Are we being conned about UK pensions and the IRS?

There is a great deal of confusion and complication about which UK pensions are actually covered by the US/UK tax treaty. There are many different UK pensions; employer final salary benefits, defined contribution plans, various personal pensions like SIPPs and now NEST. They are all accounts set up specifically for retirement in the UK, but many tax advisers say that how they are funded and that their underlying structure determines how they are dealt with under the UK/US tax treaty.

A very small number of advisers liberally apply the treaty to all UK pension plans, thus making tax filing far simpler.

I've read that the more complicated approach stems from the work and opinion of a very small number of large firms and it strikes me that having a complicated interpretation of the treaty is to the benefit of tax professionals in that it makes it difficult for the tax payer to do their own taxes.

So are the tax professionals making taxation more complex than it needs to be?

My view and the opinion of my accountant is that if the retirement pension plan is genuinely a retirement plan, and complies with HMRC rules as such, then you're fine. It's the "generally corresponds with" an IRA, 401(k) etc. It's when you get the more complex SIPP, where you may well be investing in none retirement accounts and ISA's where you can become unstuck with PFIC's and annual gains.

Question... As you can deduct, or exclude contributions on your 1040 and HMRC also provide tax relief, would you not in effect be taking a deduction twice for the same contribution? (personal pension plan)

My view and the opinion of my accountant is that if the retirement pension plan is genuinely a retirement plan, and complies with HMRC rules as such, then you're fine. It's the "generally corresponds with" an IRA, 401(k) etc. It's when you get the more complex SIPP, where you may well be investing in none retirement accounts and ISA's where you can become unstuck with PFIC's and annual gains.

The ISA is not a retirement account.....but IMHO a SIPP is just like an IRA. It's a DC plan that you contribute to yourself and invest in UK base mutual funds and can take money from when you retire, usually after 55.

Here is an interesting IRS letter about UK SIPPs. It is a response to a question about the tax implications for a US resident of a rollover from a UK employer sponsored pension plan to a SIPP.

www.irs.gov/pub/irs-wd/10-0151.pdf

It's a little non-committal, but the critical paragraph for our purposes is this

For purposes of the Treaty, paragraph 1(o) of Article 3 (General Definitions) defines the term “pension scheme” as:
       [A]ny plan, scheme, fund, trust or other arrangement established in a Contracting State which is: (i) generally exempt from income taxation in that State; and (ii) operated principally to administer or provide pension or retirement benefits or to earn income for the benefit of one or more such arrangements.

If an employer pension scheme in the United Kingdom and an SIPP are both pension
schemes within the meaning of Article 3(1)(o), then a transfer of income earned by the employer pension scheme to the SIPP would not be a taxable event in the United
States.

IMHO a SIPP is a pension plan under the meaning of Article 3(1)(o) and most tax professionals take a far too conservative approach. I'm sure they have very well researched reasons, but they do seem to be going out of their way to make things complicated. I'd like to see them being a bit more aggressive in championing a straight forward interpretation of the treaty language to make taxpayers lives simpler.

If it walks like a duck and quacks like a duck then its a duck....or pension plan.

This leads to a more general question that for me always hovers in the background -

These things are grey areas because there is no law (regs, advisories, court cases, etc, that interpret the code or Treaty, etc). There will be no answers until there is such law. What is the responsibility of the TP in these situations? What is expected of him/her? And if the TP is questioned by the IRS on one of these gray areas, what does the IRS do? how does it determine if TP got it right or wrong (if there is no right or wrong)? And if it determines that TP got it wrong, what are the consequences?

This leads to a more general question that for me always hovers in the background -

These things are grey areas because there is no law (regs, advisories, court cases, etc, that interpret the code or Treaty, etc). There will be no answers until there is such law. What is the responsibility of the TP in these situations? What is expected of him/her? And if the TP is questioned by the IRS on one of these gray areas, what does the IRS do? how does it determine if TP got it right or wrong (if there is no right or wrong)? And if it determines that TP got it wrong, what are the consequences?

I think you've hit on one of the reasons tax professionals are as conservative as they are; they need to cover their behinds. So they apply the treaty in the most limited of ways. However, I also think the treaty, regs etc are often interpreted from a perspective that might be most advantageous for high net worth individuals rather than for the regular tax payer who just wants a simple solution to filing their own taxes. If you think you will always be in a high tax bracket it may well be better to pay 15% capital gains tax on your SIPP from year to year rather than deferring tax and paying income tax on distributions. But for the average tax payer those sort of tactics aren't as useful and all we want is tax simplicity.

I'm lucky in that I don't have any UK pensions or retirement accounts, but if I did I would probably claim tax treaty benefits on any account that is set up under UK law for retirement purposes. ISAs would not not fall into that category, but SIPPs, stakeholder pensions, Group SIPPS, NEST etc all would, IMHO.

Interesting find nun.

For those that take a more aggressive approach, I'm sure a collection of such documents will be helpful in mitigating/eliminating penalties even if the IRS ultimately take a position on how to treat non-company schemes.

I'm sure you're right about the view taken by tax professionals though - and it's hard to blame them!

Interesting find nun.

For those that take a more aggressive approach, I'm sure a collection of such documents will be helpful in mitigating/eliminating penalties even if the IRS ultimately take a position on how to treat non-company schemes.

I'm sure you're right about the view taken by tax professionals though - and it's hard to blame them!

I actually do blame them because I think they have made an important part of the treaty more complex than it needs to be and have cause a lot of worry to many people who just want to file relatively simple returns. It might be advantageous is some circumstances, but the prevailing dogma associated with a SIPP owned by a US citizen is surely not what the treaty was intended to produce. I hope more tax professionals will step forward and liberally apply the treaty for the millions of US expats who want relatively simple tax solutions.

I offer this from the principal at British American Tax

http://www.taxalmanac.org/index.php/Discussion:US_taxation_of_UK_Stakeholder_Pension_/_SIPP

Lizzit (talk|edits) said:
   5 July 2011
1) UK SIPPs and Stakeholder Pensions are the same type of animal to the US. There is no appreciable difference for US tax purposes.

2) Dual product advisors, dual qualified accountants, and dual practice tax lawyers disagree a lot. You won't find any two (who have done the research themselves) having the same opinion. Thus, it's down to you to either (a) do your own research or (b) pay one of the others to provide their research supporting the position you'd like to take.

3) Like others on this site, I charge a fee for the backround research that supports the position my company takes.

4) My position is that you may either (a) make a treaty claim under Article 18 to exempt the contributions and growth from US tax or (b) not make a claim.

4a) If you make a claim, you get current year tax break in the US on the money contributed. All growth is US tax-free. There are no trust form filing requirements on an arising basis. When you take the money out, you pay tax at income tax rates the same as any stateside pension.

4b) If you don't make a claim, you pay tax now at your current US tax rate on the contributions, albiet at an effective rate of zero due to higher UK tax rates. The growth is taxable. Two schools of thought on this, one is to compute the income, capital gains, and PFIC tax on the basket of goodies annually. The other is to tax the whole shebang on a mark to market basis. I usually opt for the M2M each year, but I do the basket method when the data can be made available. There are STILL no trust form filing requirements on an arising basis. When you take the money out, you have a fully tax-free basis in the fund and therefore the basis is US tax-free.

5) You can switch back and forth year to year from making a claim to not making a claim.

6) I must reiterate this is the results of my research and that other people in the dual US/UK industry tend to be relying on the research of a single law firm here in the UK.

I know this doesn't answer your question, but it does show that the problem is more complex than what you are proposing.

100%... 

why blame the professionals. It belongs squarely on IRS and Congress. It is entirely within their power (and only their power) to make the law clearer, ditto for helping out the ordinary TP who just wants a simple fix. (I also doubt very much that when drawing up the treaty they gave a moment's thought to this kind of TP). The lawyers and accountants just work with the mess left to them.

why blame the professionals. It belongs squarely on IRS and Congress. It is entirely within their power (and only their power) to make the law clearer, ditto for helping out the ordinary TP who just wants a simple fix. (I also doubt very much that when drawing up the treaty they gave a moment's thought to this kind of TP). The lawyers and accountants just work with the mess left to them.

+1

I'll leave it to the professionals to explain their choice of respective interpretations, although I would think the price of insurance just to do business must be rising this year.

I have only one question: Does the Congressional pursuit of FATCAts aligned with their total disregard for the ordinary expat TP result in compelling that TP to use the services of professionals? The agreement between Congress and the US expat is simple. The expat is responsible for filing a tax return and FBAR every year if required. The implied, but ignored, side of the agreement is for Congress, through the IRS, to clearly define taxable income (or additional reporting) and provide understandable instructions as to how the TP accomplishes the completion of that return (or reporting). Whether for the professional, or the ordinary TP, the Congressional responsibility related to that agreement is inadequate. (Inadequate is the mildest word I could think of.)

+1

I'll leave it to the professionals to explain their choice of respective interpretations, although I would think the price of insurance just to do business must be rising this year.

Of course you'll have to engage said professional to learn their reasoning.

It seems to me though that it hinges on the interpretation of the treaty.

If it is broadly interpreted then any UK pension account can be treated similarly to a US account; so tax deferral on contributions and gains and no 3250 etc.

If it is narrowly interpreted then we have to look at where the contributions come from and the underlying structure to see how the IRS will treat the account. If most of the contributions come from an employer it could be an employee trust and thus fall under IRS regs for those, so no 3250 filing. If it's a personal pension then many say its a foreign grantor trust and 3250 is required.

I have only one question: Does the Congressional pursuit of FATCAts aligned with their total disregard for the ordinary expat TP result in compelling that TP to use the services of professionals? The agreement between Congress and the US expat is simple. The expat is responsible for filing a tax return and FBAR every year if required. The implied, but ignored, side of the agreement is for Congress, through the IRS, to clearly define taxable income (or additional reporting) and provide understandable instructions as to how the TP accomplishes the completion of that return (or reporting). Whether for the professional, or the ordinary TP, the Congressional responsibility related to that agreement is inadequate. (Inadequate is the mildest word I could think of.)

From National Taxpayer Advocate:

http://www.taxpayeradvocate.irs.gov/userfiles/file/2011_ARC_MSP%207-12.pdf

"The complexity of international tax law, combined with the administrative burden placed on these taxpayers, creates an environment where taxpayers who are trying their best to comply simply cannot. For some, this means paying more U.S. tax than is legally required, while others may be subject to steep civil and criminal penalties. For some U.S taxpayers abroad, the tax requirements are so confusing and the compliance burden so great that they give up their U.S. citizenship"

Read the whole thing. The IRS commissioner is supposed to respond this but he has ignored it. His boss, Turbo Tax Tim Geithner, has not compelled him to respond, signifying the contempt with which the US government regards its expatriates.

Read the whole thing. The IRS commissioner is supposed to respond this but he has ignored it. His boss, Turbo Tax Tim Geithner, has not compelled him to respond, signifying the contempt with which the US government regards its expatriates.

I used that exact quote in another discussion about 3 days ago. A gentleman was trying to convince me that the situation really wasn't that bad, since the increased legislation only effected the very few Americans who had decided to live abroad on a permanent basis.

If it is broadly interpreted then any UK pension account can be treated similarly to a US account; so tax deferral on contributions and gains and no 3250 etc.

If it is narrowly interpreted then we have to look at where the contributions come from and the underlying structure to see how the IRS will treat the account. If most of the contributions come from an employer it could be an employee trust and thus fall under IRS regs for those, so no 3250 filing. If it's a personal pension then many say its a foreign grantor trust and 3250 is required.

Whether it's interpreted narrowly or broadly, it requires interpretation from a substantially reasoned view point. That's great if you enjoy the detail, but I think Marty's point is that for the 'ordinary taxpayer', interpretation shouldn't be required, particularly if you fear there may be a large penalty for interpreting it incorrectly.

You're right, we do have to deal with the situation as it exists at present.