Successful entrepreneurship is the engine of private wealth creation. Business owners work very hard to build solid and valuable companies, entities that many times represent a huge chunk of their personal wealth.
Sometimes, the businesses produce enough free cash flow for the owners to become affluent beyond the company value. But often, their wealth becomes liquid only when they sell, and they dearly wish to minimize the taxes when that time comes.
There are various ways to do this. If they use certain charitable trusts, for instance, they can eliminate capital gains taxes, and their monies will eventually go to worthy causes (if they have charitable intent in the first place).
Another possible way to eliminate or mitigate taxes is by using a Malta pension plan.
The Nature Of The Plan
Since 2011, the country of Malta and the United States have established a tax treaty that makes Malta pension plans viable wealth planning tools. They offer United States citizens significant tax benefits that they could not otherwise get with tax strategies and structures in the U.S.
The Malta plan can distribute monies only when the contributor reaches a certain minimum age—according to Malta law, that can be as early as 50.
In some respects, the Malta plan resembles a Roth IRA. There are no tax deductions for contributions. The monies going into both vehicles are after-tax funds. And in both cases, the business owner may never have to pay taxes on the future profits of the assets held in the plan.
But there are critical differences. Just about any type of asset can be contributed to a Malta pension plan without tax implications. These assets include private and public business interests; partnership and limited liability company interests, including carried interests; and real estate.
However, Malta adopted regulations in 2019 that prohibit plans from holding investments with or in “connected persons.” This means the plans cannot hold shares in companies where the contributor serves as a corporate director or in limited liability companies where he or she serves as manager—or in cases where the participant is otherwise able to control the management of the business personally.
There are no formal limits on the amounts that may be contributed to Malta plans. But the IRS might question whether the account is actually being used to provide pension benefits. The agency might look askance, for example, if plan participants cannot show a reasonable relationship among three factors: 1) the amount they contribute; 2) the size of the actuarial annuity payments expected to be generated by that contribution; and 3) the participants’ annual expenses to support their lifestyles.
Still, under the Malta pension, any previous appreciation in contributed assets may avoid being taxed in the United States. So if real estate was purchased for $1 million and is now worth $10 million, the $9 million appreciation will not be taxed at the time of sale. Of course, if the asset is contributed to the pension plan very shortly before sale, or after a term sheet (or, even worse, a contract of sale) has been agreed upon, then the IRS might well succeed in taxing the participant on the sale under the assignment of income or step transaction doctrines.
Nevertheless, Malta plans are proving very attractive to business owners. Entrepreneurs would likely want to contribute equity in their companies that they intend to sell, since a substantial percentage of the capital gains taxes—if not all the taxes—can be avoided.