401(k) lump sum payment to non-resident alien: tax returns

Hi,

I used to work in the US, but am now a resident in the UK. Last year I liquidated my old 401(k) plan as a non-resident alien. The plan administrator withheld 30% tax on this (chapter 3). This is too much, so I want to claim back some of it by filing 1040-NR. I'm basically just trying to make sure I'm getting this right:


• First, I cashed out the entire 401k, so this is a lump sum and should only be taxed in the US. I will tell HMRC about it on a self-assessment tax return in the UK, but I won't pay any UK tax on it. This is based on the Double Taxation Agreement, which states that lump sum pension distributions are only taxed in the US:
  

  ARTICLE 17
  Pensions, social security, annuities, alimony, and child support
  1.
  (a)  Pensions and other similar remuneration beneficially owned by a resident of a Contracting State shall be taxable only in that State.
  (b)  Notwithstanding sub-paragraph a) of this paragraph, the amount of any such pension or remuneration paid from a pension scheme established in the other
  Contracting State that would be exempt from taxation in that other State if the
  beneficial owner were a resident thereof shall be exempt from taxation in the first-
  mentioned State.
  2.  Notwithstanding the provisions of paragraph 1 of this Article, a lump-sum
  payment derived from a pension scheme established in a Contracting State and
  beneficially owned by a resident of the other Contracting State shall be taxable only in
  the first-mentioned State.

  Unfortunately, this point seems very unclear. I find plenty of information online supporting this position, but an important exception is HMRC's guidance provided recently in their support forum ( newcomer link: https://shorturl.at/iEM78 [nonactive] ), in particular:
  

  A UK resident, Article 1(4) above permits the UK to tax any US sourced lump sum payment received, as if Article 17(2) of the DTA was not in force or applicable, Article 1(4) effectively ‘overrides’ the provision at Article 17(2), and the consequence is that both the UK and USA can tax any lump sum payment received from a US sourced pension scheme.
  In these situations, double taxation will occur since both the UK and the USA can tax the same income. However, that double taxation will be eliminated in accordance with Article 24(4)(a) of the DTA which requires the UK, as the country of residence, to provide Foreign Tax Credit Relief (FTCR) to offset the US tax correctly paid against the UK tax charged on the same the IRA withdrawal.

  I found some relevant posts in this forum, but I wonder if someone has up-to-date information on it.
• The distribution is evidenced on a form 1042-S. I put this on the 1040-NR in line 5.
  
• I'm under pension age, so the lump sum is subject to a 10% early withdrawal penalty. I calculate this using Schedule 2 and form 5329.
  
• In addition I have to pay the normal graduated income tax on the whole amount, as calculated on the 1040-NR. (I don't distinguish between payments made into the 401k by me and my employer vs. capital gains within the 401k. I simply report the entire distribution as income - correct?)
  

If anyone has been in a similar situation, I'd be grateful for confirmation or tips.

Thanks!

The portion attributable to contributions into the plan by you and your employer are taxed at graduated rates in the US. However, the portion attributable to income or gains earned within the plan are taxed to you at a flat 30% rate in the US as FDAP income.

[In addition I have to pay the normal graduated income tax on the whole amount, as calculated on the 1040-NR. (I don't distinguish between payments made into the 401k by me and my employer vs. capital gains within the 401k. I simply report the entire distribution as income - correct?)


If anyone has been in a similar situation, I'd be grateful for confirmation or tips.

Thanks!

I have not been in exactly the same situation as I am a USC living in the UK but have done similar withdrawals. With my 401k all contributions from employer and employee plus all gains were never taxed, so once I started withdrawals it was all counted as untaxed regular income as you describe and taxed as such. The 30% withholdings were indeed too high and the excess refunded as part of my IRS return.

Thank you for your help. I submitted the US tax return, now I just need to figure out the UK part of it.

Looking at the thread quoted above, it's clear that the HMRC admins get things wrong, and badly wrong. They eventually add a post starting

We apologise for the confusing replies we haved (sic) posted on the forum. Our double taxation policy team has reviewed the thread and has provided the following correct and final response:

That post is quite hard to follow, but it makes no sense. It's saying that Article 1(4) means that all of the DTA is null and void. That means that Article 17(2) on lump sums is never valid, so why would it have been written? Here's 17(2), and it's clear about it being a pension in the US owned by a resident in the UK:

Notwithstanding the provisions of paragraph 1 of this Article, a lump-sum payment derived from a pension scheme established in a Contracting State and beneficially owned by a resident of the other Contracting State shall be taxable only in the first-mentioned State.

So something doesn't make sense. Why write a tax document where large chunks have no effect?

I'm guessing this wouldn't be resolve until an audit occurs.

Looking at the thread quoted above, it's clear that the HMRC admins get things wrong, and badly wrong. They eventually add a post starting

We apologise for the confusing replies we haved (sic) posted on the forum. Our double taxation policy team has reviewed the thread and has provided the following correct and final response:

That post is quite hard to follow, but it makes no sense. It's saying that Article 1(4) means that all of the DTA is null and void. That means that Article 17(2) on lump sums is never valid, so why would it have been written? Here's 17(2), and it's clear about it being a pension in the US owned by a resident in the UK:

Notwithstanding the provisions of paragraph 1 of this Article, a lump-sum payment derived from a pension scheme established in a Contracting State and beneficially owned by a resident of the other Contracting State shall be taxable only in the first-mentioned State.

So something doesn't make sense. Why write a tax document where large chunks have no effect?

I'm guessing this wouldn't be resolve until an audit occurs.

Yes, it is as clear as mud.

My wife and I have made lump sum withdrawals of our IRAs and converted them to our Roth IRAs. In every case we only paid US tax. On filing our tax returns with HMRC we declared the lump sum in the comments and said it was only taxable in the US according to the tax treaty. It has been 7 years since we first started doing this and HMRC never came back to question either of us.  We now have only Roth IRAs so no more lump sum withdrawals, and Roth withdrawals, which I’ve started doing, are tax free in both countries.