Re-sourcing US income to UK on 1116

Dear Forum,

I took a distribution from an inherited IRA (no 10% penalty).  I'm a US citizen, resident for >10 years in the UK.  I am not claiming the remittance basis so I need to pay UK tax on it (at 40%). However, the IRS want to tax it as well.  To avoid double taxation and to simplify the whole payment thing,  can (or should) I "re-source" the income from this distribution to the UK on my 1116?  I'm going to have to pay a total of 40% tax on it anyway even if the US only wants 25%...

If you think that it cannot be re-sourced, could you direct me to a relevant IRS publication?  I can find nothing explicit in the 1116 instructions. Nor can I find anything in the tax treaty nor the treaty notes (http://www.ustreas.gov/offices/tax-policy/library/teus-uk.pdf). I only find the cryptic "certain income re-sourced by treaty" on the 1116.

The alternative, of course, is to pay the IRS their 25%, then on my HMRC self-assessment tell them that I paid the US 25% and claim it as a credit against the 40% the HMRC wants.  Giving the USA first dibs would be more patriotic... However, if I could re-source the whole thing to the UK and give them the entire 40%, it would increase my bank of unused foreign tax credits that I have with the IRS; I will desperately need these in a few years (< 10) to offset the US tax on my UK (tax-free) pension lump sum. 

Thanks for your help/ideas.

You are right that the UK has the first right to tax it and in fact will be the only country you are taxed.  You need to be looking at Article 18 of the treaty. 

Thank you Sarah,

Yes, come to think of it, that makes sense given that it is a pension and article 17 (not 18, actually) specifies that  regardless of source, pensions are taxed only by the country of residence (UK in my case).  That's helpful.  However, I realized something even better:  Article 17 also states that lump sump distributions are only taxed in the country of source (US).  I take it that, if I cashed out the entire IRA this tax year, it would be a lump sum distribution and, therefore, taxed at a more merciful 25% in the US and 0% in the UK.  Since there is no UK taxable income,  I won't even have to do self-assessment; I imagine though, that I should  send HMRC a letter explaining that I am using the Tax Treaty to avoid UK taxes.. What do you think?

You are right, it is Article 17.  Proof I shouldn't quote treaty articles from memory!

Also, you have the whole lump sum thing a bit wrong.  YOu cannot cash out the whole thing and call it a lump sum.  With lump sums they are referenceing the (up to) 25% tax free lump sum you get in the UK.

Just when I think I understand it, I find this thread:

http://www.taxationweb.co.uk/forum/taxation-of-401k-disbursements-for-dual-citizens-t29003.html

This implies I should first give the IRS it's due then take a tax credit on my HMRC self assessment.  It also suggests I should indeed cash out the whole thing as I would only be
liable for 25% in US and 0% in UK..

There is quite a range of opinions on how the savings clause in the treaty affects pensions.  If you want a bit of security on the issue, hire a dual qualified advisor and spread the liability!

This topic really interests me, since I will be inheriting a large sum this year (US citizen living in the UK). I know it will be complicated, but I'd like to get my head 'round it before I get the money.

I do not quite agree with Sara on everything she says above about the tax on IRA distributions - but I DO agree it is very complicated and you really cannot do without dual qualified advice.

I guess I still don't fully grasp how US citizens, resident in the UK,  are allowed to re-source US income to the UK on 1116.   Technically, does it follow from the worksheet (Additional foreign tax credit on US sourced income) at the back of the 1116 instructions?  Does it usually work out that you can simply re-source all of a US-sourced income? From what Sarah says, it seems that this is what people are routinely doing.  BTW, when you re-source the income on 1116, do you fill in a separate 1116 and check the "Certain income resourced by treaty" box?  Sarah also said in an earlier thread the re-sourcing doesn't have to be disclosed on 8833.

Here is a significant corollary of all this regarding pensions: What if the income was taxable at a lower (or nil rate) in the UK?  You would get no foreign tax credit but, because it has been re-sourced, you could pay  the US tax on it by using carryovers of unused foreign tax credit that you had accumulated from previous years (< 10).  I know for a fact that you can do this if the income really was sourced in the UK (e.g., a lump-sum pension payout that is tax-free in the UK; big accounting firms advise us expats to do just that). But what about, for example,  US income tax on a lump-sum pension payout from the US to a UK resident (again, not taxable in the UK). If you re-source it to the UK, you are not paying foreign tax on it so you get no tax credit.  However, if it is now UK sourced,  you can carryover unused foreign tax credits from previous years and pay the US tax with that.  One could argue that,  in such a situation,  the IRS is, in fact, maintaining its "savings clause" from Article 1; it's just that you are paying your US tax  with carryovers of unused foreign tax credits.

Gosh, this stuff can really get technical...I'd be really grateful for comments/criticism from the forum.  Could you direct me to any IRS publications that clarify this (as if..)?

Thank you guya for your post (which crossed mine..).  I should have put the IRA lump sum thing in a separate thread.  I called HMRC and asked them and they said that a lump sum pension distribution from the US is not taxed in the UK and I wouldn't need to fill in self-assessment or even anything analogous to an 8833.  However,  HMRC person didn't know what an IRA was;  I never trust the HMRC people to really know what they are talking about; they often sound like they are just making a guess..
On the other hand, the HMRC published a description of the UK/US tax treaty and a US IRA is explicitly given as an example of a "pension".  So it sounds like guya is right.

Anyways, forgive me all for complicating this by mixing two big questions in one thread.

OK - so an IRA wrapper is a "pension" plan if (and only if) one files a UK return electing the treaty so I agree zero UK tax until distribution or rollover (subject to that treaty election).

The treaty only very badly and confusingly addresses distributions - a lump sum is only a complete distribution.

Resourcing under Art 24 exists only avoid double taxation on things covered by the treaty.  I don't think there is double taxation here so Art 24 is not in point.

So...what is the question?

Yes I am muddying the waters because this is not simple and there are many different views. No-one on this open forum will necessarily be correct either should this ever come to Court (me included).

You could read the US Treasury Explanation to the US/UK Treaty for one quite well written view - although even the IRS no longer quite agree with everything that it says there and pension law has changed a lot since the Treaty was ratified so it won't all make sense any more.

Yes I am muddying the waters because this is not simple and there are many different views. No-one on this open forum will necessarily be correct either should this ever come to Court (me included).

This is so true. 

It is complex, there are tons of different views.  Not all strictly right or wrong.  Sometimes you can get lucky with "more right."  I have seen both the IRS and HMRC be inconsistent with near identical pension positions as well.

You are right that the UK has the first right to tax it and in fact will be the only country you are taxed.  You need to be looking at Article 18 of the treaty. 

I wanted to come back and quote my own post.  This is probably too aggressive of a postion to post in an anonymous forum and I wouldn't recommend it without understanding all the implications.

The more prudent position is to be taxed both in the US and the UK, taking tax credits as necessary.

OK - so an IRA wrapper is a "pension" plan if (and only if) one files a UK return electing the treaty so I agree zero UK tax until distribution or rollover (subject to that treaty election).

The treaty only very badly and confusingly addresses distributions - a lump sum is only a complete distribution.

Resourcing under Art 24 exists only avoid double taxation on things covered by the treaty.  I don't think there is double taxation here so Art 24 is not in point.

So...what is the question?

Yes I am muddying the waters because this is not simple and there are many different views. No-one on this open forum will necessarily be correct either should this ever come to Court (me included).

You could read the US Treasury Explanation to the US/UK Treaty for one quite well written view - although even the IRS no longer quite agree with everything that it says there and pension law has changed a lot since the Treaty was ratified so it won't all make sense any more.

Why is there no double taxation here? If the UK imposes the 40% tax on the US income  and the income is not resourced to the UK, surely there'll be no FTC in the US and double taxation will occur.