Tax on US State Pensions

I'm a UK/US dual citizen domiciled in the UK. I have a Massachusetts state retirement account that is a defined contribution plan. My contributions were Federal tax deferred, but made after paying 5% MA state income tax. How are withdrawals from this account going to be taxed?

I remember reading that government pensions are only taxable in the country of residence if the beneficiary is a resident and a national of that country. Does this mean that my MA state pension is only taxable in the UK. Finally can I claim credit for the 5% MA income tax I paid on the contributions?

Nun,

1)  If you are UK resident for at least 7 years at the time you start withdrawing the pension, it is taxed in the UK.  You also file a US tax return, resource the income as foreign source (i.e., pretend it's a British pension) and compute US tax, less any UK tax paid.  Forms required in the US are 8833 (to resource as foreign) and 1116 (to claim foreign tax credit).

2)  MA doesn't tax it while you live abroad, so you lose the pre-taxed quality.  Nonetheless, you should still keep track of the pre-taxed amounts for MA tax purposes in the tiny possibility you return to MA or one of the few other states that also recognize this tax-free contribution.

3)  You don't get credit in the UK for the MA tax-free portion, as it's the IRS rules that will apply in determining the taxable amount for UK tax purposes, not the MA ones.

Hope that was helpful.

Yes thanks, that's clear, concise and very helpful!!!!!!!

nun - mmm - it's a shame that tax is such a gray area so there is rarely a simple right or wrong answer...

I really think you should take specific UK advice as the infornation given in the previous reply inadvertantly overlooks several of the problems that currently exist because - quite simply - the UK introduced what are called "unauthorised payment charges" for payments made after 5 April 2006; whereas the positions mentioned above rely on the tax treaty that came into effect from 2004.  The net effect is that these potential UK charges are not included in the kinds of taxes covered under the treaty (because they had not been invented when the treaty was negotiated).

The rate of these charges can be up to 55% and they are not creditable in the US (they are a charge on the fund, not an income tax) so you need UK qualified advice both on making treaty claims on your UK returns and to do the maths so you don't inadvertantly get caught by these additional costs.

Thanks for the heads up Guya, it seems that the charges you mentioned come into effect when an "unauthorized payment" occurs, hence the name I suppose. I don't intend to take any early or unauthorized payments from my US pension accounts. The ROTH, 401k and 403b accounts won't be touched until I'm 59.5.

My state pension and 457 accounts allow me to take payments any time after leaving MA state employment so I can see that there might be an issue there, however, I've had the accounts since well before 2006 and anyway I don't intend to take payments until I'm over 55.

I agree.  These charges only occur when payments/withhdrawals/rollovers occur.

However you will need to disclose the other plans on your UK returns - certainly after 6 April 2008 - and possibly before if you are relying on the treaty exemption.

2)  MA doesn't tax it while you live abroad, so you lose the pre-taxed quality.  Nonetheless, you should still keep track of the pre-taxed amounts for MA tax purposes in the tiny possibility you return to MA or one of the few other states that also recognize this tax-free contribution.

3)  You don't get credit in the UK for the MA tax-free portion, as it's the IRS rules that will apply in determining the taxable amount for UK tax purposes, not the MA ones.

Lizzit,
It's a bit annoying having to pay MA tax upfront on my state pension and then not being able to claim that against my UK tax. It feels like double taxation.......

If, while domiciled in the UK, I had wages from MA I'd pay Fed and MA income tax on it, would I then be able to claim credit for both the Fed and MA income tax on my UK return?

Nun,

Your question is not clear. 

If you are UK domiciled, and US resident, then you pay Fed and MA tax on your wages and do not pay any tax in the UK on the wages.

If you are UK domiciled, and UK resident, and either 100% of your workdays were performed in the UK or you meet the treaty test to count US workdays as UK workdays, then you pay UK tax on your wages, pay MA tax on MA workdays only (usually only bothered with if two or more weeks in MA), and pay Fed tax on the whole lot less any UK tax paid - for a net tax of usually just the UK tax.  Many people would not compute or pay the MA tax in this situation, under the assumption that the Fed treaty resourcing of US workdays as UK workdays will also resource their MA nature.  Tax is grey in some areas, this is one of them.  The conservative position is to tax the MA workdays in MA, the aggressive position is to not tax the MA workdays based on the treaty. 

Then there's the messy position of not being able to resource the US days as UK days under the treaty, where there is an even greater divergence in the amount of taxes paid (the total of UK, MA, and US taxes) between the conservative position and the aggressive position.

Once you get into anything more complicated than just getting a W2 and living, working, and being a citizen of the same state and country, tax stops being black and white.  Seeking B&W answers on a forum is never going to provide you with a satisfactory answer, especially as the answer is long, complicated, and covers loads of factors you haven't posted.  It would take me, Guya, or any of the other accountants who post here hours to answer comprehensively.  Invariably, at least one other person on this forum will disagree; post an equally lengthy and erudite reply, leaving you more confused than ever. 

Any answer posted here must be applicable to anyone in remotely similar situations, and thus answers posted here must be extremely conservative and can not take into account shades of grey or any bits of your personal info you might have unwittingly not mentioned.

If you ask it here, you will not necessarily get the answer you are looking for, and you may unwittingly back yourself into a legal corner where you are stuck with a less-than-desirable result simply because you've laid it all out in black and white on the internet for everyone (the government) to see.  Alternatively, if you ask it of a tax accountant or a lawyer in a private one-on-one in-person or telephone session, you will get the right answer, specific to you and only to you.