The IRS’ crackdown on a tax scheme involving Maltese pension plans has taken a turn as the agency’s Criminal Investigation unit has started contacting taxpayers and practitioners.
Background.
After The U.S.-Malta Tax Treaty became effective in 2011, some U.S. taxpayers established personal retirement plans under the Retirement Pensions Act of 2011 to contribute non-cash assets including appreciated property, such as securities. Interpreting the Treaty in a way that became seen as a loophole, these taxpayers would take the position that they could take out tax-free distributions on a staggered basis.
The IRS initially took issue with this “potentially abusive” practice two years ago July 2021, adding it to that year’s Dirty Dozen campaign, an annual series of tax scams and avoidance schemes. “Ordinarily gain would be recognized upon disposition of the plan’s assets and distributions of the proceeds,” the agency explained at the time. “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.”
Later in 2021, the U.S. and Malta entered into a Competent Authority Agreement (CAA) to close this loophole by narrowing the definition of a pension fund for purposes of the Treaty. “Accordingly, U.S. citizens and residents may not claim benefits under paragraph 1(b) of Article 17 and Article 18 of the Treaty with respect to the type of fund, scheme or arrangement described in the paragraph immediately above, including a personal retirement scheme established in Malta under the Retirement Pensions Act of 2011,” read the CAA.
“Additionally, these funds, schemes or arrangements may not apply paragraph 2(e) of Article 22 of the Treaty to be treated as a qualified resident and may not claim the benefits of paragraph 3 of Article 10 of the Treaty,” it continued.
Recent developments.
The Malta pension plan scheme stayed on the Dirty Dozen list in 2022 and again in 2023. The IRS’ attitude towards the scheme further soured as the practice went on despite the CAA, as evidenced by the language now used. “By improperly asserting the foreign arrangement as a ‘pension fund’ for U.S. tax treaty purposes, the U.S. taxpayer misconstrues the relevant treaty provisions and improperly claims an exemption from U.S. income tax on gains and earnings in and distributions from the foreign individual retirement arrangement,” this year’s Dirty Dozen list read.
In June, the IRS took another step by issuing proposed regs rendering the practice a “listed transaction,” a type of reportable transaction formally identified by the IRS as a vehicle for tax avoidance. When finalized, the Malta pension plan as a listed transaction would subject promoters, or “material advisors,” to special recordkeeping rules like tracking information about those they have consulted on Maltese plans. Taxpayers conducting such transactions would then face possible penalties for failure to disclose, as much as $100,000 for individuals and $200,000 for others.
IRS Investigation.
While the proposed regs move through the rulemaking process, some firms have reported that the IRS has started conducting a criminal investigation into the Malta pension plan and issuing summonses.
Joel Crouch, partner at Meadows, Collier, Reed, Cousins, Crouch & Ungerman, LLP, told Checkpoint that word-of-mouth traveled quickly through the tax community. “The next thing we know we were getting a bunch of calls on these from taxpayers and tax professionals even saying: ‘Hey, my client’s been contacted about this. They need representation,'” said Crouch.
He recommended to those who have been contacted by the IRS reach out to a lawyer first before responding. “You want to make sure that you’re not a target of the investigation, that in fact maybe you’re a witness or you’re a subject but not really the target of the investigation,” Crouch explained, urging caution since it is a criminal investigation, not civil. “Find out what your status is and then determine if it makes sense for you to go talk based on providing that information.”
He added that good representation means an attorney experienced in dealing with the IRS who can communicate on a taxpayer’s behalf. One taxpayer preemtively filed an amended return, which may or may not be advised to others given each taxpayer’s unique situation.
Crouch noted the CAA claims taxpayers are “misinterpreting” the Treaty, as opposed to “violating” it. This may indicate, Crouch speculated, the focus of the investigation will be on promoters of the Malta scheme, with the IRS angling at what clients were told by their advisers that lead to them using the supposed loophole.
“I think that gives the taxpayers an additional defense,” he said, offering a reminder of the timing of the investigation. Because the regs deeming Malta pension plans as a listed transaction are currently only proposed, the associated penalties and disclosure requirements are not yet “in play.”
However, it is still possible the IRS may use audits in the meantime to address those transactions “and say: ‘No, the money you took out … was subject to income tax and therefore you have unreported income,'” according to Crouch. Penalties for failing to report that income may be assessed, perhaps for negligence, depending on the position the IRS wishes to take.
“Taxpayers do have some potential exposure there.”
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