IRS Tax Treatment of EPF and other Income
US Taxation of Malaysia EPF: The United States taxes U.S. persons on their worldwide income. Therefore, when a person is a either a U.S. citizen, Legal Permanent Resident, or Foreign National who meets the Substantial Presence Test, then they are subject to U.S. tax on their worldwide income.
When it comes to the IRS and U.S. Taxation of Malaysian income, there are several moving parts to be aware of.
Complicating the tax analysis with Malaysia is the fact that there is no income tax treaty, totalization agreement or estate tax treaty between the U.S. and Malaysia.
When it comes to Malaysia and U.S. Income, the two main issues are:
- Taxation of Earned Income
- Taxation of Employees Provident Fund Income
Let’s explore the tax consequences:
U.S. Tax on Malaysian Income
Common forms of income, include:
- Employment and Consulting Income
- Capital Gains
- Real Estate Income
- Pension and Retirement Income
Employment and Consulting Income
The U.S. taxes U.S. persons on worldwide income. Therefore, if a U.S. person earns income that is sourced in Malaysia, they will be subject to U.S. tax on that income. Even if the income is tax-free or tax-exempt in Malaysia, it is generally taxable in the U.S.
Dividends are Taxed as either Qualified or non-qualified, and it is a 2-part analysis:
In order to be considered “qualified”, dividends received must meet all three conditions:
- Dividends are paid by a U.S. corporation or a qualified foreign corporation.
- The dividends are not of those are not qualified to be “qualified dividends”
- The holding period requirement is met.
What is a Qualified Foreign Corporation
- The (foreign) corporation is also incorporated in a U.S. possession.
- The foreign corporation is eligible for the benefits of a comprehensive income tax treaty with the United States that the Treasury Department determines is satisfactory for this purpose, and that includes an exchange of information program.
- The corporation does not meet (1) or (2) above, but the stock for which the dividend is paid is readily tradable on an established securities market in the United States.
Capital Gains can be taxed as Short-Term or Long-Term. In the U.S, Long-Term Capital Gain is capital gain for stock sales held for more than 1-year.
Even if the Long-Term rates are different in the foreign country of source, the LTCG rules would still apply.
Foreign Interest Income is taxed the same way that U.S. interest income is.
It is included and grossed-up into a person’s income, to arrive at their progressive tax rate.
Even if the foreign interest income is accruing in a Term Deposit or similar, the accrued, non-distributed earnings are included.
Real Estate Income
Foreign rental income can be confusing for taxpayers.
That is because it is reportable in the U.S. just as if it were U.S. rental income. Therefore, even if the taxpayer nets a loss after deductions are taken, the IRS requires the total income and expenses on the Schedule E.
The IRS does allow depreciation (which is not permitted in many countries outside of the U.S.), which can help to reduce the overall tax liability.
Pension and Retirement Income
The most common retirement vehicle for foreign nationals of Malaysia is the EPF.
U.S. Tax Treatment of EPF by the IRS
Unlike the United States, many foreign countries do not have a traditional social security system in place. Rather, as is common in Asian countries such as Malaysia, Hong Kong, Thailand and Singapore, the countries have developed “provident funds.”
One of the more common provident funds we handle is the Malaysian Employees Provident Fund (EPF) and how to treat it in the U.S. for tax and reporting purposes.
Other Provident Fund Treatment
The IRS has not issued much if any memoranda or rulings to date on the taxation of the EPF.
But the IRS has issued memoranda about the CPF (Central Provident Fund). The programs are similar (not identical). But like Singapore, Malaysia does not have a tax treaty or totalization agreement with the U.S.
Therefore, chances are the IRS will treat the EPF similar to the CPF.
The EPF System
As provided by the EPF system website:
“The Employees Provident Fund (EPF) is one of the world’s oldest provident funds. Established in 1951, we help the Malaysian workforce to save for their retirement in accordance to the Employees Provident Fund Act 1991.
Today, we at the EPF continue to refine our vision to not only stay relevant but to create a better retirement for all our members. This strengthens our commitment in safeguarding our members’ savings and increasing our dedication in providing excellent services.
In tandem with our main vision in helping members achieve a better future, we have extended our mandate to include aiding national infrastructural development while safeguarding and growing members’ retirement savings.”
World Bank Pillars
In 2005 (expanding the prior 1990s framework), the World Bank provided a 5-Pillar Approach (pillars 0,1,2,3 and 4) in support of “old Age Protection.”
Pillar Zero: a non-contributory, publicly financed and managed system that provides a minimal level of protection for retirement;
Pillar One: a mandatory, contributory and publicly managed system;
Pillar Two: a mandatory, privately managed, fully funded contribution system;
Pillar Three: voluntary savings (e.g. personal savings and insurance); and
Pillar Four: informal support (e.g. family support), other formal social programmes (e.g. health care and housing), and other individual assets (e.g. home ownership).
Important Aspects of the EPF
As summarized from the Employees Provident Fund Schemes Authority
- The EPF refers to itself as Retirement Protection (not Social Security)
- Two individual accounts per member (70%/30%)
- Certain Income contribution requirements from Employers and Employees
- Voluntary Contributions are permitted
- Immediately Vested Contributions (and Growth)
- Can withdraw benefits or lump sum when Permanently Depart Malaysia
- Accrued benefits may be claimed at death as part of the Member’s Estate
Social Security or Pension?
The EPF most closely resembles pension.
Members have their own individual accounts with an accrued value (vs Social Security and a Joint Fund).
In addition, there is a “set amount” of full amount of benefits may be withdrawn per person, which will vary based on the contributions. Moreover, the contributions and accrued benefits immediately vest.
Social Security in the U.S.
In the U.S., both the employer and employee contribute to Social Security.
- It goes into a single fund.
- Unless A totalization agreement applies, U.S. person submit to it, whether or not the Employer is U.S. or Foreign (some limitations may apply)
- There is no distinction between who owns “what” portion
- Taxpayers cannot choose the investment
- Taxpayers cannot cash out
- If you die before you receive any…your loved ones cannot “cash out” (Spouse payments)
- There is no account number
- You can withdraw the full amount based on various milestones or loss of nationality
No Treaty so no 8833 available
Form 8833 is for treaty countries. Since there is no treaty with Malaysia, there is no treaty position Form 8833 position to take.
By not reporting the income that is immediately accruing on a U.S. Tax Return, it may lead to future penalties and interest.
Depending on the size of the account, this may be substantial.
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