US citizen in the UK - issues with income / pension / redundancy payments

Hello fellow slaves of the US tax system (fellow Americans)

I am US citizen currently living in the UK. As most of us, I am very confused by the US tax code and spend thousands of $$$ and hours of my time every year on the subject. I am obviously not a fan of the US tax system and am considering renunciation as I believe I am unfairly taxed by the US government – I live outside the US more than 10 years, rarely visit the country (maybe once every two years for 2 weeks to see some friends), yet I still need to file and (most annoyingly) pay taxes to the US government. I consider this extortion, yet this is not a subject of my message. I believe many of us share the same boat and hope that someday the US government stops penalising us for choosing to live abroad.

There are several questions which I am trying to understand and clarify for myself. I spent a lot of time on the tax code and the UK/US double tax treaty; however, the language in both is extremely confusing (on purpose?) and I was not successful to find any good analysis of the treaty anywhere online.

I still do not understand on what basis the US federal government taxes its citizens on their worldwide income and considers its citizens who are not residents as residents for tax purposes? Is there a clause in the Constitution for this? Any law passed by our beloved Congress (anyone has a link to the specific clause)? Are there any Supreme Court rulings on the subject? I could not find anything.

I am US citizen living in the UK. I am a resident of the UK and am not a resident of the US (for many years). I have a residence permit in the UK and do not have any intention to return to the US. I am employed by non-US company and do not have any US source income. I am compensated fairly well (above FEIE which again I believe should be adjusted based on location, same as housing exclusion - $100,000 in Sri Lanka is definitely the same $100,000 in the UK) and have both defined contribution (to which both my employer and I contribute with employer matching) and defined benefit (a lump sum which I will receive once I separate from the employer) plans.

There are four questions which I am trying to clarify:

1.   Income: according to the article 14(1) of the UK/US treaty, income (such as wages) is taxable only in the country where one is a resident. Why is it then still taxable for the US purposes - even if the US considers me a resident (which I am not), I cannot be a resident of both countries at the same time? I am aware of FEIE and foreign tax credits; however, the UK/US treaty clearly states that wages are only taxable in the country of residence. For instance, if the income is exempt from the UK tax (for whatever reason) while I live in the UK, why is it still taxable in the US? Why doesn't the treaty apply?

2.   Pensions: let’s say I leave my employer this year and will be entitled to receive X amount of money for Y years of service under the defined benefit plan. This is a lump sum. According to articles 17(1)(a) and 17(2) of the treaty, “pensions and other similar remuneration beneficially owned by a resident of a Contracting State shall be taxable only in that State”. Let’s say calculated tax for the UK is $10,000 and for the US is $15,000 – why do I need to pay the difference of $5,000 to the US if, according to this clause 17(1), it is taxable only in the state of residence? What happens if this lump sum is tax exempt in the UK – do I have to pay $15,000 to the US even with the UK/US treaty? What specific clause applies to the US citizens?

3.   Lump sum payment: let’s say I am made redundant and am paid a severance payment, which is tax exempt in the UK. Will I be fully liable for the US taxes on this amount? What happens if it is a mutual voluntary separation with a lump sum payment?

4.   Employer contributions to the pension schemes: for the defined contribution plan, my employer matches my contribution. Let’s say we each contribute $10,000 per year. This is not a qualified US plan (such as 401k), but is not taxed in the UK. How does the treaty protect me from US taxation or does it? This is covered in article 18; however, the language is very confusing. Do I include my contribution as income for the US tax purposes? Do I include the employer’s contribution as income as well ?

I will really appreciate any ideas/thoughts on the above. If you have a good UK/US tax expert who charges reasonable fees, I will really appreciate contacts.

Many thanks.

I would like to comment, but only on the issues relating to the UK US double tax treaty.

For UK residents, the treaty sets out detailed provisions relating to the interaction with US tax. However the position is fundamentally different for UK resident US citizens.

Article 1(4) is the savings clause which preserves the right of the US to tax its citizens as if the treaty had not come into effect. Article 1(5) then preserves some treaty benefits for US citizens.

Therefore what Arlekin should do, as he is a US citizen, is to consider only the reduced number of provisions set out in Article 1(5) and ignore the remainder of the treaty.

You'll have to talk to the US Congress about the fundamental questions about how US citizens are taxed. However, the rules in place do allow you to avoid double taxation and while there are complications there are far more important "injustices" in the world so I don't loose much sleep about it.

1) The US taxes the worldwide income of it's citizens; it has citizen based tax (CBT). The saving clause of the treaty allows the IRS to ignore most of the treaty. So Article 14(1) is moot for US citizens.

2) A lump sum pension payment is covered in Article 17(2).....this is not exempted from the saving clause. UK has primary taxation authority....so you pay UK tax and as the US taxes world wide income you must also pay tax to the US but can take a foreign tax credit for UK tax paid. Take a look at Article 24

3) I don't know how the IRS taxes a redundancy payment...there have been different opinions on here about it's taxable status in the US.

4)You have a choice. You can use the treaty to exclude employee and employer contributions from UK pension plans from US tax........or you can include them both as income on your US taxes and use UK excess tax credits and thus build up a US tax free basis in the UK pension.

I would like to comment, but only on the issues relating to the UK US double tax treaty.

For UK residents, the treaty sets out detailed provisions relating to the interaction with US tax. However the position is fundamentally different for UK resident US citizens.

Article 1(4) is the savings clause which preserves the right of the US to tax its citizens as if the treaty had not come into effect. Article 1(5) then preserves some treaty benefits for US citizens.

Therefore what Arlekin should do, as he is a US citizen, is to consider only the reduced number of provisions set out in Article 1(5) and ignore the remainder of the treaty.

What is the point of the treaty then if 99% of it is not applicable to the US citizens?

What is the point of the treaty then if 99% of it is not applicable to the US citizens?

The tax treaty is there to agree-both for US and UK residents- how to deal with issues of double taxation. It is the US that has decided to tax its citizens, and it is only UK resident US citizens who have the reduced benefits. Once you accept that this is the position, the Article 1(5) rules are entirely logical. But everyone else gets the benefit of the full treaty.

Well, I cannot talk to the US Congress because I am one of those citizens with taxation without representation. I do not live in the US for many years, so I am not represented. I do not have a Senator or a Congressman.

On 2: if there is no tax in the UK, I still must pay to the US on the full amount?

On 3: tried to find discussion threads on this, but couldn't

On 4: do I understand correctly? If I make say USD 100,000 and both I am my employer contribute 10% (USD 10,000 each) - I only state USD 90,000 for IRS gross income. What about USD 20,000 contributed by both employer and I to a foreign pension plan (defined contribution plan)? I just omit this or is there any specific form which I must file?

You'll have to talk to the US Congress about the fundamental questions about how US citizens are taxed. However, the rules in place do allow you to avoid double taxation and while there are complications there are far more important "injustices" in the world so I don't loose much sleep about it.

1) The US taxes the worldwide income of it's citizens; it has citizen based tax (CBT). The saving clause of the treaty allows the IRS to ignore most of the treaty. So Article 14(1) is moot for US citizens.

2) A lump sum pension payment is covered in Article 17(2).....this is not exempted from the saving clause. UK has primary taxation authority....so you pay UK tax and as the US taxes world wide income you must also pay tax to the US but can take a foreign tax credit for UK tax paid. Take a look at Article 24

3) I don't know how the IRS taxes a redundancy payment...there have been different opinions on here about it's taxable status in the US.

4)You have a choice. You can use the treaty to exclude employee and employer contributions from UK pension plans from US tax........or you can include them both as income on your US taxes and use UK excess tax credits and thus build up a US tax free basis in the UK pension.

On 2: if there is no tax in the UK, I still must pay to the US on the full amount?

Yes, of course. If your withdrawal is classed as income from the pension rather than a lump sum then it would be tax free in the US to the same extent it's tax free in the UK.t

On 4: do I understand correctly? If I make say USD 100,000 and both I am my employer contribute 10% (USD 10,000 each) - I only state USD 90,000 for IRS gross income. What about USD 20,000 contributed by both employer and I to a foreign pension plan (defined contribution plan)? I just omit this or is there any specific form which I must file?
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Your gross income would be $110k, you can exclude employer and employee contibutions but must remain within the limits set by both countries.

I still do not understand the difference between "income from the pension" and a lump sum? can you clarify?

and on 4: why is my income USD 110,000 if I am allowed to exclude USD 20,000? VERY CONFUSED.

Yes, of course. If your withdrawal is classed as income from the pension rather than a lump sum then it would be tax free in the US to the same extent it's tax free in the UK.t

On 4: do I understand correctly? If I make say USD 100,000 and both I am my employer contribute 10% (USD 10,000 each) - I only state USD 90,000 for IRS gross income. What about USD 20,000 contributed by both employer and I to a foreign pension plan (defined contribution plan)? I just omit this or is there any specific form which I must file?


Your gross income would be $110k, you can exclude employer and employee contibutions but must remain within the limits set by both countries.

IRS defines lump sum payments as payouts of pension or retirement funds that occur once or that occur over a period of time, but do not occur at least once a year.

Periodic pension payments are payouts of pension or retirement funds that occur over a period of time and have at least one payment per year. They are classed as income and would include annuity and defined benefit pensions and 72t distributions.