US/UK Tax Treaty impact on IRA distributions.

I have spent some of a very wet summer trying to understand my US and UK tax obligations as a non-resident alien when taking a full distribution from my Traditional IRA.

I do understand my UK tax obligation in so far as I have to declare the gain I have made from my IRA contributions but will be able to partially offset that by the tax I pay to the IRS.

However my US tax obligations are slightly more complicated. With respect to this I have to deal with Effectively Connected Income (ECI)  and Non-Effectively Connected Income (NEC). My understanding is that ECI is my IRA contributions and NEC is the gain I have made.

The ECI is declared on Line 4a of the current 1040-NR and is taxed at graduated rates depending on value. (I guess I can’t claim tax treaty benefits for this). For NEC I have to complete 1040-NR Schedule NEC. This is where it becomes more complicated. Because I have taken a lump sum distribution it appears I cannot take advantage of the US/UK Tax Treaty benefit of 0% tax. What I haven’t been able to establish is what the tax treaty rate is, if there is one, on the lump sum withdrawal. I ask this as 1040-NR Schedule NEC, Line 7 requires me to enter a %.

Does anybody know?

You asked the same question last year and I don't know the answer. Hopefully Guya will come along and expand further on the details he provided last year.

https://talk.uk-yankee.com/index.php?topic=101001.msg1326170#msg1326170

On the HMRC side, I would have thought that a lump sum distribution of your IRA is not taxed at all by HMRC.  My wife and I are both USCs living in the UK and our lump sum distributions from our IRAs were declared on our HMC returns as taxable only by the USA.

You asked the same question last year and I don't know the answer. Hopefully Guya will come along and expand further on the details he provided last year.

https://talk.uk-yankee.com/index.php?topic=101001.msg1326170#msg1326170

On the HMRC side, I would have thought that a lump sum distribution of your IRA is not taxed at all by HMRC.  My wife and I are both USCs living in the UK and our lump sum distributions from our IRAs were declared on our HMC returns as taxable only by the USA.

My understanding re a lump sum withdrawal is this:  the US will get first dibs on the tax because it's a lump sum (as opposed to a periodic withdrawal) and it will be taxed according to ECI and NEC.  HMRC will also tax it, but give foreign tax credit for the tax paid to the IRS.  This is annoying - the effective US tax is likely to be less than 30% but for any significant withdrawal the top UK tax rate of 45% comes into play so there's potentially tax to be paid in the UK.  BTW, I think the UK will assess tax on the whole lump sum - not just the amount left over after US tax is paid.

I'm not a tax expert but this is the conclusion I've come to from reading various opinions on various forums.  Helpfully, the DTA doesn't define "lump sum" or "periodic withdrawal".  Someone, who needs a definitive answer should take HMRC to court so that we can have some legal precedent.  Having said that, I'm not a lawyer either.

If anyone knows different, and has tested this with HMRC, especially if it works in our favour, then I'd be more than happy to hear it.

(I should say that my opinion is based on me being a UK citizen and UK resident)

I started doubting myself after I posted the above, so I tried to find out where I'd seen it discussed.  Here's one example:

https://community.hmrc.gov.uk/customerforums/sa/2535b7a2-1c36-ee11-a81c-002248c79814

In particular this paragraph written by HMRC Admin 5 Response

In summary, both periodic and lump sum payments from Traditional IRAs are taxable in the UK and need to be declared on the on the Foreign Income pages (SA106) of a self-assessment return.

The only difference is that periodic payments are taxable in the UK, so any US tax paid on those payments should be refunded by the IRS or, if you are a US Citizen, you should claim the US version of FTCR and offset the UK tax paid against the US tax charge. Whereas ’non-periodic’ or lump sum payments are taxable in both the UK and USA. In this situation, the UK should provide FTCR to offset the US tax correctly paid against the UK tax charged on that payment.

I should say that I don't always believe what HMRC Admins say on that forum.  In particular I find it odd that withdrawals from an IRA should be reported as "foreign interest" and I've just reported them as foreign pension income.  Makes little difference though, I think.

I'm not at all sure what the real answer is, but this is my current understanding.  I'll be sticking to periodic payments for now so that I avoid the lump sum question.

Edit: note that I'm talking about traditional IRAs, I know nothing about Roth IRAs.

Just a bit more detail on what I did. I'm not saying what I did was necessarily correct, but it's sometimes helpful to know what others did and experienced - and it puts the information out there so the experts on the forum can shoot me down if I messed up. ;-)

I had two 401(k)/403(b) accounts with two different academic institutions. I am a UK resident and citizen; I am not a US resident or citizen.

In 2017, when I knew I had no plans to return to the US, I started pulling what I thought of as "lump sums" from these accounts. I won't go into some of the confusing interactions I had at the time with TIAA-CREF about definitions of lump sum vs periodic payment, etc., but initially, TIAA-CREF withdrew 30% federal taxes from the withdrawals. Initially, I managed to get a "refund" by submitting a 1040-NR form, claiming exemption in section L of the form and citing article 19.2(b) of the UK-US tax treaty, along with form 1042-S.

After this initially very trying period, TIAA-CREF eventually came round to the idea that I was exempt, I used form W-8BEN to claim exemption, and they stopped withholding taxes from any subsequent payments. On at least one occasion, they actually withdrew 30% federal taxes and after several communications, they subsequently refunded the 30% themselves (I have no idea how they did this).

Separate to these "lump sums," I also started receiving interest from the TIAA Traditional holdings I had, which TIAA calls an annuity;  it's ostensibly interest. [I couldn't withdraw these holdings as a "lump sum" due to a restriction in the state of Tennessee's retirement rules on state university retirement funds]. Just this year, I converted the TIAA Traditional holdings to a "lifetime annuity" (which is more like what we call an annuity). Since 2017, therefore, I've been receiving monthly payments from the interest, and subsequently from July this year, from the lifetime annuity.

The relevance to UK taxes is this: I ultimately paid no US taxes on any of these withdrawals (because any amounts withheld were refunded, although it often took some time). I declared all of these amounts on an HMRC self-assessment, under the Foreign Pensions section. Rightly or wrongly, I only declared amounts I actually received in any tax year - I declared any tax withheld in the tax year it was refunded (IIRC). This may or may not have been the correct process, but I calculated that, regardless of whether I declared it in the UK tax year it was withheld, or in the UK tax year it was refunded, it made no difference to any tax I owed to HMRC, so I was able to sleep at night.

From reading this forum over the years, I realise I may have been able to offset the US federal taxes I'd paid, against UK taxes due, but I really CBA (I was working in excess of 80 hours a week at the time), and again I figured the amount of tax I owed/paid between the two countries wouldn't change regardless of what UK tax year I declared it.