US tax on pensions of UK residents

Topic split off :Fidelity IRA distribution to UK-periodic No-no!  (I apologise - it's not done very well - I hope readers can figure out the continuity !)

Quote from: parklane on 10November 2016 at 09:19:58 PM

    I am considering the position of a UK resident as defined by the Treaty, who may or may not be a US citizen.  US SS and UK State Pension are not included in this discussion - they are clearly taxable only in the State of residence.

Actually UK state pension when paid to a US citizen who is a UK resident is taxable in both the US and the UK according to the treaty language because it is not a cross border payment.

Quote
    As I understand it, an IRA is specifically included under the definition of pension scheme for the purposes of the DTA, so it is taxed to UK residents, as defined by the treaty, under Article 17(1) of the UK-US treaty.  An IRA is US sourced.  Other pensions may be UK or US sourced.  In the table in PUB 901 US Tax Treaties, the witholding rate for pensions is 0%, and the column headed Pensions does not specify the source of the pensions, unlike interest and dividends, so I conclude that both US and UK based pensions are taxed the same way.  Should it actually specify US pensions ?  Article 17(1) says pensions are taxed by the UK when received by a UK resident.  If that UK resident is a US citizen as well, then since Article 17(1) is not exempt from the savings clause, they can be taxed by the IRS as well.  The IRS still expect it to appear on the 1040 of a US citizen and will tax it accordingly, but the US will allow a credit against US tax for tax paid to the UK.  I believe this is done using Form 1116 (I have yet to figure out if it goes under the general category income or resourced by treaty income - maybe somebody can tell me).  Is the rather obtuse re-sourcing procedure of Article 24 (as applied to dividends in the example in the Technical Explanation to the Treaty) applied to pensions, but using the 0% witholding rate ?

    I have read on several accountancy firm websites that the US can, and will tax a regular UK source employment pension received by a US citizen, which confirms my analysis.  I have also read a number of blogs that say a UK pension is only taxable in the UK (which is not the same as saying that a tax credit reduces US tax to zero), so I would like to resolve the conflict with some hard evidence.

If you are a US citizen living in the UK then you pay the UK the tax on your pension income an take a FTC on your US tax return......you would resource the US pension income to the UK so it appears as foreign.

If you are a NRA living in the UK with a US pension then for income other than a lump sum distribution there is no US tax due at all. There should be 0% withholding, but if tax is withheld it can be all claimed back on a 1040NR


Quote from: nun on 11 Nov 2016 at 09:43:49 PM

    Actually UK state pension when paid to a US citizen who is a UK resident is taxable in both the US and the UK according to the treaty language because it is not a cross border payment.

Thanks for your response, but I must take issue with this first statement.  Cross border payments have nothing to do with it (or can you please provide a reference to support your conclusion).  The Treaty clearly says in Article 17(3) "3. Notwithstanding the provisions of paragraph 1 of this Article, payments made by a Contracting State under the provisions of the social security or similar legislation of that State to a resident of the other Contracting State shall be taxable only in that other State."  The application of the savings clause of Article 1(4) to Article 17(3) is excepted by Article 1(5)a, so US Social Security and UK State Pension are taxable ony by the state of residence.  Note that the savings clause, Article 1(4) allows the US to tax its citizens and residents.  If you are not a citizen or a resident of the US, then it does not apply, so Article 17(3) can then be taken at face value.  So, for example, a UK citizen resident in the UK can ignore the savings clause.

Quote from: nun on 10 November 2016 at 09:43:49 PM

    If you are a US citizen living in the UK then you pay the UK the tax on your pension income an take a FTC on your US tax return......you would resource the US pension income to the UK so it appears as foreign.


This is much as I thought, but the precise mechanisms involved are not clear to me.  Is the pension in question included in the amount on line 16a of the 1040.  If so, it becomes taxable unless it is then deducted from the taxable amount on line 16b.  I think the tax credit is then calculated using the convoluted antics of Form 1116, and you suggest classifying the pension as resourced income by ticking box d rather than the other possiblity of box b, general category income.  Logic suggests that you could not take a credit for foreign tax on an item that does not apear on the US 1040 in the first place, i.e., what US tax are you taking the credit against ?  This is all done through the convoluted antics of Form 1116, but I would like some more opinions on this.
PL

Thanks for your response, but I must take issue with this first statement.  Cross border payments have nothing to do with it (or can you please provide a reference to support your conclusion).  The Treaty clearly says in Article 17(3) "3. Notwithstanding the provisions of paragraph 1 of this Article, payments made by a Contracting State under the provisions of the social security or similar legislation of that State to a resident of the other Contracting State shall be taxable only in that other State."  The application of the savings clause of Article 1(4) to Article 17(3) is excepted by Article 1(5)a, so US Social Security and UK State Pension are taxable ony by the state of residence.  Note that the savings clause, Article 1(4) allows the US to tax its citizens and residents.  If you are not a citizen or a resident of the US, then it does not apply, so Article 17(3) can then be taken at face value.  So, for example, a UK citizen resident in the UK can ignore the savings clause.

Read exactly what the Article says:

"Article 17(3) "3. Notwithstanding the provisions of paragraph 1 of this Article, payments made by a Contracting State under the provisions of the social security or similar legislation of that State to a resident of the other Contracting State shall be taxable only in that other State."

A state pension payment made by the UK to a UK resident is not a payment to a resident of the other Contracting State, hence the treaty does not apply. However, I have had an IRS agent tell me that it does apply and that the UK state pension would not be taxed by the IRS when paid to a UK resident.

The US-UK Double Taxation Treaty Article 17(1) says:  1. (a) Pensions and other similar remuneration beneficially owned by a resident of a Contracting State shall be taxable only in that State.

According to this, only the UK can tax a pension paid to a resident of the UK, regardless of whether that pesnsion is sourced from the US or the UK and whether the resident is a US citizen or not, BUT

The savings clause (Article 1(4) allows the US to tax its citizens as if the treaty (including Article 17(1)) did not exist, so that all pensions paid to a US citizen resident in the UK can be taxed by the US, BUT

The exception to the savings clause (Article 1(5a)) prevents its application to SS and UK State Pensions, so Article 17(1) stands exactly as written with regard to US SS and UK State Pensions.  So a UK resident can only be taxed on US SS and UK State Pension by the UK regardles of the pensioner's US citizenship or otherwise.  The IRS agent was correct.

Article 17(3) does not addres payments of UK pensions to UK residents so is irrelevant to such payments.  That does not mean that the rest of the Treaty does not apply in all other respects.

So US SS and UK State Pensions paid to a UK resident are exempt from US tax.  Nevertheless, I was told by an IRS agent that the SS payment should be entered on line 20a, and then a taxable amount of zero entered in line 20b with the note 'UK-US tax treaty'.  So this makes me wonder if other pensions paid to a UK resident and subject to 0% witholding should be entered on line 16a, and a taxable amount not including the UK pensions entered similarly on line 16b so that it is not part of your adjusted gross income?

Whether or not you can also take a credit for UK tax paid on the UK pension against US tax paid on other income I am still not clear about.  I suspect that the 'witholding rate' is exactly that - a witholding rate, meaning that it is the maximum amount that a payer of the pensions, dividend, interest etc., can withold.  It is not the actual tax rate levied, as shown by the examples in the technical explanation to Article 24 where a dividend subject to 15% witholding nevertheless suffers 26% taxation by the US after the full weight of Article 24(6) is applied.  This whole Article 24 is exempt from the saviings clause, yet its application can result in US tax on the income that exceeds the witholding rate!

The US-UK Double Taxation Treaty Article 17(1) says:  1. (a) Pensions and other similar remuneration beneficially owned by a resident of a Contracting State shall be taxable only in that State.

According to this, only the UK can tax a pension paid to a resident of the UK, regardless of whether that pesnsion is sourced from the US or the UK and whether the resident is a US citizen or not, BUT

The savings clause (Article 1(4) allows the US to tax its citizens as if the treaty (including Article 17(1)) did not exist, so that all pensions paid to a US citizen resident in the UK can be taxed by the US, BUT

The exception to the savings clause (Article 1(5a)) prevents its application to SS and UK State Pensions, so Article 17(1) stands exactly as written with regard to US SS and UK State Pensions.  So a UK resident can only be taxed on US SS and UK State Pension by the UK regardles of the pensioner's US citizenship or otherwise.  The IRS agent was correct.

UK state pension when paid to a UK resident is not covered by the treaty so it will be taxed when paid to a US citizen. Perhaps you have the spirit of the treaty correct, but not that actual meaning of the language in the treaty.


So US SS and UK State Pensions paid to a UK resident are exempt from US tax.  Nevertheless, I was told by an IRS agent that the SS payment should be entered on line 20a, and then a taxable amount of zero entered in line 20b with the note 'UK-US tax treaty'.  So this makes me wonder if other pensions paid to a UK resident and subject to 0% witholding should be entered on line 16a, and a taxable amount not including the UK pensions entered similarly on line 16b so that it is not part of your adjusted gross income?
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US SS goes on line 20 and you would enter the taxable amount as zero if you are a UK resident. UK state pension goes on line 16 and by strict interpretation of the treaty is fully US taxable when paid to a US citizen and UK resident.

If a UK resident NRA gets non-government US pension payments then the amount would go in 16a, zero would go in 16b and you'd end up with a refund for any withholding.

UK state pension when paid to a UK resident is not covered by the treaty so it will be taxed when paid to a US citizen.

Why is it not covered, and taxed by whom - we are dealing with legal stuff here so we need to be very precise.  I think it is certainly covered if the UK resident is a US citizen, but that US citizen resident in the UK is not taxed on US Soc. Sec or UK State Pension by the US because of the exception to the savings clause.

To summarise: 
The UK state pension and US Soc. Sec. received by a UK resident will, under the treaty, be taxed by the UK whether that resident is a US or UK citizen.  A US citizen resident in the UK will not be taxed by the US on either a UK state pension or US Soc. Sec.  The exact reverse situation applies if the US Soc. Sec. or UK State Pension recipient is a resident of the US - both are taxed only by the US in that case.  Or to put it another way, a resident of a state is taxed on the Soc. Sec. and UK State Pensions by the State of residence (UK or US) only, and not by the other state.

US SS goes on line 20 and you would enter the taxable amount as zero if you are a UK resident.

Thats what I thought too.  Does this agree with what you said in the first quote of this post above if I am a US citizen ?

UK state pension goes on line 16 and by strict interpretation of the treaty is fully US taxable when paid to a US citizen and UK resident.

I disagree.  I think the UK pension is exempt from US tax under the treaty when received by a UK resident regardless of citizenship.

If a UK resident NRA gets non-government US pension payments then the amount would go in 16a, zero would go in 16b and you'd end up with a refund for any withholding.

A NRA would be filing a 1040NR which is whole different form, but a UK resident NRA, not being a US citizen, cannot be subject to the savings clause as excercised by the US, so Article 17(1) cannot be over-ridden by the US, and so a pension can only be taxed by the the State of residence which is the UK.

Its different if you are a US citizen.  The US could, and probably does invoke the savings clause in the case of its citizens, so the US source pension becomes taxable by the US regardless of residence.  I agree that the IRA or pension would be entered on line 15a or 16a, but whether or not you can enter zero on lines 15b and 16b is the Big Question.  If you believe it can, please cite the relevant clauses of the Treaty or other document that allow it - I need to be convinced.

My comments, by the way, represent my understanding of the Treaty and other associated stuff, and I could be wrong, so if there is any doubt, get professional advice.

Regards, PK

The treaty Article 17(3) only covers SS payments made by one country to a resident of the other country. It does not deal with SS payments made by a country to it's own residents. So it only deals with cross border payments. So the payment of UK SS to a US citizen resident in the UK is not even covered by the treaty leaving the US to tax it.

If you search UK-Yankee forums you'll find a couple of threads where this is discussed.

nun - I see your point.  I did search the forum and found one or two who agreed with you and one or two who didn't, including yourself in the early years !  It does seem ridiculous that after all that wordage in the Treaty it seems that the UK ends up taxing a US pension, and the US taxes a UK pension, the exact opposite of what simplicity would conclude.

One could note that under the Savings Clause a Contracting State 'may' tax its residents and citizens as if the Treaty did not exist, but does not say it must or that it will.  In general, the US does, and the UK doesn't.

I wonder if any seriously intelligent accountant has ever costed the time spent by ordinary people trying to make an honest job of completing a US tax return.  The economic cost must be in the $billions.  (Don't even think of quoting the ridiculous preparation times noted on the tax forms !)