On January 13, 2019, the New Jersey governor signed S. 3246 into law, referred to as the “Pass-Through Business Alternative Income Tax Act” or “BAIT” Act.  The new law creates an election for pass-through entities (PTEs) to pay at the entity level, and creates a corresponding tax credit for its members.  In response to federal tax reform enacted in December 2017, New Jersey was one of several states searching for workarounds to help its residents manage the federal $10,000 SALT deduction limitation and amended Internal Revenue Code (IRC) Section 164.  The BAIT Act was one of those responses and was introduced over a year ago. 
The BAIT Act is effective immediately, and the election for PTEs applies to tax years beginning on or after January 1, 2020.


Pass-Through Business Alternative Income Tax
Effective for taxable years beginning on or after January 1, 2020, New Jersey will allow a PTE to elect to be taxed at the entity level.  A PTE with at least one member who is liable for New Jersey gross income tax may elect to be liable for, and pay, the BAIT in a tax year.  Eligible PTEs include partnerships, S corporations, and limited liability companies (LLCs) with at least two members.
Filing the Election, Tax Returns, Payments, and Estimates
To make the election, each member of the PTE must consent at the time the election is filed.  Alternatively, the election can be made by any officer, manager, or member who is authorized to make the election on behalf of the PTE.  The election must be made annually on or before the original due date (without extensions) of the entity’s New Jersey return.  The election cannot be made retroactively.  Finally, if the members decide to revoke the election, that revocation must be made on or before the original due date of the PTE’s return for the tax year in which the revocation is to be effective.
Electing PTEs must file a BAIT tax return and pay the entity level income tax by the 15th day of the third month following the end of their tax year, or March 15 for calendar-year taxpayers.  Estimated payments must be made by the 15th day of the fourth month, sixth month, and ninth month of the taxable year, and by the 15th day of the first month following the close of the tax year.
Tax Rates
The BAIT is imposed on a tax base that is equal to the sum of each member’s share of the PTE’s “distributive proceeds” attributable to the PTE for the tax year.  “Distributive proceeds” are defined as the net income, dividends, royalties, interest, rents, guaranteed payments, and gains of the PTE derived from or connected with sources within New Jersey upon which the New Jersey gross income tax would be imposed if the PTE were an individual taxpayer.  For tax years beginning on or after January 1, 2020, the four tiers of income tax rates are as follows:

  • 5.675 percent for distributive proceeds under $250,000
  • $14,187.50, plus 6.52 percent for distributive proceeds between $250,000 and $1,000,000;.
  • $63,087.50, plus 9.12 percent for distributive proceeds between $1,000,000 and $5,000,000
  • $427,887.50, plus 10.9 percent for distributive proceeds over $5,000,000

Combined Groups and Composite Returns
If a PTE makes the BAIT election and is also engaged in a unitary business with a corporate member that is also a member of a New Jersey combined group, then the PTE is also included in that combined group and the group’s New Jersey combined return.  If all the members of the PTE are taxpayers otherwise liable for New Jersey gross income tax, and no entity subject to the New Jersey corporation business tax (CBT) has a direct, indirect, beneficial, or constructive ownership or control of the PTE, then the PTE cannot be a member of a New Jersey combined group. 
The new bill does not prevent a group of PTEs under common ownership by individuals, estates, or trusts from filing a composite or consolidated pass-through business entity income tax return.  “Common ownership” means a group of related individuals, estates, or trusts must own more than 50 percent of the direct or indirect voting control of each PTE, using IRC Section 318 to determine voting control.
Credits for Individual Members
Non-corporate members of a PTE making the BAIT election are allowed a refundable New Jersey gross income tax credit equal to their pro rata share of the BAIT tax paid by the PTE.  The credit is applied against the gross income tax liability of the member in that tax year after all other credits available to the member have been applied.  Any excess credit is treated as an overpayment, but without the accrual of interest. The credit allowed to a trust or estate can be allocated to beneficiaries, or it can be used against the gross income tax liability of the estate or trust.
New Jersey residents are allowed a credit against their New Jersey gross income tax due for the amount of any state PTE tax that the director determines is substantially similar to the New Jersey BAIT.  The credit cannot exceed what would have been allowed if the income was taxed at the individual level and not taxed at the entity level.
Credits for Corporate Members
A corporation that owns an interest in a PTE making the BAIT election is allowed a credit against both the CBT and the temporary surtax.  The amount of the credit equals the corporate member’s pro rata share of the BAIT tax paid by the PTE and applies to the corporate member’s CBT or surtax liability in that same tax year.  The credit cannot reduce the corporation’s tax liability below the statutory minimum tax and any excess credit can be carried forward for up to 20 years.
If the PTE is unitary with both the corporate member and that corporate member’s combined group, then the credit is shareable and allowed to reduce the total tax liability of that combined group, but not below the aggregate statutory minimum tax of the taxable members of the group.
If, however, the PTE is only unitary with the corporate member, but not that corporate member’s combined group, then the credit is not shareable.  In that case, the credit is only allowed to reduce the tax liability of the corporate member derived from the corporate member’s activities that are independent of the unitary business of its combined group.
A corporate member of the PTE that is exempt from taxation under the CBT Act is permitted to have its share of the BAIT refunded.


  • New Jersey is the most recent of a new state tax trend – PTE tax elections as workarounds to the federal SALT deduction limitation – and joins Louisiana, Oklahoma, Rhode Island, and Wisconsin.  Similar PTE tax elections have been introduced in a number of other state legislatures.
  • The New Jersey PTE election must be made annually.  The New Jersey legislation does not create a binding election.
  • An analysis should be completed on each PTE, along with its members, to determine the potential impact of making the election.  Factors that will come into play include tax rates, residency issues, PTE tax base, and whether a member’s resident state will allow a credit on their individual returns for taxes paid at the entity level in New Jersey.
  • Questions remain on how the New Jersey BAIT election will be applied to tiered partnership structures, including those having corporate partners in upper tier partnerships.
  • The election forms, tax forms, and estimated vouchers have not been created.  Stay tuned for future guidance issued by the New Jersey Division of Taxation on compliance issues and tax forms.



Janet Bernier
  Nicholas Montorio
Managing Director

Mariano Sori-Martin


  Scott Smith
National Tax Office
Technical Practice Leader – State and Local Taxes


New Opportunities for Workplace Retirement Plans Under the SECURE Act

By now, most employers know that the Setting Every Community Up for Retirement Enhancement Act (SECURE Act) became law on December 20, 2019, as part of a federal budget and spending bill (H.R. 1865). The SECURE Act is landmark legislation that affects the rules for creating and maintaining workplace retirement plans for all employers — including for-profit and tax exempt employers of all sizes. In a nutshell, the SECURE Act eases employers’ administrative burdens for operating workplace retirement plans and encourages plan participation. Some of the SECURE Act changes in the law are most beneficial to smaller employers, while other provisions address changing workforce demographics, such as longer life expectancies and long-term part-time employees in what is often called the “gig” economy.

Whether you currently offer your employees a retirement plan (or are planning to do so), you should consider how these new rules may affect your workplace retirement savings program (or your decision to create a new one). This tax alert summarizes some of the planning opportunities under the SECURE Act for employer-sponsored retirement plans with broad applicability.

Different effective dates for plan documents vs. plan operations.

The SECURE Act makes 30 changes to retirement plan law, affecting tax-qualified defined benefit (DB) plans (such as cash balance plans and traditional pension plans) and defined contribution (DC) plans (such as 401(k) plans, employee stock ownership plans (ESOPs), 403(b) plans and 457(b) plans) and individual retirement accounts (IRAs). Some of these changes are effective immediately, while others are effective in plan or tax years beginning on or after January 1, 2020, 2021, 2022, or later. Generally, amendments to written plan documents are not required until the last day of the 2022 plan year (2024 for governmental plans). However, plan administration must be updated to reflect the SECURE Act’s provisions by the applicable effective date of each change, even if the plan amendment deadline is later.

Employers can expect to hear from their retirement plans’ third-party administrators (TPAs), recordkeepers and other service providers about how SECURE compliance changes to their systems will impact their services, as well as whether any new documents need to be executed to implement SECURE Act changes.

What should employers be doing right now?

The SECURE Act requires employers to take action with respect to certain plan administrative changes, employee notices and plan amendments. Right now, employers should educate themselves about the SECURE Act provisions, prioritize those which have an immediate impact (See our earlier tax alert discussing immediate actions needed by retirement plans to comply with the SECURE Act), evaluate the new features and consider plan design changes.

Opportunities to expand workplace savings.

The SECURE Act encourages workplace retirement plan access and participation in several new ways, which are discussed below.

Increasing QACA auto enrollment safe harbor cap. An annual nondiscrimination test called the actual deferral percentage (ADP) test applies to elective deferrals under a 401(k) plan. The ADP test is deemed to be satisfied if a 401(k) plan includes certain minimum matching or qualified non-elective contributions (QNEC) safe harbors. Automatic enrollment can be part of a safe harbor plan design called a “qualified automatic contribution arrangement” (QACA). For plan years beginning after December 31, 2019, the SECURE Act increases the maximum default contribution rate under a QACA from 10 percent to 15 percent for years after the participant’s first deemed election year.

BDO Insights

  • For the participant’s first deemed election year in an automatic enrollment plan, the cap on the default rate remains 10 percent.
  • Employers that use the QACA safe harbor may (but are not required to) increase the cap on automatic enrollment deferrals under their plans.
  • Employers should work closely with their TPA and recordkeeper to ensure changes needed to plan operations and systems are implemented in a timely manner to reflect the increased cap on the QACA default percentage.
  • Retirement professionals generally recommend an annual retirement savings rate of 15 percent for individuals, so increasing the automatic enrollment safe harbor cap from 10 percent to 15 percent reflects this industry trend.
  • This provision (along with other SECURE Act changes) is designed to increase retirement readiness by closing the gap between actual and recommended retirement savings. Evidence indicates many employees continue the QACA without reducing their savings rate. 

Covering long-term part-time employees in 401(k) plans. Generally, tax-qualified retirement plans must cover all employees who work at least 1,000 hours per year unless they are not yet age 21. Starting for plan years beginning after December 31, 2020, the SECURE Act will require 401(k) plans (other than collectively bargained plans) to also cover employees who have worked at least 500 hours for three consecutive years starting after December 31, 2020. No employer contributions (not even top-heavy minimum contributions) are required until the employee satisfies the plan’s normal eligibility requirements. A special vesting rule that also applies to these individuals seems to provide vesting credit at 500 hours of service (but guidance is needed on how this provision works).

BDO Insights

  • Employers can also continue to impose an age 21 requirement.
  • Employees will not need to be permitted to defer under this new rule before 2024. But as a practical matter, starting January 1, 2021, employers will need to begin tracking hours worked that are less than 1,000 to determine the future eligibility of such employees to join the 401(k) plan.
  • This change would not apply to 403(b) plans.
  • Since studies show that women are more likely than men to work part-time, the new rule may be especially helpful to women in preparing for their retirement.

Relaxed QNEC safe harbor rules. QNEC safe harbor plans generally are deemed to pass certain nondiscrimination tests that would otherwise apply.

Starting in 2020, employers can amend their 401(k) plan into being a QNEC safe harbor plan “mid-year,” so long as the amendment is adopted (1) no later than 30 days before the end of the plan year; or (2) after that date but before the last day for distributing excess contributions for the plan year (i.e., by the close of the following plan year), but only if the QNEC is at least 4 percent (instead of 3 percent) of participants’ compensation. In other words, instead of amending before the end of the current plan year, employers can amend their plan up until the end of the following plan year end if they make a 4-percent contribution to all eligible employees rather than a 3-percent contribution.

Also, starting in 2020, plans that use the QNEC safe harbor are no longer required to give employees a written safe harbor notice before the start of each plan year.

BDO Insights

  • This change gives employers greater flexibility and facilitates plan adoption. Employers will now be able to implement a QNEC safe harbor toward (or even after) year-end, which syncs up better with the business cycle and when employers typically would decide whether to contribute to the retirement plan for that year. Plan sponsors would need to adopt an amendment to implement this feature in a timely manner. This is welcome news for employers, since historically the IRS has been very strict in limiting employers’ ability to implement safe harbor provisions after a plan year has begun.
  • Giving participants advance notice of the matching safe harbor contribution made sense so that they could take full advantage of the match. But since the QNEC safe harbor is funded entirely with employer non-elective (not matching) contributions, giving employees advance notice of the QNEC safe harbor plan design made little sense, because participants would receive the QNEC regardless of whether they made any salary deferrals into the plan. For many years, the retirement plan industry has been asking the IRS to eliminate this unnecessary burden.
  • These new rules do not apply to safe harbor plans that use either the basic or enhanced matching contribution formula to satisfy the safe harbor requirements (since the change only applies to safe harbor plans that use the QNEC safe harbor).
  • Reports indicated that about 30 to 40 percent of 401(k) plans use a safe harbor plan design, so making compliance easier and more flexible will likely increase usage of the QNEC safe harbor.

Delay of required minimum distributions (RMDs). Before the SECURE Act, RMDs generally had to start by April 1 of the calendar year following the calendar year in which an employee reached age 70 ½. The SECURE Act increases the age at which RMDs must begin from age 70 ½ to age 72. This change applies to individuals who attain age 70 ½ after December 31, 2019. The exception that allows active employees who are not 5-percent owners to delay RMDs until separation of employment is unchanged.

BDO Insights

  • This change is designed to match RMDs with trends in delayed retirement and increased life expectancies. However, its prospective nature does not help individuals already in RMD pay status. Participants who attained age 70 ½ before January 1, 2020, will continue to receive RMDs on their current schedule.
  • Accordingly, 5-percent owners and other participants who are no longer active employees and who have attained age 70 ½ during 2019 will still need to receive the 2019 RMD payments by April 1, 2020, and the 2020 RMD by December 31, 2020, notwithstanding the fact that they might not yet be age 72 on December 31, 2020.
  • An individual who attains age 70 ½ in 2020 will not be required to take an RMD from a tax-qualified retirement plan for the 2020 calendar year. Any distribution that such an individual does receive before age 72 will be subject to the regular income tax and withholding rules (including rollover rules) that generally apply to retirement plan distributions.
  • Delaying RMDs is not mandatory and the plan sponsor can choose to retain its plan feature that provides distributions at age 70 ½.
  • Action Plan: Plan sponsors will need to evaluate the new RMD rules to determine if they want to delay RMDs as allowed. If elected, procedures need to be changed immediately and the plan documents amended before the remedial amendment period.
  • Plans will need to coordinate with TPAs and record keepers to update policies and procedures for notifying participants of an upcoming RMD trigger date and update any routine notices sent to participants regarding RMDs. For example, distribution reporting will probably need to be updated beginning January 1, 2020, for participants who turn 70 ½ in 2020 to ensure that distributions between age 70 ½ and 72 are treated as being eligible for tax-free rollover and the mandatory 20-percent withholding is deducted (if not rolled over).

Elimination of extended payouts to young beneficiaries. For distributions made with respect to DC plan participants who die after December 31, 2019 (December 31, 2021 for collectively bargained and governmental plans), the SECURE Act changes the RMD rules to generally require that all distributions (except for payments to certain beneficiaries) must be made by the end of the 10th calendar year following the year the participant died. “Eligible designated beneficiaries” are not subject to the new 10-year rule. Eligible designated beneficiaries include the surviving spouse, minor children, certain chronically ill or disabled beneficiaries, and individual beneficiaries who are not more than 10 years younger than the deceased participant. Eligible designated beneficiaries may continue to receive RMDs over their life expectancy, provided however, that the account balance must be distributed within 10 years after the death of the eligible designated beneficiary or, in the case of an eligible beneficiary who was a minor child, within 10 years after such child reaches the age of majority (determined under applicable state law).

This change in the law eliminates what is often referred to as a “stretch payment.” Such payments typically were structured so that, upon the participant’s death, RMDs would be paid over the life expectancy of a much younger designated beneficiary (such as the participant’s grandchild). Smaller annual RMDs resulted, which allowed for continued tax deferral on the retirement account assets while they continue to appreciate.

BDO Insights

  • This change eliminates the tax benefit of naming grandchildren or any beneficiary more than 10 years junior as the beneficiary for retirement funds unless the beneficiary meets the exception.
  • The new post-death DC plan distribution rule does not apply to DB plans.
  • Action Plan: Plan language regarding beneficiary designations and RMD should be reviewed in light of the SECURE Act.
  • Participants should rethink beneficiary designations in light of the lost benefits of stretching distributions over generations.

Employers can adopt a retirement plan up until their tax return due date, plus extensions. One of the most welcome SECURE Act changes for employers is that, for tax years beginning in 2020, employers can retroactively adopt a new qualified retirement plan as late as the employer’s extended federal income tax filing deadline.  Except for salary deferral plans (because salary deferrals can only be made prospectively), the new plan can be retroactively effective as of the beginning of the tax year for which the tax return is being filed.

BDO Insights

  • This gives employers an alternative to adopting a Simplified Employee Pension (SEP). For example, calendar-year unincorporated business owners could establish a DB or DC plan for the 2020 tax year anytime up until October 15, 2021, if they extended the due date of their federal income tax filing. For a calendar year partnership, S-corporation or limited liability company (LLC), the deadline to adopt DB or DC plan and make a prior year contribution would be September 15, 2021. But due to DB plan funding rules, calendar year C corporations would need to adopt a DB plan by September 15, 2021 (even though they technically have until October 15, 2021 to file their extended tax return), if they want the employer’s contribution to the plan to count as a deduction for the prior year (since those contributions must be made by September 15, 2021). Calendar year C corporations could adopt and fund a DC plan by October 15, 2021, effective for the 2020 tax year.
  • One other consideration is that if an employer retroactively adopts a plan, the plan would still need to file a Form 5500 for its initial plan year in a timely manner. Depending on when the employer adopts the plan, it may be too late to file a Form 5558 to extend the due date of the Form 5500, which means that the due date for the initial Form 5500 would be the due date of the employer’s federal income tax return. Depending on facts and circumstances, the employer may not have much time to prepare and file the Form 5500.
  • Even though this change in the law allows retroactive effective dates and income tax deductions, complex retirement plan rules nevertheless apply for both plan documents and operation. Hasty decisions to implement without proper lead-time often results in funding and compliance problems.

Increased tax credits for having a retirement plan. Effective for tax years beginning after December 31, 2019, small employers (i.e., employers with 100 or fewer employees) may be entitled to a new non- tax credit of up to $500 per year for the first three years that they put in place an automatic enrollment feature in a DC plan (like a 401(k) plan or SIMPLE IRA). Automatic enrollment has been shown to increase employee participation and result in higher retirement savings.

The automatic enrollment tax credit is in addition to an existing tax credit for small employers that start a retirement plan, such as a tax-qualified retirement plan, Simplified Employee Pension (SEP) or SIMPLE. Effective for tax years beginning after December 31, 2019, the SECURE Act increases the small employer tax credit to encourage small businesses to set up retirement plans. Starting in 2020, the credit is increased by changing the calculation of the flat dollar amount limit on the credit to the greater of (1) $500, or (2) the lesser of: (a) $250 multiplied by the number of non-highly compensated employees (NHCEs) who are eligible to participate in the plan, or (b) $5,000. The credit applies for up to three years.

BDO Insights

  • Employers who already have a retirement plan can claim the credit if they add an automatic enrollment feature to an existing plan.
  • The automatic enrollment credit is in addition to the tax credit for employers that start retirement plans. Tax credits are generally better than tax deductions because they reduce the amount of tax owed on a dollar-by-dollar basis.
  • These tax credits are non-refundable, so they can only be used to reduce tax owed.
  • These tax credits are intended to help small employers cope with the financial costs of starting or maintaining a workplace retirement savings plan as a way of increasing access to (and participation in) such programs. Studies show that payroll deduction workplace retirement savings plans are the most effective way to save for retirement.
  • It appears that employers who put a new plan in place in 2019 (or earlier) can increase their credit for 2020 (and later) years, so long as they are still within the three-year start-up period to which the credit applies.
  • BDO can help employers decide which plans may be the best fit for their workforce and assist in implementing the program, including advising on how to make the most out of these new tax credits.


Lifetime income (annuity) options in DC plans. As workplace retirement benefits have shifted over the years from being mostly provided by traditional DB plans to being primarily offered through DC plans, and as the workforce lives and works longer, the retirement industry has emphasized the need to educate DC plan participants about the importance of lifetime distribution options, so they do not outlive their retirement savings. The SECURE Act made three changes in the law to address lifetime income issues.

  • The SECURE Act encourages DC plan sponsors to offer lifetime income during retirement by creating a new ERISA fiduciary safe harbor for employers that include such options in their plans. The new safe harbor became effective on December 20, 2019. For more on the new fiduciary safe harbor, please see our previous tax alert on immediate actions for plan sponsors under the SECURE Act.
  • The SECURE Act allows DC plan participants to make in-service, direct trustee-to-trustee transfers of lifetime income investments (or annuity transfers) to an IRA or other retirement plan or to receive a distribution of that investment option if the plan discontinues offering that particular investment option. The transfer or distribution must be made within 90 days after the date when the lifetime income product is no longer authorized to be held as an investment option under the plan. This change is effective for plan years beginning after December 31, 2019; before this change in the law, with certain exceptions, participants generally could not make in-service transfers or take a distribution of just one investment option.


BDO Insights

  • This change in the law allowing for portability of lifetime income investment options gives DC plans flexibility to try out a lifetime income investment without having to worry about being stuck with it forever.
  • It also enables participants to potentially avoid surrender charges and other fees or penalties that would otherwise apply upon liquidation of the investment if the plan sponsor eliminates the investment option from the investment lineup (assuming the participant can find an IRA or other retirement plan that is willing to accept a direct trustee-to-trustee transfer of the investment or is willing to take a distribution of the investment option).
  • Plans that intend to offer lifetime income investment options will likely need an amendment to permit these types of in-service and in-kind distributions.
  • Employers may also want to consider whether their DC plan should be amended to accept in-kind transfers of lifetime income investments (such as a rollover from an employee’s prior employer’s plan).
  • Employers should also be alert that lifetime income investment options may be acquired through mergers or acquisitions (if a legacy plan was terminated or if a plan merger is undertaken).


  • The SECURE Act requires DC plans to eventually provide participants with an annual benefit statement showing hypothetical lifetime income disclosures illustrating the monthly amount a participant would receive if his or her DC plan account provided a lifetime annuity benefit. The required disclosure will estimate the monthly annuity income payments that the participant would receive if the participant’s account balance was used to purchase a qualified joint and survivor annuity (with a spouse the same age) and a single life annuity (even if the plan doesn’t actually offer those forms of benefit). But the new disclosures won’t be required until at least 12 months after the later of when the Department of Labor (DOL) issues either (1) an interim final rule regarding these disclosures or (2) model disclosures and assumptions for converting account balances into lifetime annuity streams (note that SECURE directs the DOL to issue these by December 31, 2021). The SECURE Act also relieves plan fiduciaries, plan sponsors or anyone else who provides lifetime income disclosures from ERISA fiduciary liability based on the DOL’s model disclosures and assumptions.

Increased IRS retirement plan penalties. To pay for some of the SECURE Act provisions, some of the more common potential IRS maximum penalties related to retirement plans have increased significantly (i.e., by 10 times). These changes are generally effective for returns, statements and notices required to be filed or provided beginning after December 31, 2019, for the following failures:

  • The IRS penalty for failure to timely file a Form 5500 or a Form 5310-A (to report certain transfers, mergers or spin-offs) has increased from $25 per day (capped at $15,000 per year) to $250 per day (capped at $150,000).
  • The IRS penalty for failure to file a Form 8955-SSA has increased from $1 per participant multiplied by the number of days the failure occurred (up to a maximum of $5,000) to $10 per participant multiplied the number of days the failure occurred (up to a maximum of $50,000).
  • The IRS penalty for failure to file a required notification of changes in a plan’s Form 8955-SSA has increased from $1 per day to $10 per day (up to $10,000).
  • The IRS penalty for failure to provide participants with a required notice regarding withholding on periodic and nonperiodic pension plan payments has increased from $10 to $100 per failure.
  • The IRS penalty for failure to file a Form 8822-B (to register a change in plan name or plan administrator name/address) will increase from $1 per day (up to $1,000) to $10 per day (up to $10,000).
  • The IRS penalty for failure to timely file and pay the prohibited transaction excise tax reported on Form 5330 (used to report and pay the prohibited transaction excise tax related to employee benefit plans) was increased from the lesser of $330 or 100 percent of the amount due to $400 or 100 percent of the amount due.
BDO Insight
These increases affect IRS penalties only and have no effect on the much higher DOL penalties. For example, the maximum DOL penalty for failure to timely file a Form 5500 is currently $2,233 (with no maximum). The IRS and DOL have amnesty programs that can reduce late filing penalties significantly. BDO can help employers obtain relief through those programs and with mitigating potential penalty risks. Because correction through an amnesty program generally cannot be started once the employer has been notified of an examination, submitting a filing under those programs is advisable as soon as possible if errors occurred.


Penalty-free (not tax free) withdrawals for child birth or adoption. Usually, in-service withdrawals from a DC plan before age 59 ½ are subject to a 10-percent early withdrawal penalty, unless an exception applies. Withdrawals that are “eligible rollover distributions” are also subject to mandatory 20-percent federal income tax withholding. But for distributions made after December 31, 2019, the SECURE Act creates a new exception to the early withdrawal penalty and mandatory withholding rule for participants who take withdrawals from DC plans of up to $5,000 within one year after the birth of the participant’s child (or after the adoption is finalized) that is used for expenses related to the birth or adoption. Plans may allow such distributions to be repaid with after-tax dollars at any time — essentially allowing retirement plan participants to restore the full amount of the distribution to their plan accounts. So, if a participant withdrew $5,000 as a qualified birth or adoption expense, he or she could recontribute the full $5,000 back into the plan (even years later), even though the participant paid income tax on the distribution. For more on these rules, please see our previous tax alert on SECURE Act issues for individuals.


BDO Insight
The $5,000 limit is per individual. So, a married couple may each separately receive a $5,000 qualified birth or adoption distribution from an eligible retirement plan.
Employers should consider whether to offer these special distributions. Plan amendments and updates to forms and communications may be needed if the distributions are allowed.


Retirement plan disaster relief. Congress finally provided special retirement plan disaster relief for the 2018 California wildfires and other major disasters that occurred between January 1, 2018, and February 18, 2020. This relief is similar to relief provided for 2016 and 2017 hurricanes and California wildfires, but is not an extension of (or additional relief) for those earlier disasters. For more on the these rules, please see our previous tax alert on immediate actions for plan sponsors under the SECURE Act.

Pooled employer DC plans. For plan years after December 31, 2020, the SECURE Act provides new rules that will allow unrelated employers with no common interest to participate in a “pooled employer plan” (PEP). PEPs would be limited to DC plans that satisfy certain ERISA fiduciary and registration requirements. A PEP must be sponsored by a “pooled plan provider” (PPP), like a financial services company, TPA, insurance company, record keeper, or similar entity (and PPPs will be subject to a $1 million bond). The PPP must serve as the plan’s ERISA plan administrator and named fiduciary and will have other duties, such as ensuring that all parties are properly licensed and bonded (beyond just “handling funds,” which is required for ERISA bonds). The SECURE Act clarifies that an employer who adopts a PEP will be acting as an ERISA fiduciary in deciding to join the PEP and will be remain responsible for monitoring the PPP and other plan fiduciaries. The adopting employer will remain the PEP’s investment fiduciary unless the PEP delegates investment management duties to someone else.

PEPs will be treated as a single ERISA plan, which means the plans will have a single plan document, one Form 5500 filing and a single independent plan audit. However, PEPs are not required to be audited until they either cover 1,000 participants or any adopting employer has more than 100 participants. SECURE continues the multiple employer plan (MEP) requirement that the Form 5500 must include a list of adopting employers and show the percentage of current year contributions and plan accounts for adopting employer’s participants.

A MEP is a plan (that is not a collectively bargained plan) maintained by two or more unrelated employers. Historically, DOL rules permitted only “closed” MEPs, where the participating employers shared a common interest. In 2019, the DOL expanded that rule to allow “association retirement plans” (ARPs), allowing looser affiliations to satisfy the common interest requirement. But ARPs were not true “open” MEPs. Similarly, the IRS recently proposed regulations that would provide some relief from the “one bad apple” rule. Under that rule, if just one participating employer failed to satisfy any of the many tax-qualified plan rules, the entire MEP could be disqualified. The SECURE Act goes further than both the DOL and IRS relief, since it will allow unrelated small employers with no common interest to participate in PEPs and will not disqualify the entire PEP if one participating employer fails a qualification requirement.

BDO Insights

  • Small to mid-size employers who either do not have a workplace retirement plan or who currently maintain their own DC plan but who are frustrated by the burden of running the plan may want to keep an eye on how PEPs develop, since PEPs may provide the same (or similar) benefits, rights and features at reduced cost and also reduce the employer’s potential ERISA liability exposure. It is likely that many PEP offerings are being prepared to launch effective January 1, 2021, and beyond. The SECURE Act directs the IRS to issue model PEP documents.
  • Employers who currently participate in a state-run automatic IRA program (such as CalSavers, OregonSaves, Illinois Secure Choice, etc.) may want to consider whether joining a PEP may increase retirement savings.
  • PEPs will clearly allocate responsibility between the pooled plan provider and the adopting employers, which the employer community and retirement plan industry have been requesting for many years.
  • The SECURE Act creates a new form of plan — PEPs, which do not apply to ARPs or “open” or “closed” MEPs, including professional employer organization (PEO) MEPs. Existing MEPs will not be considered PEPs unless they have a PPP, elect to be a PEP and satisfy all other requirements. Guidance on whether (and how) an existing MEP could be converted into a PEP would be helpful.
  • The SECURE Act allows PEPs to use electronic disclosures to participating employers and participants, which will simplify plan administration and reduce costs.


Combined Form 5500s for DC Plans. Effective for plan years beginning after December 31, 2021, DC plans can file a consolidated Form 5500 if all the plans have the same trustee, named fiduciary, plan administrator, plan year and investment options.


BDO Insight
Small employers should watch this development, which may streamline their Form 5500 filing requirements. An employer does not need to participate in a PEP to be able to file a single Form 5500 for multiple plans. But the DOL and IRS will need to issue guidance and a consolidated Form 5500 no later than January 1, 2022, since the SECURE Act merely says that members of a “group of plans” can file a consolidated Form 5500. It appears that the consolidated reporting is not meant to apply only to controlled groups or affiliated service groups. Rather, it appears intended to cover unrelated employers or even PEOs, as a form of MEP/PEP (for reporting purposes only, not for plan document or operation purposes).

Nondiscrimination testing relief for closed DB plans. The SECURE Act included long-awaited, permanent nondiscrimination testing relief for DB plans that are closed to new participants. The relief applies to plans that were closed as of April 5, 2017, or that have been in operation but have not made any increases to the coverage or value of benefits for the closed class for five years before the freeze can now meet nondiscrimination, minimum coverage, and minimum participation rules by cross-testing the benefits with the employer’s DC plans. For more on the these rules, please see our previous tax alert on immediate actions for plan sponsors under the SECURE Act.

Lower in-service withdrawal ages for certain plans. The SECURE Act provides that defined benefit plans (including hybrids like cash balance plans) and 457(b) plans can now allow in-service withdrawals at age 59 ½.

BDO Insights

  • Although lowering the age for in-service distributions seems contrary to the trend of keeping retirement savings in the retirement system, it was enacted to enable so-called “phased retirement” where full-time employees switch to part-time or make other arrangements with their employer to continue working as an independent contractor.
  • The Pension Protection Act of 2006 lowered in-service distributions from DB plans to age 62. The SECURE Act takes that one step further and reduces the in-service distribution age even lower to age 59 ½.
  • Lowering the age for in-service distributions is an optional (not mandatory) plan design change that will likely require a plan amendment.

403(b) plan terminations. The SECURE Act directs the IRS to issue guidance by June 20, 2020 (within six months after enactment), providing that individual 403(b) custodial accounts may be distributed in-kind to a participant or beneficiary when the 403(b) plan terminates. The guidance will be retroactively effective for tax years beginning after December 31, 2008.

BDO Insights

  • This change in the law means that terminated 403(b) custodial accounts will be treated the same as terminated 403(b) annuities (in other words, a 403(b) plan is allowed to distribute individual custodial accounts to participants and those accounts can continue to be tax-free until amounts are withdrawn from those accounts).
  • In Revenue Ruling 2011-17, the IRS clarified that a terminating 403(b) plan may consider an annuity contract to be distributed (in-kind) upon the establishment of a fully paid individual annuity contract to the plan participant. Such individual annuity contracts would hold the benefit until properly distributed. But the Revenue Ruling did not afford the same treatment to 403(b)(7) custodial accounts, so the SECURE Act addresses that issue.
  • The retroactive effective date syncs up with other important IRS 403(b) plan guidance, including final regulations that require a written plan document effective for tax years beginning after December 31, 2008.

Changes for individuals. Self-employed individuals may want to review our other SECURE Act tax alert, which provides an overview of the most significant changes for individuals.


Many of the SECURE Act retirement plan changes in the law apply to both large and small employers, including for-profit and non-profit employers. Some of the changes are especially helpful to small employers. Almost all tax-qualified retirement plans will need to be reviewed for possible amendments and operational changes to reflect the SECURE Act. While further guidance on many of the SECURE Act provisions is needed, employers should review their plan documents and systems in the meantime to determine what, if any, amendments will need to be made, what operations need to be changed, and what systems or processes should be updated. Employers may want to consult with BDO on how to address the SECURE Act to take advantage of new opportunities and minimize the impact of unfavorable changes.


Norma Sharara
National Tax Office, Compensation & Benefits Managing Director
  Joan Vines
National Tax Office, Compensation & Benefits Managing Director

Kimberly Flett
National Practice Leader ERISA Compliance and Reporting
  Nicole Parnell
Specialized Tax Services, Compensation & Benefits Managing Director

Alex Lifson
Specialized Tax Services, Compensation & Benefits Principal


U.S. and China Sign “Phase One” Trade Agreement

On January 15, 2020, the U.S. and China signed a “phase one” trade agreement previously announced by the United States Trade Representative (USTR) in December 2019. The complete text of the trade agreement can be read here.
When the “phase one” trade agreement was first announced, the U.S. had suspended the additional 15-percent tariff on List 4B goods imported from China that was scheduled to take effect on December 15, 2019. Read here. The formal text of the “phase one” trade agreement does not directly address any further tariff reductions. However, the USTR is expected to publish a separate Federal Register notice on reduction of tariffs on List 4A goods from 15 percent to 7.5 percent later this week, and the tariff reduction is scheduled to take effect on February 14, 2020. Further, the U.S. will maintain the 25-percent tariffs currently in place on List 1, 2, and 3 goods imported from China totaling approximately $370 billion.
According to the “phase one” trade agreement, China will increase its imports of certain U.S. goods worth no less than $200 billion by the end of 2021, along with commitments in other areas including intellectual property, technology transfer, agriculture, financial services, and currency and foreign exchange.
Beyond this limited truce, no further developments in the ongoing trade negotiations between China and the U.S. are expected this coming year due to November’s impending U.S. presidential election.
For more information and to discuss ways to mitigate the continuing cash impact of the Section 301 China tariffs, please contact a BDO Customs and International Trade Services professional:


Damon V Pike
  James Pai
Senior Manager

Yun Gao
  Jay Cho

Travis Fournier



BDO Knows: ASC 740 – Updated December 2019 (Original March 2016)

Financial Reporting Treatment Under ASC 740 and ASC 450 of Tax Provisions in the PATH Act 


BDO issued our first analysis on the financial reporting treatment under ASC 740 of certain income tax provisions in the Path Act in March 2016. This update is meant to provide additional guidance on accounting for the use of R&D credits against payroll taxes, as well as considerations that are necessary when assessing uncertain tax positions related to the R&D credits.
By way of background, on December 18, 2015, President Obama signed into law the Protecting and from Tax Hikes (PATH) Act of 2015 and the Fiscal Year 2016 Budget (the omnibus). The PATH Act contained provisions that retroactively restored and extended a large number of expired tax provisions, commonly known as “tax extenders.” These extenders, which had expired prior to 2015, were retroactively restored effective January 1, 2015. While some provisions have been extended permanently, others have been extended only temporarily. The omnibus also contained several important income and excise tax provisions (e.g., certain excise taxes required under the Affordable Care Act were delayed or temporarily suspended).   


The PATH Act restored and permanently extended the research credit under Internal Revenue Code (IRC) Section 41 for qualified research and development (R&D credit).
The PATH Act also created two new types of R&D credits: one for eligible small businesses and one for qualified small businesses. Eligible small businesses were allowed to utilize the research credit even if they were subject to the Alternative Minimum Tax1 and qualified small businesses were allowed to utilize, for up to five years, the research credit against the employer portion of payroll tax (i.e., FICA tax) not exceeding $250,000 per year. These new research credits are available for credits generated in tax years beginning after 2015.    

This alert will highlight some of the PATH Act’s more significant income tax accounting implications accounted for under ASC 740 Income Taxes.

The Election to Treat R&D Credit as Payroll Tax Credit Available to Offset Payroll Tax

The PATH Act allows qualified small businesses to elect, pursuant to IRC Sections 41(h)(1) and 3111(f)(1), to apply a portion of their research credit, capped at $250,000 per year, as a payroll tax credit against their payroll tax liability (i.e., FICA tax), rather than income tax liability.2 The payroll tax offset is an amount specified by the entity that cannot exceed the smallest of (1) $250,000, (2) the R&D credit determined for the current year, and (3) the business credit carryforward under IRC Section 39 to the following year.3 That is, the payroll tax offset is limited to the general business credit carryforward to the following year that would be available if the payroll tax offset were not available. Therefore, a payroll tax offset would be limited to the R&D credit after any offset of regular tax (said another way, a payroll tax offset would be available only when the R&D credit exceeds the pre-credit tax liability).

To qualify, an entity’s gross receipts for the taxable year must be less than $5 million, and the entity must not have had gross receipts for any taxable year before the five taxable year period ending with the taxable year. A qualified small business can be a corporation, including an S corporation, or a partnership that meets the gross receipts requirements in any year.4  This election can only be made during a five-year period, and the election must be made on or before the due date (including extension) of originally filed returns. The payroll tax offset is made on Form 941.

The PATH Act authorizes the Department of Treasury to issue regulations requiring recapture of R&D credits utilized as offset to payroll tax, including the filing of amended returns when an adjustment to the payroll tax portion of the research credit is necessary.

This change is beneficial to startups and small businesses with no current income tax liability (due to losses) that also generate R&D credits that would otherwise be carried forward into future periods and would require an  income tax liability to utilize. Assuming the requirements and limitations are met, a company can use its R&D credits to offset payroll tax expense recognized in operating income.

Qualified small business reporting entities would need to determine whether the R&D credit is an income tax benefit accounted for under ASC 740 or as an item of pretax income, such as reduction of payroll tax expense, accounted for under a different accounting standard in the Codification.5

The Master Glossary definition of “income tax” in ASC 740 states the following: “Domestic and foreign federal (national), state, and local (including franchise) taxes based on income.” In fact, ASC 740 does not apply to franchise tax based on capital or to certain withholding taxes for the benefit of the owners.6 The standard also explains that when the reporting entity incurs an excise tax that is independent of taxable income – i.e., the tax is due on a specific transaction regardless of whether there is any taxable income for the period in which the transaction occurs – the tax is not an income tax and it should be recognized as an expense in pretax income.The employer’s portion of FICA taxes (i.e., payroll tax) is based on the employees’ income and not the reporting entity’s income, making it clear that payroll tax is not an income tax.

However, ASC 740 does not specifically address the accounting for income tax credits that are also available, by election, to offset payroll tax (i.e., dual purpose tax credits). Generally, refundable tax credits (i.e., credits that can be refunded for cash) are not accounted for under ASC 740, even when the reporting entity is currently paying income tax and can utilize the credit to offset income tax liability. Rather, when entities determine the proper classification of credits used to offset payroll tax, the guidance under IAS 20, Accounting for Government Grants and Disclosure of Government Assistance, may be applied in these situations. Specifically, IAS 20 notes that grants related to income are presented as part of profit or loss, either separately or under a general heading such as “other income”; alternatively, they are deducted in reporting the related expense.8

This new qualified small business R&D credit is not refundable. However, a qualified small business with currently minimal or no regular income tax liability has an option to either use the credit to offset income tax liability during a 20-year R&D credit carryforward period or use the credit to offset payroll tax (up to $250,000 per year for five years).

Therefore, the accounting question is how to consider the ability to utilize current year R&D credits, after reducing net income tax, if any, to reduce payroll taxes. Two approaches are considered in this alert.

One approach is to account for the benefit consistent with the chosen annual election and management’s expectation concerning the manner in which a credit carryforward is expected to be monetized.9 For example, assume that a qualified small business generates a current year R&D credit of $200,000. Under this first approach, three scenarios exist:

  1. The qualified small business expects that the credit would be used against income tax only. In this scenario, an entity would record an income tax benefit of $200,000 and either record a corresponding reduction in income taxes payable if the credit is being used to reduce current year taxes, or record a deferred tax asset, subject to valuation allowance assessment, if the credit is being carried forward.
  2. The qualified small business has a pre-credit tax liability limitation of $130,000 and the entity elects to treat $70,000 as payroll tax credit available to offset payroll tax liability on Form 941, assuming the entity has no general business credit carryforward. Under this approach, the entity would recognize $130,000 as income tax benefit (the offset to current-year income tax) and $70,000 as pretax income benefit (the offset to payroll tax).
  3. If the entity does not owe income tax in the current year, it can elect to utilize up to $200,000 of the current-year R&D credit as an offset to payroll tax. If payroll tax is less than $200,000, the entity would consider the manner in which it is expecting to monetize the R&D credit carryforward. If the R&D credit carryforward is expected to offset future income tax, it would be accounted for as income tax benefit and any deferred tax asset credit carryforward would be evaluated for a valuation allowance.

Note, that if the recognition requirements in ASC 740 are met, a deferred tax asset for an R&D credit carryforward must be recognized under ASC 740 regardless of the income statement presentation of the benefit (i.e., pretax income or income tax benefit).10

Another approach is to treat the R&D credit generated during the five year period up to $1,250,000 as a non-income tax benefit (i.e., an item of pretax income).

There are unique considerations that might favor the first approach.

The election is only available during a five-year period and the law, as currently written, limits the optionality to the R&D credits that are not otherwise used to reduce net income tax expense.

Recognition of the maximum credit amount (i.e., $1,250,000) in pretax income would potentially result in having to reclassify unused credits to income tax after the five-year period (a qualified small business would need to report approximately $20.2 million in payroll expense to owe $1,250,000 of FICA payroll tax during the five-year period). Further, an R&D credit utilized on the income tax return to offset income tax liability would necessitate complex accounting to gross up income tax expense and reclassify the benefit into pretax income.    

It should be noted that an election to offset payroll taxes does not affect the payroll expense amount allowable as a deduction (i.e., a taxpayer that elects to offset its payroll tax liability is not required to include such offset into income for tax purposes). Therefore, recognition of the R&D credit offset in pretax income (i.e., offset to payroll tax expense) would result in a book-to-tax adjustment (i.e., an “M-3” adjustment in Form 1120) to reflect a deduction for payroll tax expense without an offset (i.e., the R&D credit benefit is not taxable income and is thus removed from pretax income when it is recognized as a payroll tax expense offset). Finally, if a payroll tax offset is elected, the entity is required to follow the rules in IRC Section 280C and reduce deductible qualified R&D expenditures to the extent of the R&D credit (or elect a reduced credit rate).


Uncertain Tax Positions

Many companies find that in conjunction with determining the amount of R&D credit available, uncertainty exists as to whether the full amount of the credit will be sustained under audit by the IRS. As a result, companies have recorded reserves to reflect the potential exposure of the amount of available credit under audit.

For companies utilizing R&D credits against their income tax liability, guidance is available under ASC 740-10 (previously referred to as FIN 48) that can be followed to determine the appropriate amount of the R&D credit to recognize.

For companies utilizing R&D credits against their payroll tax liabilities, the guidance under ASC 740-10 is not applicable. Instead, companies should rely on the guidance provided in ASC 450 – Contingencies (formerly FAS 5) to determine whether a contingent liability must be recorded.
ASC 450 provides that an estimated loss from a loss contingency must be accrued as a charge to income if both of the following conditions are met:11

  1. Information indicates that it is probable that an asset had been impaired, or a liability had been incurred at the date of the financial statements.
  2. The amount of loss can be reasonably estimated.

Using this guidance for payroll tax credit offsets of up to $250,000, companies would need to assess whether there is a potential loss contingency where a portion of the credit may be reduced under IRS audit. If it is determined that the loss contingency is probable and reasonably estimable, then a charge to pre-tax income would be necessary to record a contingent liability.

How BDO Can Help

BDO can assist clients with the evaluation of the significance of the accounting impact of the PATH Act’s tax extenders, including appropriate disclosures that should be included in financial statements. 



For more information, please contact one of the following ASC 740 technical leaders:

Daniel Newton
Tax Partner – ASC 740 Practice
Leader – National Tax Office
William Connolly
Tax Managing Director –
National Tax Office

Michael Williams
Tax Partner – National Practice
Leader – ASC 740
Thomas Faas
Tax Managing Director –
National Tax Office

Steve Maniaci
Partner – National Assurance
ASC 740 Leader

1The Alternative Minimum Tax was repealed as part of the Tax Cuts and Jobs Act in 2017, effective for taxable years beginning after December 31, 2017.
2 Payroll tax includes two components: (1) social security tax of 6.2 percent and (2) Medicare or hospital insurance (HI) tax of 1.45 percent. Under this change, R&D credits would be allowed, by election, to be treated as payroll tax credits to offset the social security payroll tax component, but not the Medicare or HI or the employee portion of payroll tax that the employer is required to withhold.   
3 There are many general business credits listed in IRC section 38, and the order of absorption is prescribed in IRC Section 38(d), which follows the order in which the credits appear in IRC Section 38(b) (the R&D credit coming fourth).
4 Individuals carrying active trade or business may also qualify if they meet the gross receipts test and requirement.
5 The Codification encompasses all of the U.S. Generally Accepted Accounting Principles (GAAP) standards, including the ASC 740 Income Taxes.
6 ASC 740-10-15-4.
7 ASC 740-10-55-75.
8 IAS 20, paragraph 29.
9 By analogy to ASC 740-10-55-23, which explains that the measurement of deferred income taxes is based on tax elections expected to be made in future years.
10 ASC 740-10-55-35.
11 ASC 450-20-25-2.

Foreign Trusts From a United States Perspective: Taxpayer Nightmares and How to Keep Them from Happening

Download PDF Version
by John Nuckolls, Managing Director and Technical Leader, BDO National Tax Office Private Client Services

For understandable reasons, the United States has adopted a series of laws designed to prevent U.S. taxpayers from taking advantage of foreign trusts as tax shelters from U.S. income taxation. The obvious application of these laws is to a U.S. citizen attempting to transfer cash or income-producing assets to an offshore trust. When dealing with foreign trusts, however, these laws can apply in circumstances where unsuspecting non-U.S.-citizen taxpayers can be financially devastated by the consequences.

Jane Moves to the United States

Jane moved to the United States in 2017 to work as a high-level executive for a U.S.-based company. Jane is a participant in a foreign pension plan and has made regular contributions to the retirement plan for the four years prior to her move to the United States. Three years before her move to the United States, Jane had established a trust in a tax haven jurisdiction that would impose no local income tax on the trust. The trust is a discretionary trust for the benefit of herself and her family, including her husband, John, and their three children. Jane had been advised by European tax professionals to establish the trust to reduce her tax burden in her home country.
The trust is irrevocable and holds $10 million (all dollar amounts in this article are U.S. dollars unless otherwise noted) worth of stocks and bonds. The trust has interest and dividend income of approximately $500,000 per year. The retirement plan holds $500,000 worth of securities, and has interest and dividend income of $50,000 per year. Because the trust is irrevocable, and both the trust and retirement plan were formed outside the U.S. long before she moved to the U.S., Jane assumed that the U.S. would have no taxing authority over either the trust or the retirement plan. When asked by her U.S. accountant if she had any foreign bank accounts or foreign trusts, she failed to inform the accountant of the offshore trust and pension plan.
As a result of this inaccurate information, the accountant failed to check the appropriate box on Schedule B of Jane’s Form 1040 (U.S. individual income tax form), indicating that she had a foreign trust. Later, to purchase a vacation home in 2018, Jane received a distribution from the foreign trust of $1 million. The $1 million was initially deposited in her U.S. bank account and then transferred to an escrow agent for closing on the purchase of the home.
Jane received notice from the Internal Revenue Service (IRS) indicating an intent to audit her 2018 tax return. As a part of the audit, the IRS agent requested and received copies of Jane’s bank statement for 2018.  The IRS also inquired about any retirement plans in which Jane was a participant. Jane was dismayed when the agent requested substantial information concerning her foreign trust and retirement plan. After the agent received the requested information, Jane was notified by the IRS of the following:

  1. Jane should have filed a Form 3520 by the due date of her 2017 income tax return to report a deemed transfer of $10 million to the foreign trust on the date of her arrival in the United States for U.S. income tax purposes.  IRC §§6048(a) and 679(a)(4) and IRS Notice 97-34, 1997-1 C.B. 422. Further, upon examination of the retirement plan documents and Jane’s contributions made thereto, it was determined that Jane was the owner of a nonqualified deferred compensation trust for U.S. income tax purposes.  IRC §402(b) and Treas. Reg. §1.402(b)-1(b)(6). As a result, Jane also should have reported the deemed transfer of $500,000 to the retirement plan on the date of her arrival in the United States. IRC §§6048(a) and 679(a)(4) and IRS Notice 97-34, 1997-1 C.B. 422. A transfer to the foreign trusts is deemed to occur because Jane funded the foreign trusts within the five years preceding her arrival in the U.S.  Id. The penalty for the failure to file the Form 3520 is $3,675,000 million (35 percent of the value of the deemed transfers).  IRC §6677(a).
  2. Jane’s trust and retirement plan should have filed Form 3520-A by March 15 each year after she became a U.S. resident. IRC §6048(b) and IRS Notice 97-34.  At that time, both the foreign trust and retirement plan acquired a U.S. transferor (within five years of being created) and U.S. beneficiaries, causing them to become “grantor trusts.” IRC §679.  This form must be filed by any foreign trust considered a “grantor trust” with respect to a U.S. citizen or U.S. resident for U.S. income tax purposes.  The filing of Form 3520-A is an on-going requirement as long as Jane remains a U.S. person.  The penalty for failure to file Form 3520-A is 5-percent of the end of the year value of the trust. IRC §6677(b).  Assuming that the trust and retirement plan had a combined value of $10,500,000 at the end of both 2017 and 2018, the total penalty would be $1,050,000.
  3. Because Jane’s trust and retirement plan are considered “grantor trusts,” she is deemed the owner of the property. IRC §§671 and 679. In other words, the trust and retirement plan are more or less transparent for U.S. income tax purposes. Therefore, Jane should have been reporting the interest, dividends, and capital gains of her foreign trust and retirement plan on her U.S. income tax return each year. Since Jane is in the maximum tax bracket (39.6 percent for 2017, 37 percent for 2018), she would owe approximately $421,300 in additional income taxes for 2017 and 2018, along with net investment income taxes of $41,800. Interest expense would also be paid to the IRS for any past due taxes.
  4. The IRS also imposed a 20-percent negligence penalty of $92,620, ($463,100 tax times 20 percent penalty) with respect to the underreported income earned by the foreign trust and retirement plan.  IRC §6662(b)(1).
  5. Jane should also have filed Form 3520 in the year she received the $1 million distribution from the trust. Because she failed to file Form 3520 reporting the receipt of the $1 million, a penalty equal to 35 percent of the unreported $1 million distribution or $350,000 would be imposed.  IRC §§6048(a) and 6677(a).

Therefore, the total amount due to the IRS was $5,630,720.
Jane was so disenchanted with the experience that she immediately resigned her position and returned to her home country on December 31, 2019. Jane was shocked once again when her U.S. accountant prepared her final U.S. income tax return. Included on this final return was the unrealized gain in her foreign trust and retirement plan portfolios.  This is because the trust and retirement plan reverted to non-grantor trust status upon her departure causing another deemed transfer.  IRC §§672(f) and 684, Treas. Reg. §1.684-2(e).  Most of this gain had accrued prior to her arrival in U.S. The total gain on the two portfolios was $5,250,000. Since the U.S. imposes a maximum capital gains rate of 20-percent, the total tax due on the appreciated portion of her foreign trust portfolio was $1,050,000, plus net investment income tax of $199,500.
Jane made three mistakes regarding the trust and retirement plan:

  • Jane assumed the U.S. would treat her foreign trust and retirement plan the same way her home country did;
  • She failed to notify her U.S. accountant of the existence of the foreign trust and retirement plan; and
  • She failed to consult with her accountant prior to her abandonment of her U.S. residency for U.S. income tax purposes.

With proper planning, Jane could have limited her liability to $687,500—the taxes on the trust and retirement plan’s income for the 3-year period that she was a U.S. resident. As seen by the size of the penalties imposed on taxpayers who fail to file the information Forms 3520 and 3520-A, the U.S. government is very serious about compliance with foreign trust reporting activities. Such penalties can be avoided if the IRS is convinced that failure to file was for reasonable cause. IRC §6677(d).  In this case, because Jane failed to inform her accountant about the trust and retirement plan’s existence, the IRS may not waive the penalty. Furthermore, the IRS may consider civil and criminal actions for tax fraud as well.


As one might expect, the U.S. government is taking a serious look at the finances of foreigners and foreign entities, like foreign trusts. The IRS has a number of tools in their arsenal to ensure compliance with foreign trust tax and reporting rules by U.S. taxpayers. Both U.S. citizens and non-U.S. citizens resident in the U.S. —who have established foreign trusts or retirement plans, or who are beneficiaries of a foreign trust or retirement plan—must comply with these rules. As discussed, the tools at the IRS’ disposal include penalties for failure to file Form 3520 and Form 3520-A, the grantor trust rules, negligence penalties, and the accumulation distribution tax and associated interest charges. Given the financial impact and the complex nature of these foreign trust rules, any person dealing directly or indirectly with a foreign trust or retirement plan should consult with a professional experienced in the U.S. income taxation of foreign trusts. 
A foreign trust is not a “bad” thing in and of itself, and may have practical and useful purposes, including enabling the purchase of international investments, creditor protection planning, reduction of taxes in other countries, and efficient management of trust assets for the benefit of non-U.S. beneficiaries. Therefore, the U.S. tax system does not prohibit the use of foreign trusts, but rather has imposed a complex system of reporting, tax transparency, accumulation taxes, and deemed sale rules to discourage U.S. taxpayers from using offshore trusts as tax shelters. Any person either directly or indirectly involved with a foreign trust as a creator of the trust, as a trustee of the trust, or as a beneficiary of the trust, should consult with a qualified professional to make sure they have complied with the foreign trust tax rules. Failure to comply with these rules could be harmful to an investor’s financial health.
The information contained herein is general in nature and based on authorities that are subject to change. Applicability to specific situations should be determined through consultation with your tax adviser.

About the Author:

John (Jack) Nuckolls is the Technical Tax Leader of the Private Client Services group for BDO in the U.S.  His primary responsibilities include assisting the San Francisco office with their high net worth individual practice, addressing national technical issues associated with the Private Client Services group and advising BDO professionals and clients with respect to international income, trust and estate planning issues.