US citizens may pay double tax on Kahlon’s child savings program

December 21, 2016 00:18
4 minute read.
Moshe Kahlon

Moshe Kahlon. (photo credit: MARC ISRAEL SELLEM)

While many Israeli parents were thrilled to hear about Finance Minister Moshe Kahlon’s “Savings Plan for Every Child,” it seems that not every child will be equally able to enjoy the same high yields and some – namely children with US citizenship – might even be double-taxed if they don’t make the right choice regarding the account.

Under Kahlon’s plan, which is expected to be implemented next month, parents will be able to open a savings account through the National Insurance Institute (NII) for any child under 18, into which the state will make monthly deposits that may be withdrawn by the child upon reaching the age of 18 or 21. Parents can choose whether the account is opened in a provident fund or bank account.

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“When we heard about this NII program, we thought it was perfect – it’s a great way to put some money aside for our kids for when they’ll start to need it. We checked with our US accountant who does our US taxes, but he recommended against setting up that program in a provident fund because of exorbitant double taxation,” Noam Waldoks, a father of three who immigrated from the United States four years ago, told The Jerusalem Post.

According to the Finance Ministry, a provident fund is the default option for children under the age of 15. Additionally, if parents do not choose between a bank account or a provident fund by May 2017, the NII will automatically open the savings plan in a provident fund regardless of age. Once a decision between a bank or a fund has been made, it is impossible to then transfer the savings from a fund to a bank and vice versa.

Finance Ministry officials, the NII and private investment consultants all recommend opening the savings plan in a provident fund, especially for any child with a long-term investment horizon. However, because of the tax implications, that is not a viable option for Waldoks and other parents of children with US citizenship who, therefore, must choose the bank account by default, which has lower yields.

“My kids are little, one of them isn’t even born yet, their investment horizon is long. Any financial consultant will tell you that if you have a 20-year investment horizon you want to be in the [stock] market, not in a bank,” Waldoks told the Post.

The problem is that Israeli provident funds are considered Passive Foreign Investment Companies (PFIC) by the US Internal Revenue Service (IRS) and, as such, are subject to high US taxation in addition to Israeli taxation, as well as onerous reporting requirements by the IRS.

Furthermore, the IRS can and does tax PFICs before gains are realized by investors by annually taxing income from activity within the fund. Not paying the tax on an annual basis is considered by the IRS as a deferral of tax and results in penalties and high interest payments when the child decides to realize the fund when coming of age.

While the US and Israel have a bilateral tax convention that prevents or reduces most instances of double taxation by both countries, it does not cover investment funds that are not employment related.

“These provident funds for the kids are not employment related, these are solely private investment related.

Therefore, they would fall under the IRS’s category of PFIC and would be subject to higher rates of tax in the US and possibly interest charges,” Larry Stern, a licensed US accountant from Modi’in, told the Post.

“Currently the only option [for Israeli Americans] is the bank option as opposed to the fund option, otherwise their children are going to have to deal with the implications,” Stern said.

Hearing of Waldoks’s plight, former deputy finance minister and current member of the Finance Committee MK Mickey Levy (Yesh Atid) sent a letter to US Ambassador Dan Shapiro asking him to “take this issue to the appropriate US authorities to consider how to arrange, if possible, for the IRS to declare these accounts ‘tax free.’” However, that course of action is highly unlikely, since in order to exempt the Savings Plan for Every Child from US tax, it must be included in the US-Israel Tax Convention.

“The whole process of including this in the tax convention is a whole long administrative nightmare. These are things that take years to deal with.

You’ll have to get the two governments to sit down and hammer out whatever changes to the treaty – and there are more pressing issues to deal with in this case rather than the savings plan,” Stern told the Post.

Another possibility Waldoks suggested is for the NII to create a track for US citizens that would use a US-based provident fund. This, however, would take time to approve and the parents don’t necessarily have that much time to make the irreversible decision between a bank and a fund.

“This is money that is supposed to go to my kids and lots of other kids, and it is not right for kids to be disadvantaged in this way,” said Waldoks.

The Finance Ministry and the NII did not respond to requests for comment.

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