Keren Hishtalmut and US Tax: What Is Clear, and What Is Still Disputed

A keren hishtalmut is a savings fund that employer and employee contribute to every month, and after six years it can be withdrawn tax-free in Israel. For a US citizen that's a sensitive point: the US taxes its citizens on their worldwide income, and an Israeli tax benefit doesn't automatically become a US one.

What is completely clear: the reporting obligation

• FBAR: under most professional approaches a keren hishtalmut is a foreign financial account, and its balance counts toward the $10,000 threshold together with your other accounts
• Form 8938: if your total foreign financial assets pass the threshold for people living outside the US, the fund is reported there too

On this the IRS has been explicit: even where it exempts certain funds from other reporting, the obligation to file the FBAR and Form 8938 remains.

What is no longer as threatening as it was: Form 3520

For years a major worry was that the IRS would treat a keren hishtalmut as a foreign trust, requiring Forms 3520 and 3520-A, with heavy penalties for not filing. In 2020 the IRS issued Rev. Proc. 2020-17, which exempts from those forms tax-favored foreign funds that meet certain conditions, such as contribution caps and withdrawal restrictions. Many practitioners believe a keren hishtalmut meets them, but the IRS hasn't said so explicitly about this fund, and some take the cautious route and file anyway.

An important condition that people tend to miss: the exemption only applies to someone who is compliant with all their tax filing obligations, and who has reported income from the fund to the extent US law requires. Someone who doesn't file returns at all doesn't benefit from it.

What is disputed: whether and when tax is owed

Here there is no single official answer. Most practitioners treat employer contributions as part of salary for US tax purposes, and the open question is mainly about the earnings inside the fund: are they reported every year, or only on withdrawal. The US-Israel tax treaty doesn't mention the keren hishtalmut by name, and different accountants' approaches lead to different results.

In some cases there is a further complication: if the fund's money is invested in Israeli mutual funds, those may be treated in the US as PFICs, a classification that brings separate reporting and unfavorable taxation. In practice, for most families the credit for Israeli tax already paid, or the foreign earned income exclusion, neutralizes most of the US tax on salary. But that has to be checked case by case, not assumed.

So what do you do

• Don't give up the fund out of worry. In most cases it still pays off
• Report it on the FBAR, and on Form 8938 when you reach the threshold
• Choose one approach to reporting the earnings and keep it consistent year to year
• Check what the fund is invested in before choosing an investment track
• Before a large withdrawal, check in advance what it means on that year's US return

How we help

We gather the fund's figures, make sure it's reported on the FBAR and in the right places, and coordinate with a licensed US accountant who knows Israeli products, so the approach chosen is reasoned and consistent. An initial check with no commitment.