My contributions and employer contributions to UK pension

Sarah - why wouldn't it work for a DB scheme? For ex, The total after-tax contributions are $50,000. The value of the fund at retirement is $200,000, consisting of 20 yrs. payment of $10,000. Why couldn't the taxable portion of the yearly $10,000 be reduced by 25% (ie, the ration of the after contributions to fund value).

My post was just specific in explanation to a dc scheme. It isn't that you can't do it for db, it just adds a layer of complexity.

Can I piggy-back on this with a question? I will be giving up my US citizenship later this year, so I'm not concerned about long-term tax planning. Therefore I would like to claim the treaty exemption so I don't have to report my employer contributions; this is because I'm now married filing separately, which means I can't claim the student loan interest that has previously counterbalanced the tax that would be due on those contributions. I'm in a weird situation where I think I actually pay less tax here than I would on the exchange rate value of my salary for the US (20% bracket here, 25% bracket there), so I'm not sure using the FTC would benefit me. How do I actually go about claiming the treaty on my return?

Please post about how the US citizenship renunciation goes!!

To claim the treaty exemption on contributions you'll have to use form 8833 and reference Article 18(5)

Thanks everyone for their replies. 

Sara Smile - Why does your example only work for somebody that is going to retire in the US?  I realise retirement is very far away for me, and many things will happen in the next 37 years, but as it stands now, I'll be retiring in the UK.  I like the relative simplicity of just lumping it all in as gross pay (and keeping good records).  Why doesn't this make sense for somebody that is retiring in the UK?

Regards,
Sam

Thanks everyone for their replies. 

Sara Smile - Why does your example only work for somebody that is going to retire in the US?  I realise retirement is very far away for me, and many things will happen in the next 37 years, but as it stands now, I'll be retiring in the UK.  I like the relative simplicity of just lumping it all in as gross pay (and keeping good records).  Why doesn't this make sense for somebody that is retiring in the UK?

Regards,
Sam

Under the treaty, you are only taxed on pension distributions in your State of residence.  If you are retiring in the US and you have essentially pre-paid a large portion your US tax liability - great!  However, if you are retiring in the UK and your pension distributions are taxed in the UK, your US tax planning becomes irrelevant.

Under the treaty, you are only taxed on pension distributions in your State of residence.  If you are retiring in the US and you have essentially pre-paid a large portion your US tax liability - great!  However, if you are retiring in the UK and your pension distributions are taxed in the UK, your US tax planning becomes irrelevant.

I don't think this is quite right as Article 17(1a) is subject to he Savings Clause. So a US citizen resident in the UK taking UK pension distributions will be taxable in both the UK and the US. Of course the UK tax paid on the income may well mean that there is no US tax due. So as you say, all the prepayment of US tax on the contributions doesn't gain you anything.

If the pension were to be paid to someone in the US then the situation would be different as it would only be taxable in the US and if you had prepaid the US tax on the contributions with excess FTC you would only have to pay tax on the gain portion of the pension.

So it looks like it's best/simpler to use the treaty if you intend to retire in the UK and FTC if you plan on retiring in the US.

   I'm now more confused than ever. 

After reading the comments (thanks all), I went off and did some more research.  I then read that if I personally am paying for than my employer into the fund (I am, the numbers in my original post are the actual numbers) then it's not really a pension according to the IRS (although the treaty might help).  This discussed here in the section "When is a pension not a pension?"

http://www.buzzacott.co.uk/insights/how-us-citizens-can-make-the-most-of-uk-pensions-changes/34

This sh!t makes me so angry.  All I want to do is go about my life and not become a tax expert.  When I can afford one, I'll pay one, but right now, I just can't afford one.  I just want to make sure  I don't give the IRS anything to pursue me over whilst also not having to pay tax twice on my meagre attempt to save for the future.

I'm so confused, I even rang the IRS!  I asked how I should handle my employer contributions and he told me it was part of my income so it had to be reported. Thanks Sherlock.  He offered no help on where I should report it or if it was ok to treat it as part of my gross Foreign Earned Income of it I had to treat it as other income.  Thanks.  Thanks for nothing.

So, can we all agree that I'm probably okay to include both my employee pension contributions and my employer contributions into my UK defined contribution pension plan as part of my Gross Foreign Earned Income and then offset that with my Foreign Earned Income Tax credits?  I think I understand why this isn't strictly necessary according to Sara Smile (a UK pension collected in the UK will be untaxed by the US thanks to the treaty), but I'd rather not mess about with another form (the treaty form) that I could easily foul up. Given the piddling amounts of pension contributions, including it won't hurt me too much.  Thoughts?

My second concern is the regarding whether or not my pension is really a pension or not.  If I'm paying more than my employer, will I have to invoke the treaty anyway?

Thanks for all your help.

Regards,
Sam

I don't think this is quite right as Article 17(1a) is subject to he Savings Clause. So a US citizen resident in the UK taking UK pension distributions will be taxable in both the UK and the US. Of course the UK tax paid on the income may well mean that there is no US tax due. So as you say, all the prepayment of US tax on the contributions doesn't gain you anything.

If the pension were to be paid to someone in the US then the situation would be different as it would only be taxable in the US and if you had prepaid the US tax on the contributions with excess FTC you would only have to pay tax on the gain portion of the pension.

So it looks like it's best/simpler to use the treaty if you intend to retire in the UK and FTC if you plan on retiring in the US.

Yep, you are exactly right.  There is a lot of background going on with my simple statement and I should have caveated it more heavily.  There are a couple of different schools of thought about pensions and thus what my original statement was based on.  It isn't really the scope of this forum for me to go into all the details and I shouldn't have brought it up.  I should have just stuck to saying that someone would be taxed in the UK on distribution (lump sum aside) and that tax would already cover US tax liabilities.

Regardless, one way or the other, if you retire in the UK your US planning becomes much ado about nothing.

 I'm now more confused than ever.  

After reading the comments (thanks all), I went off and did some more research.  I then read that if I personally am paying for than my employer into the fund (I am, the numbers in my original post are the actual numbers) then it's not really a pension according to the IRS (although the treaty might help).  This discussed here in the section "When is a pension not a pension?"

http://www.buzzacott.co.uk/insights/how-us-citizens-can-make-the-most-of-uk-pensions-changes/34

You've run into an area of debate. Some professionals would argue that your pension (and personal pensions and SIPPs) are qualified pensions under the Treaty some that they aren't.

You will have to take a treaty position at some point to protect the gains in your pensions.

So, can we all agree that I'm probably okay to include both my employee pension contributions and my employer contributions into my UK defined contribution pension plan as part of my Gross Foreign Earned Income and then offset that with my Foreign Earned Income Tax credits?  

Yes, although I think the employer contributions might be unearned income, and you should file 3520 and 3520-A as described in the Buzzacott link.

I think I understand why this isn't strictly necessary according to Sara Smile (a UK pension collected in the UK will be untaxed by the US thanks to the treaty), but I'd rather not mess about with another form (the treaty form) that I could easily foul up. Given the piddling amounts of pension contributions, including it won't hurt me too much.  Thoughts?

Actually a UK pension paid to a US citizen resident in the UK is taxable by the UK and the US because of the savings clause in the Treaty, but you can take a tax credit for any UK tax you pay so practically speaking there will probably be little or no US tax due.

My second concern is the regarding whether or not my pension is really a pension or not.  If I'm paying more than my employer, will I have to invoke the treaty anyway?

If you don't invoke the treaty the IRS will definitely treat your pension as a foreign trust. If you don't invoke the treaty for the contributions you'll file the foreign trust forms and then use the treaty to shelter any gains as described in the link you posted

Thanks Nun.  I think I understand things better now.

I was feeling rather beaten last night when I made my last post.  However, it's a new day, I've given myself a pep talk telling myself that the IRS and the tax code will not defeat me! 

I managed to find some text on here from another poster that used the treaty and I think I can use that to invoke the treaty with a bit more confidence, but I'm sure I'll be asking a few more questions along the way.  However, I'm at work right now, so writing much more might mean that I won't have to worry about pension contributions or any foreign earned income if I don't get to work.

As an aside, my partner thinks I'm crazy for bothering to report my income to the IRS.  She doesn't appreciate how scary they can be and doesn't see how the IRS will ever find out what I earn over here (how will they know if I don't tell them?).  I told her that some IRS employees have guns in America.  She said, they don't here, which is true.  I think I'll still report though

Thanks again all.

Regards,
Sam

A response wrt several earlier comments: "if you retire in the UK your US planning becomes much ado about nothing." and ".....the UK tax paid on the income may well mean that there is no US tax due. So as you say, all the prepayment of US tax on the contributions doesn't gain you anything." Whilst they are both correct, I would hesitate in accepting them as a guide for all retirement planning. I don't believe they were intended as a blanket statement.

Is a USC, retired in the UK, prevented from relocating back to the States? Does anyone currently know for certain in which country, if either, they will spend their entire retirement period? There is constantly changing legislation in both countries. The UK is increasingly favouring tax free amounts, whether at early retirement, or in retirement. There were more proposals/studies announced this week. The offsetting measures to recapture this lost revenue could increase the chances of a US tax liability for a USC retired person. There will be a number of people retiring in the next 15/20 years who may not hold perfect treaty based past retirement planning. They may have a combination of US taxed and untaxed contributions. (There are methods to assist in this situation.) From a retired persons view: as long as the US taxes on citizenship, and your current tax situation allows it, consideration of protective planning against US taxation of a UK residents UK pension income would still seem advisable.

I don't believe any post in this thread would, in the end, disagree with the need for caution. As was stated, it's beyond the scope of this forum to explain all needed considerations or actions required for complete resolution of any specific pension situation.   

I decided to take the (tax) law into my own hands and wrote to the IRS at the London Consulate regarding my original question.  I did this as the website states that if you make less than $120,000 USD a year, they can provide limited tax prep advice.  This is good to know for those of us that have relatively simple cross-border tax situations, are of limited means, but still require some help. My text is below.  There reply was essentially, you're correct.  Report all your gross, don't need to report employer contribution because of treaty.  They actually wrote me back and said that my strategy was fine (only took a week to respond as well).  I may have laid my ignorance on a bit thick (After all, the friendly people on this board had pointed out this strategy to me in the first place).   Hope this helps others.

I'll type the IRS exact response when I get a chance.

United States Embassy
IRS – Box 44
24 Grosvenor Square;
London  W1A 1AE

To Whom it May Concern:

I am writing in regards to a few questions I have regarding my 2011 US tax return.  I am having trouble understanding how I should report my and my employer’s contributions to my UK pension scheme.

I have spent hours researching this topic on the internet and reading the relevant treaties and IRS publications, but I cannot understand how to handle these contributions for US tax purposes. I cannot afford to pay a US/UK tax specialist to advise me on this issue. I rang the international taxpayers helpline in Philadelphia, but the gentleman I spoke with could not offer me any guidance other than to say all benefits from employment must be reported.   


My situation:
Gross Income for 2011: $48705. Throughout the year, I put $2898, UK tax free, of my total gross income into my company’s defined contribution money purchase pension scheme.
Employer contribution: $2415 tax free over the year into the same company’s defined contribution money purchase pension scheme. This is not included in my gross income.
US Citizen living full time and indefinitely in the UK and working for a UK company


My tax plan:
Report my gross foreign earned income, including my personal pension contributions, on IRS Form 1116, using foreign tax credits to completely offset any US tax obligation. This enables me to set a cost basis for my pension upon distribution as my contributions will have been already taxed in the US.
Invoke the US-UK tax treaty to accomplish the following two objectives:
Use Article 3 Paragraph 1 Subparagraph O to ensure that my company’s UK pension scheme is treated as a pension scheme by the IRS although I contribute more than 50% to the pot each year (I sacrifice 6% of salary, company pays in 5% of my salary).  My understanding is that without the treaty, I would have to treat my company’s pension scheme as a foreign trust, and I do not understand form 3520.
Use Article 18 Paragraph 5 Subparagraph A section i to exclude my UK employer’s contributions to the pension scheme from my taxable income.

My questions:
Is my proposed tax plan reasonable and within the IRS reporting rules?
Assuming my tax plan is within the rules and I can invoke the treaty to exclude my employer’s contributions, do I still need to report the employer contribution somewhere on my Form 1040?
If my proposed plan is not within the rules, what is the simplest way to report my employee and employer pension contributions whilst minimising or eliminating double taxation?

I do not want to omit  reporting something that should be reported, or report it incorrectly. I am especially concerned about my employer’s pension contributions. I believe that it is okay for me to simply include my employee contributions in my gross income (please tell me if the IRS does not agree).

I appreciate that the amount of advice you can offer to my specific situation is limited, but I would be truly grateful for any guidance you may be able to provide. I would prefer any response to be sent via the post, although for the sake of efficiency, you could also email at $$$$$@gmail.com.



Sincerely,

Thought I'd resurrect this thread rather than start a new one. I'm trying to fill out form 8833 in order to claim the tax treaty for my employer pension contributions. However, I don't know what Internal Revenue Code provision is overruled or modified by the treaty-based return position. Can anyone give me a clue on that?

Do you need to file? The last sentence maybe helpful.

Taken from the IRS web site...

Exceptions

You do not have to file Form 8833 for any of the following situations:

"You claim a reduced rate of withholding tax under a treaty on interest, dividends, rent, royalties, or other fixed or determinable annual or periodic income ordinarily subject to the 30% rate.
You claim a treaty exemption that reduces or modifies the taxation of income from dependent personal services, pensions, annuities, social security and other public pensions, or income of artists, athletes, students, trainees, or teachers. This includes taxable scholarship and fellowship grants.
You claim a reduction or modification of taxation of income under an International Social Security Agreement or a Diplomatic or Consular Agreement.
You are a partner in a partnership or a beneficiary of an estate or trust and the partnership, estate, or trust reports the required information on its return.
The payments or items of income that are otherwise required to be disclosed total no more than $10,000. "

Do you need to file? The last sentence maybe helpful.

Taken from the IRS web site...

Exceptions

You do not have to file Form 8833 for any of the following situations:

"You claim a reduced rate of withholding tax under a treaty on interest, dividends, rent, royalties, or other fixed or determinable annual or periodic income ordinarily subject to the 30% rate.
You claim a treaty exemption that reduces or modifies the taxation of income from dependent personal services, pensions, annuities, social security and other public pensions, or income of artists, athletes, students, trainees, or teachers. This includes taxable scholarship and fellowship grants.
You claim a reduction or modification of taxation of income under an International Social Security Agreement or a Diplomatic or Consular Agreement.
You are a partner in a partnership or a beneficiary of an estate or trust and the partnership, estate, or trust reports the required information on its return.
The payments or items of income that are otherwise required to be disclosed total no more than $10,000. "

+1, although it might be a "CYA" move to file. If I did maybe the relevant IRS code
would be IRC 401. I'm just guessing though.

It is over $10,000, just, thanks to the exchange rate. I'm not sure if the second point applies, because it isn't an income from a pension, it's an employer contribution to a pension. Since I'm planning to renounce citizenship soon, I want to make sure my Is are dotted and my Ts are crossed so as not to get in any trouble.

I'm also confused about question 4 on the form. 'List the provision(s) of the limitation on benefits article (if any) in the treaty that the taxpayer relies on to prevent application of that article.' What does that even mean?