Taking the FTC and pension contributions

Hi all,

I've always used FEIE (for 20+ years!!), but I am thinking of revoking that this year and using FTC. I should have done this years ago to get the child tax credit back, since my son is now 15 and I only have two years left to do this! Anyway....

I'm mulling over the options in terms of how to treat my pension contributions if I use FTC. My employer contributions are substantial because I am in a public sector defined benefit scheme, so I don't have enough UK tax paid to cover the US tax due if include both my contributions and employer contributions in total income. I could use the child tax credit to cover this, but only for the next 2 years and that also means no refund of CTC. As I see it I can:

1. Take the FTC but use a treaty position to not include the employer contribution in income. I have paid enough UK tax to cover my contributions (which are not taxed here in the UK).

2. Carry on with FEIE and just include everything.

3. Can I include some employer contributions but not all to soak up the extra tax credits rather than rolling them over???

I am also interested in the idea of allowing a 'basis to build up' which as I understand it would allow me at some later date when I draw the pension to say I have paid tax on $X of pension contributions previously. Can this basis be built up through including just my own contributions? Can you build up the basis using FEIE or no because the income is essentially excluded in tax?  I've struggled to find good resources online about the basis aspect and an accountant I worked with a couple of years ago was vague...and costly!

Of course I know you can't give advice, but I'm interested to hear thoughts on this, or someone is in a similar position.

Thanks!

I've always used FEIE (for 20+ years!!), but I am thinking of revoking that this year and using FTC..........

I see no one has responded so I'll try to help, but for the non-professionals, we're into very iffy territory. I'm afraid my contribution will be of limited use to you.

First, the normal response on whether to use FEIE or FTC is try it both ways for your unique situation (everyone's situation is unique) and see which works best. For your questions, repeating that simple mantra will not be enough.
 

3. Can I include some employer contributions but not all to soak up the extra tax credits rather than rolling them over??? 

Simple,....I don't know! Since "employer contributions" is a separate category (along with growth in the plan and employee contributions), my guess would be no, it's either all or nothing. My guess could be wrong.

I am also interested in the idea of allowing a 'basis to build up' which as I understand it would allow me at some later date when I draw the pension to say I have paid tax on $X of pension contributions previously.......... Can you build up the basis using FEIE or no because the income is essentially excluded in tax?

Sorry, but I have to start with the best article I know of which explains foreign pension plans. In this case, we need:
Employees' trust: If a pension plan is more than 50% funded by the employer and the plan does not favor highly compensated employees, the foreign pension is considered a nonexempt employees' trust and governed by Sec. 402(b). [bold mine]
https://www.thetaxadviser.com/issues/2020/may/foreign-pension-plans-us-uk-tax-treaty.html

Two things: this assumes your employer contributes more than 50%, and does the Treaty somehow alter this. As for the last, I don't know, but would guess not.

In a recent thread, calliope pointed out the following information concerning the FEIE from the IRS:
Amounts Not Included in Foreign Earned Income
Amounts included in your income because of your employer's contributions to a nonexempt employee trust or to a nonqualified annuity contract [bold mine].
https://www.irs.gov/individuals/international-taxpayers/foreign-earned-income-exclusion-what-is-foreign-earned-income
So, it appears if you want to declare the employers contributions, it cannot be part of the FEIE and would have to be declared as a separate, non-excludable item subject to taxation when declared. Will the standard deduction be a larger amount than the contribution + other non-earned income? The good news (which requires reading between the lines) appears to be that employee contributions can be included and therefore should constitute a basis in the pension (My guess!). You know where this is going.......it's down to interpretation.

As for FTC, pension distributions are listed as income on the 1040; a tax due is imposed on the income; but FTCs are used to offset the tax due. My interpretation is there are no restrictions which would not allow both employee and employers contributions to constitute a basis in the pension.

Can this basis be built up through including just my own contributions? 

Yes, it can. This is how I have determined my basis in foreign pension plans. The basis calculation is limited to my recorded contributions only.

Now, two more caveats!
1. A UK pension plan will almost certainly be a non-qualified plan in the US. Non-qualified plans require the use of Publication 939, The General Rule, to calculate the basis in the pension. On the 1040, most filers with US plans (qualified) will use the simplified rule to calculate basis, which we cannot use.

2. Interest income on FTC is "passive category". Pension distributions are (or may be, depending on who you talk to) "general category". With the current UK tax free allowances on interest (£500/£1000) and the interest from any tax free Cash ISA, there will be income in the passive category for which no UK tax has been paid, and therefore no FTCs are available. Unfortunately, since tax credits for the categories cannot be interchanged,  that means having sufficient taxed interest to cover both the taxed and tax free interest. I have to do this (sigh).

In a recent thread, calliope pointed out the following information concerning the FEIE from the IRS:
Amounts Not Included in Foreign Earned Income
Amounts included in your income because of your employer's contributions to a nonexempt employee trust or to a nonqualified annuity contract [bold mine].
https://www.irs.gov/individuals/international-taxpayers/foreign-earned-income-exclusion-what-is-foreign-earned-income
So, it appears if you want to declare the employers contributions, it cannot be part of the FEIE and would have to be declared as a separate, non-excludable item subject to taxation when declared.

Interesting...the preparer I used a couple of years ago included my employer contributions in my income and included them on line 22f of the 2555 and added a statement to show the amounts (I had some additional income marking exams as well that he put there). This is what frustrates me about trying to do the right thing - no agreement on what that actually is.

My employer contributes almost 24% to my pension, so yes this exceeds my standard deduction. If I didn't included it in the FEIE or it couldn't be covered by FTC, I would need to use the treaty position to avoid tax I guess.

As for your second caveat, I can't envisage a time in the near future where I will have significant taxable interest on any savings. Not with interest rates as they are. I do have dividends, but they are quite small amounts at the moment.

Thanks for your thoughts. I'm not entirely sure what the best option is for my unique situation either!

Interesting...the preparer I used a couple of years ago included my employer contributions in my income and included them on line 22f of the 2555 and added a statement to show the amounts (I had some additional income marking exams as well that he put there). This is what frustrates me about trying to do the right thing - no agreement on what that actually is.

Interesting, yes, but neither surprising nor unusual.

Tax preparers have their interpretation of the tax code. The IRS has its interpretation of the tax code. The two may vary. What may surprise many is both interpretations may be acceptable. IRS guidance can sometimes be just plain wrong, as in the 2019 Publication 54, filing threshold for MFS.

Frustrating? Yes, very frustrating.

Go with the stance you believe will give the best result for you, but at the same time can be substantiated by reliable information. Yes, that can be a Catch 22. Have you considered contacting one of the IRS help lines and asking for an interpretation given your specific situation? They may respond with their interpretation, or they may reply that they can't comment. I've done this in the past and received a definite answer to my question. A tax professional has told me the answer from the IRS is most certainly wrong, and the pro can cite substantial evidence to support that stance.

Ah, welcome to the world of self-prepared US tax returns for US citizens with lives centered abroad.

I'm satisfied with the explanation they've given me about why they used this approach.The preparer also pointed out that if I didn't include the employer pension contributions in FEIE I could use FTC instead to bring tax liability to 0, which is true, and would have the same effect.

 I doubt the IRS are hugely interested in me and my measly salary anyway!

I doubt the IRS are hugely interested in me and my measly salary anyway!

Agreed for most of us, but win £1M in the lottery,.......!

I really don't think the IRS is bothered that much about returns from us average folk residing abroad. Besides, and contrary to what many seem to believe, using the General Method to determine a basis doesn't yield all that much of an advantage and usually only increases the amount of excess credits on 1116 (required when retired). In normal circumstances for a UK resident, tax due will be $0 with or without a basis. The basis for my contributions to my foreign pensions only reduces the taxable amount of the pensions by less than 10% (I'm sure of the figures used in the 939 worksheet). For those including employer contributions as well, the basis will be higher, but it won't wipe out all the taxable amount.

I am curious if the UK pension payments are considered “amounts received as an annuity”.  IRS Publication 939 is only applicable to “amounts received as an annuity”.  Page 4 of Publication 939 (“If you receive an amount from your plan that is a nonperiodic payment (amount not received as an annuity), see Taxation of Nonperiodic Payments in Pub. 575.”).

Nonqualified pension payments are amounts received as an annuity only if: (i) received after the “annuity starting date”; (ii) payable in periodic installments at regular intervals; and (iii) the total of the amounts payable can be determined at the annuity starting date either directly from the terms of the contract or indirectly by the use of mortality tables.  See Treas. Reg. §1.72-2(b)(2).

Publication 939 refers to this as “a series of definitely determinable payments.”  See the definition of “pension” on Page 3.

Sometimes the third requirement is not met.  To meet this requirement it must be possible, at the beginning of the start of the payments, to determine the total amount of the payments that will be received.  This determination can be made statistically, for example, if the payments are a fixed monthly amount for life.

However, if the payments are not fixed over a period of years or over your life, they are probably not amounts received as an annuity and you should probably be using IRS Publication 575.  Publication 575 states on Page 18:

“If you receive a nonperiodic distribution before the annuity starting date from a plan other than a qualified retirement plan (nonqualified plan), it is allocated first to earnings (the taxable part) and then to the cost of the contract (the  tax-free part).”

If the pension payments you are receiving are not being “received as an annuity,” then the annuity starting date has not yet occurred, and the payments are being received before the annuity starting date.  Treas. Reg. §1.72-4(b)(1).

The rule that says the payments are “allocated first to earnings” is sometimes referred to as the “basis last” rule.  The rule is in Code §72(e)(2)(B).  I think that the rationale for this rule is that you can’t easily allocate basis to each of the payments if you don’t know how much the total payments will be.

Of course, I have no idea if your pension payments are amounts received as an annuity.  Just thought I would mention this rule in case it applies to you.

I am curious if the UK pension payments are considered “amounts received as an annuity”.

Reading your post, I can understand questioning the interpretation of 939. Been there, done that - many times. As I've said before, I always thought US tax returns were logical.................and then I retired in the UK with UK/EU pensions.

The OP made several comments of note: they are a public sector employee, and the pension is defined benefit. We don't know if they are a dual US/UK citizen or if there is a spouse who would also be a beneficiary if the OP were to die after commencement (drawdown) of the pension.

The following are my interpretations:

The basics are pretty simple. Generally, it is highly unlikely that a UK public sector pension would qualify as ERISA compliant and would therefore be nonqualified requiring use of the General Method. Since the pension is DB and providing it is retained with the current provider, the payments will be periodic, even if a lump sum is taken (939 accounts for this possibility). It also means once the drawdown commences, the periodic amount will be known. By use of the periodic amount in the first year (or months of the first year), a total value of the pension can be determined using the actuarial tables in 939. The resulting information is then used to calculate a "tax free" basis by use of the worksheets.

Both the General Method and the Simplified Method cannot be employed prior to commencing periodic drawdown benefits. The reference to Pub. 575 concerns non-periodic. Payments into the plan, prior to drawdown, are a separate issue. Other than the total amount of contributions, generally the act of contributing is not related to 939.

939 talks of "pensions", "foreign pensions", and "annuities", yet for the worksheets all are considered an annuity.   939 is poorly written in that sense. Pensions are mentioned initially, but never spoken of again. 

There are 2 problems not covered thus far in this thread.

First, is the OP a dual US/UK citizen? Do they intend to reside in the UK forever after they retire or will they someday return to the US? Since this is a public sector pension will Article 19 of the Tax Treaty come into play? Judging from the comments, evidently the tax professional who was engaged believed not.

Second, is there a beneficiary to the DB pension. Most DB pensions are for the individual and a surviving spouse with the spouse receiving benefits if the individual dies during drawdown. Is the spouse a USC or an NRA?   939, being a typical IRS publication, assumes both the individual and beneficiary are USCs resident in the the US. If an NRA, will the spouse ever reside in the US and become a US citizen? If not, why are we calculating the basis on two beneficiaries and not a single beneficiary? (Answer - because 939 says we have to if there is a benefiting survivor!)

I damn near lost all hope of ever figuring it all out once I retired. I will admit I may not yet have it all figured out after all these years.

I agree that if it is a defined benefit plan that the amounts are likely received as an annuity and that Publication 939 is likely the right one to use.

This thread has gone over my head a bit, but... I am not worrying about drawdown until it happens. Very little I can do about it until then!