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Topic: Inherited 401(k) and tax implications  (Read 3589 times)

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Inherited 401(k) and tax implications
« on: April 12, 2017, 04:53:40 PM »
Hi all, it's been quite some time since I posted. I've done a search for one of the terms in my subject but didn't find a good answer. Here's my situation:

I'm resident in Northern Ireland and haven't ever made enough to claim the foreign income exemption and truthfully, haven't filed taxes in the US in years due to this. I am a U.K. taxpayer and work full-time with PAYE and National Insurance deductions.

My mother left me a 401(k) distribution upon her death and to minimise the tax implications for five years, I decided to take a lump sum and understandably was charged the 20% Federal tax rate. The income was $16,000 of which I received approximately $12,800. This is my only US income for 2017 other than life insurance, which I believe isn't taxable as income. My question is this: will I be able to claim back that tax since my US income is nil and my UK income falls well below the threshold? Also what are the tax implications for the U.K. regarding foreign income in this form?

I'd like to avoid paying for an accountant in both countries so any advice would be greatly appreciated!


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Re: Inherited 401(k) and tax implications
« Reply #1 on: April 12, 2017, 08:23:40 PM »
As you are both income tax and information return delinquent, most people in these circumstances would use the current IRS streamlined filing procedures to catch up.
« Last Edit: April 13, 2017, 10:42:41 AM by guya »


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Re: Inherited 401(k) and tax implications
« Reply #2 on: April 13, 2017, 03:02:54 AM »
There should be no UK tax due on the inherited IRA because the UK does not tax foreign inherited capital. If you had any gains in the IRA since you inherited it then those would be UK taxable. However, you need to be filing US taxes and using the FEIE or FTC. Your reference to "life insurance" scares me....is this some US based policy....is it term or permanent with an investment component?
« Last Edit: April 13, 2017, 03:07:51 AM by nun »


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Re: Inherited 401(k) and tax implications
« Reply #3 on: April 13, 2017, 09:39:42 AM »
There should be no UK tax due on the inherited IRA because the UK does not tax foreign inherited capital. If you had any gains in the IRA since you inherited it then those would be UK taxable. However, you need to be filing US taxes and using the FEIE or FTC. Your reference to "life insurance" scares me....is this some US based policy....is it term or permanent with an investment component?
Just for my own clarity, I believe you are saying that there should be no UK tax due on inherited capital (e.g. inherited IRA, 401k) taken all at once, but that there would be US tax to pay on such a payment, as per Article 17.2.  Is my understanding correct?

But, as you've nicely outlined in another place (http://britishexpats.com/forum/usa-57/tax-ira-852618/), inherited capital taken as regular distributions would be taxable in the UK but not the US, as per Article 17.1a.  Correct?


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Re: Inherited 401(k) and tax implications
« Reply #4 on: April 13, 2017, 12:30:00 PM »
Just to clarify my mother named me a beneficiary on a 401(k) plan and half a life insurance policy. I inherited both when she passed away in February. The investment account was distributed immediately because I don't have any other US investments or income. It wasn't an IRA and hadn't gained anything because it was fully distributed (100%) minus the Federal tax.

I'm not sure why the life insurance would scare you, it was an employer policy that paid out upon her death. It isn't a policy for me, rather I was one of the beneficiaries.


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Re: Inherited 401(k) and tax implications
« Reply #5 on: April 13, 2017, 12:50:46 PM »
Just for my own clarity, I believe you are saying that there should be no UK tax due on inherited capital (e.g. inherited IRA, 401k) taken all at once, but that there would be US tax to pay on such a payment, as per Article 17.2.  Is my understanding correct?

But, as you've nicely outlined in another place (http://britishexpats.com/forum/usa-57/tax-ira-852618/), inherited capital taken as regular distributions would be taxable in the UK but not the US, as per Article 17.1a.  Correct?

Article 17 does not apply......The OP has inherited an amount of money, and there's no UK tax on an inheritance. There's no need for the treaty here. If the OP kept the IRA and took regular amounts out then the UK would only tax the gains, not the capital.


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Re: Inherited 401(k) and tax implications
« Reply #6 on: April 13, 2017, 12:53:07 PM »
Just to clarify my mother named me a beneficiary on a 401(k) plan and half a life insurance policy. I inherited both when she passed away in February. The investment account was distributed immediately because I don't have any other US investments or income. It wasn't an IRA and hadn't gained anything because it was fully distributed (100%) minus the Federal tax.

I'm not sure why the life insurance would scare you, it was an employer policy that paid out upon her death. It isn't a policy for me, rather I was one of the beneficiaries.

That sounds ok, no UK tax issues.


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Re: Inherited 401(k) and tax implications
« Reply #7 on: April 13, 2017, 01:19:58 PM »
Article 17 does not apply......The OP has inherited an amount of money, and there's no UK tax on an inheritance. There's no need for the treaty here. If the OP kept the IRA and took regular amounts out then the UK would only tax the gains, not the capital.
Sorry Nun, I'm still confused.  At the other place, you said that in respect to an inherited IRA:

That is, taking regular money out under options 1) and 2), one would claim exemption under treaty, it's free of US tax, but in the UK one would pay tax on 90% of the income as foreign pension payment.

I'm sure I've misunderstood something along the way.  Can you help clarify?


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Re: Inherited 401(k) and tax implications
« Reply #8 on: April 13, 2017, 03:02:22 PM »
Still a bit confused as to whether the distribution from the 401(k) would be considered income for my UK taxes. It will be considered and taxed accordingly as income in the US and I'll be sent a 1099-R to file next year, so my question still stands. If it isn't considered income, though yes the account itself was inherited, can someone explain the difference in the US's view of this and the UK view?


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Re: Inherited 401(k) and tax implications
« Reply #9 on: April 13, 2017, 04:29:42 PM »
Sorry Nun, I'm still confused.  At the other place, you said that in respect to an inherited IRA:

That is, taking regular money out under options 1) and 2), one would claim exemption under treaty, it's free of US tax, but in the UK one would pay tax on 90% of the income as foreign pension payment.

I'm sure I've misunderstood something along the way.  Can you help clarify?

I think I was wrong. Distributions from the Inherited IRA would not be income......similarly an IRA to ROTH rollover is not income so Article 17 does not apply.

US tax is due on the distribution, but there's no UK tax on the initial capital, just tax on any gains.


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Re: Inherited 401(k) and tax implications
« Reply #10 on: April 13, 2017, 04:36:18 PM »
But the amount of any gains is going to be nearly impossible to figure out if a beneficiary is taking an RMD over the life expectancy of the decedent.  In practice I suspect that most people declare these as foreign pension income (because they have character of income).


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Re: Inherited 401(k) and tax implications
« Reply #11 on: April 13, 2017, 08:17:11 PM »
But the amount of any gains is going to be nearly impossible to figure out if a beneficiary is taking an RMD over the life expectancy of the decedent.  In practice I suspect that most people declare these as foreign pension income (because they have character of income).

For the OP who took the Inherited IRA in a single sum it's pretty easy....no UK tax as they just treat it as inherited capital and they pay US tax on the distribution.

If the IRA is kept and RMDs taken over a number of years then US tax will be due.....I don't think these distributions are classified as income fro US tax purposes that falls under Article 17, just as a ROTH rollover isn't classified as income for Article 17 purposes. The IRS is going to want the tax on the Inherited IRA so whatever your residency or citizenship you'll have to pay US tax on the distributions and then you can take a tax credit in the UK. If you treat the payments as foreign pension you'll get full credit up to the amount of UK tax. If you decide to treat the IRA as a regular account for UK tax purposes they'll be no UK tax on the capital, but you'll have to deal with UK tax on the gains and reporting/non-reporting funds issues.


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Re: Inherited 401(k) and tax implications
« Reply #12 on: April 18, 2017, 11:46:58 AM »
I think I was wrong. Distributions from the Inherited IRA would not be income......similarly an IRA to ROTH rollover is not income so Article 17 does not apply.

US tax is due on the distribution, but there's no UK tax on the initial capital, just tax on any gains.

I'm still struggling on the treatment of an Inherited IRA from a UK perspective.

One the one hand you can argue that, as an inheritance, the capital itself is not taxed but any subsequent gains would be taxable.  Googling around, I found one tax expert (David Treitel) who also supports that view.  http://www.accountingweb.co.uk/any-answers/likely-penalties-for-non-disclosure-of-foreign-income-when-no-tax-is-due  Although worryingly I haven't found any other supporters of that perspective.

On the other hand, the HMRC has a website that appears to provide guidance on tax on inherited private pensions.  https://www.gov.uk/tax-on-pension-death-benefits  Here, much depends on the type of payment you get, type of pension pot and age of the pension pot's owner when they died.  Sometimes it's taxable, sometimes it's not.  But does any of this apply to an Inherited IRA?  Is an Inherited IRA an inherited pension?

Another HMRC website considers the UK tax position for the 2003/4 tax year and beyond (under the treaty). 
https://www.gov.uk/hmrc-internal-manuals/double-taxation-relief/dt19876a
"IRAs: Years up to 2002/03

The UK tax position for income tax years up to and including 2002/2003 is as follows;

Provided that the taxpayer has not nominated a beneficiary to receive the balance of the IRA on his death, the trust is transparent for UK tax purposes. Income of the IRA trust is chargeable as it arises, unless the Remittance Basis applies (see IM1560 et seq). The nomination of a beneficiary creates a settlement within the terms of the provisions of ICTA88/S672. In such a case the taxpayer is liable to UK Income Tax under Case VI of Schedule D on the IRA income arising in the tax year (ICTA88/S675).

Whether or not a beneficiary has been nominated, an IRA is a bare trust for the purposes of TCGA92/S60. The taxpayer is therefore chargeable to United Kingdom Capital Gains Tax in respect of any chargeable gains arising on the disposal of IRA investments. Changes in IRA investments will generally involve acquisitions and disposals of chargeable assets by the taxpayer.

Withdrawals from an IRA do not of themselves give rise to a charge to Income Tax or Capital Gains Tax, but they will often be preceded by the disposal of IRA investments (including the conversion of dollars to sterling) giving rise to a chargeable gain or an allowable loss.

IRAs: Year 2003/04 et seq.

This will not be the position for years 2003/04 onwards. The new Agreement takes precedence and this will mean that no liability will arise until it would have done so under US tax law. Under US law, this will be when distributions are made. As indicated above, this will generally not be before age 591/2 but must be before age 701/2. The important point to note is that income will no longer be assessable in the UK on the basis of income arising within the IRA. Any case of doubt or difficulty should be referred to HMRC, Customs & International, Tax Treaty Team."


This appears to say that UK tax liability only applies to distributions received.  Note that is says "The important point to note is that income will no longer be assessable in the UK on the basis of income arising within the IRA."  I take this to mean that there is no tax any any capital gains within the IRA.  But again, is an "IRA" in this context the same or different to an "Inheritied IRA"?

More generally, do we actually have a choice how to treat an Inherited IRA from a UK perspective (i.e. as a regular account or as a pension)? 

Any thoughts are welcome.


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Re: Inherited 401(k) and tax implications
« Reply #13 on: April 18, 2017, 01:26:13 PM »
There are a number of ways you can approach the taxation of the Inherited IRA. Often there isn't a single answer.

1) for UK tax purposes treat it just like an inheritance, this will avoid tax on the capital, but you'll be left with having to pay UK tax on the annual gains.

2) treat it like a foreign pension and pay income tax on withdrawals. This might be easier if you are taking income over a number of years.


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Re: Inherited 401(k) and tax implications
« Reply #14 on: April 18, 2017, 01:35:22 PM »
What surprises me is the implication that there is a choice as to how to treat an Inherited IRA from a UK perspective.  I would have thought it would be one way or the other.


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