Quirks in a US treaty with Malta turn into a tax play4 min read . Updated: 20 Aug 2021, 05:04 PM IST
- An offshore tax shelter promises rich Americans they can avoid lots of capital-gains taxes by setting up pension plans in Malta—and maybe some can
Have you heard of Malta Pension Plans? They’re offshore tax shelters that are hot with some wealthy Americans.
As usual with tax shelters, the promoters promise they’ll slash tax bills by making clever use of legal quirks. That puts them in a somewhat gray area, meaning the tax savings could bring legal risks.
Malta has caught the attention of advisers due to quirks in a 2011 tax treaty between the U.S. and the small, sunny island that sits at a historic crossroads in the Mediterranean Sea.
Advocates say Malta plans can dramatically lower U.S. taxes on the sale of highly appreciated assets like cryptocurrency, stock or real estate. Instead of paying a top federal rate of 23.8% on capital gains—or 43.4% if a Biden administration proposal is enacted—U.S. investors can fund a Malta pension with such assets, sell them, and soon withdraw large chunks of the money tax-free if the saver is age 50 or older.
Predictably, Malta pensions have also caught the eye of the Internal Revenue Service. In July, the agency put them on its “Dirty Dozen" list of tax scams to avoid. However, the IRS said only that it may challenge some Maltese pensions—not that all plans are abusive, or that it will challenge them.
California attorney and Malta-plan advocate Jeffrey Verdon has posted a YouTube video extolling these strategies as a “unique opportunity" for high-income taxpayers. The video says these pensions are like “a supercharged cross-border Roth IRA" that offer high earners benefits they typically can’t get from Roth IRAs under U.S. rules.
Mr. Verdon declined to comment on Malta pensions.
Cross-border specialists concur that the U.S-Malta treaty’s language provides unusual tax benefits. They caution that the Treasury Department may have overlooked them when it negotiated the treaty, and the loopholes may not last.
“Malta exempts pension payments received by its own residents, so the treaty requires the U.S. to exempt certain payments from U.S. tax," says Jeffrey Rubinger, an international tax lawyer in Miami.
Did U.S. officials mean to allow Americans to set up Maltese pensions mainly to avoid U.S. taxes? “It’s unlikely this outcome was intended," he says.
Here’s a simplified example of how Malta pensions work under the plain language of the treaty, based on a blog post by Mr. Rubinger.
Say that Jane is a 49-year-old U.S. resident with highly appreciated cryptocurrency holdings and shares of a startup about to go public. These assets have a cost basis—i.e. the starting point for measuring taxable capital gains—of $10 million. After the IPO, the assets could have a total value of $100 million. Under current law, the top rate on these gains would be 23.8%, or about $21 million.
As part of her retirement planning, Jane contributes these assets to a Maltese pension account, which is allowed to receive large contributions of appreciated assets. (Assets in the plan don’t have to be in Malta; they can be held at a U.S. institution and invested by U.S. managers.) Jane then sells both assets and has $100 million in her pension account.
Under Malta rules, Jane needs enough assets to provide her with a pension payout of “sufficient retirement income," but meeting that threshold isn’t hard. She’ll owe tax to Uncle Sam at ordinary-income rates on part of this payout. But she doesn’t have to withdraw right away, and the assets can grow tax-free.
Now comes the tax magic: Based on the Maltese criteria, Jane has more than enough money saved for her pension, and she can take large withdrawals of excess funds as lump-sum payments once she turns 50—even on assets that had a lot of untaxed appreciation going into the plan.
These payouts are free of both Malta and U.S. tax under the treaty language, say advocates.
The Maltese rules allow the first tax-free lump sum to be about 30% of the assets, or $30 million for Jane. The next tax-free lump sum, about half the remainder, can come out in the fourth year. If the assets have grown to $85 million by that point, Jane could likely take another tax-free payout of $40 million or more.
As a result, Jane could withdraw $70 million or more, tax free, within five years of setting up her plan—saving her about $17 million of U.S. tax. She can take further tax-free withdrawals annually after that.
This strategy comes with caveats. Richard LeVine, an international tax lawyer with Withers Bergman, says that to be free of U.S. tax, the payouts under the U.S.-Malta treaty must also comply with the treaty’s overall conception of a pension.
“To qualify for the tax-free treatment, a plan has to operate mainly as a pension—or the IRS could argue it’s not one," he says.
Improper moves could include making large withdrawals too fast, or putting too much of one’s net worth into a plan—judgment calls that depend on a taxpayer’s circumstances. In addition to an IRS crackdown, the Treasury Department could seek changes to the Malta treaty. Congress could also move to limit benefits, says Mr. LeVine.
Scott Diamond, a Los Angeles-area adviser who heads Roxbury Consultants, has a simpler reason for not allowing clients to have Malta pensions.
“My struggle has been the smell test. Does the law really intend to allow people to avoid all these taxes?" he says.
Still, Malta plans aren’t totally out of bounds. Andrew Mitchel, an international tax lawyer in Centerbrook, Conn., who also hasn’t recommended Malta plans to his clients, says he can understand their appeal.
“Someone who has $200 million in bitcoin or IPO shares may not mind spending $2 million on legal fees to see if they can avoid a lot of taxes," he says.
(This story has been published from a wire agency feed without modifications to the text.)
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