient, but rather by a fiduciary. This arrangement involves a third party assuming partial or full responsibility and/or control of the funds. Americans with foreign trusts are only taxed when they receive distributions.
Foreign grantor trusts, on the other hand, are subject to onerous U.S. tax and filing requirements. In addition to paying tax on distributions, owners of foreign grantor trusts must pay tax on the income of the trust annually. They also have much more stringent reporting regulations. If you have a foreign grantor trust, you'll need to file these forms each year:
- Form 3520: "Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts"
- Form 3520-A: "Annual Information Return of Foreign Trust with a U.S. Owner"
U.S. filing requirements for Australian supers
In addition to your income tax return, superannuations must be reported on offshore disclosure forms. These are information returns and typically don't affect the amount of tax you owe. However, there can be serious penalties for not reporting these financial assets (in some cases, an automatic $10,000 per tax year)!
- FATCA (IRS Form 8938): All Americans with an Australian super are required to submit Form 8938, "Statement of Specified Foreign Financial Assets," to disclose information about their super to the IRS. This is part of the Foreign Account Tax Compliance Act (FATCA).
- FBAR (FinCEN Form 114): Additionally, Americans with Australian supers must report those foreign financial accounts on FinCEN Form 114, "Report of Foreign Bank and Financial Accounts (FBAR)." All Americans with an Australian super are required to submit FinCEN Form 114 to declare information about their super to the IRS.
If you haven't reported your superannuation to the IRS
Didn't realize you had to report your super to the IRS? The IRS might not know about your super fund yet, but they will detect the super when you start taking retirement distributions.
At that point it may be too late—and the U.S. could automatically treat your account as a foreign grantor trust, which carries annual income tax liabilities and stricter reporting requirements. Since Australia doesn't tax super distributions in most cases, it's very unlikely that you will be able to offset this tax bill using foreign tax credits.
It is best practice to take a proactive approach and ensure compliance with the IRS, rather than waiting for potential issues to arise. One way to get into filing compliance and avoid penalties is the Streamlined Foreign Offshore Procedures through the IRS, which allow you to correct missing reports and even file past tax returns.
If you have missing or unfiled forms relating to your super fund, contact us today to speak with a tax professional who can help you solve this issue before the IRS penalizes your hard-earned super.
Meet your new international tax pros
Simply put, international tax law is complicated. It's nearly impossible for someone unfamiliar or inexperienced in international tax law to know which laws apply to you and give sound advice. It is essential to work with an experienced international tax professional to ensure that you capitalize on all available tax advantages. Our tax attorneys can help ensure that you avoid unnecessary penalties and get the foreign tax credits you deserve!
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.