Early liquidation of traditional IRA while (only) UK tax resident

My sister has a traditional IRA with ~$20,000 stemming from a 401(k) rollover from employment in the US ~13 years ago. She is 40 years old, now UK tax resident and has otherwise no US tax connection whatsoever.

She's thinking of closing the IRA and repatriating the funds to the UK. The broker (Charles Schwab) has advised that they will withhold 30% for federal taxes upon closure of account.

Will a UK tax liability arise? Based on §17(2) of the UK/US DTA and HMRC guidance DT19876a (payment of lump sums), I understand that there will be no additional UK liability. Correct?

Are further steps with regards to the US necessary? I understand that the 30% is a standard withholding for NRAs and should be complete and sufficient. Does the fact that it's an early withdrawal matter here?

Would appreciate any pointers.

Many thanks!

Presumably she would elect into the treaty on her UK return & - separately - file her US income tax return for 2017 next year.

Thanks - not sure I understand, would you mind clarifying?

Presumably she would elect into the treaty on her UK return

Meaning she would mention the account liquidation but would state that no taxes are due under the treaty?

& - separately - file her US income tax return for 2017 next year.

Why would she do that? Isn't that what the 30% withholding is for or does she need to file to determine the actual marginal rate? Could she elect not to file or would it be mandatory? She has no other US tax obligations...

Thanks!

My sister has a traditional IRA with ~$20,000 stemming from a 401(k) rollover from employment in the US ~13 years ago. She is 40 years old, now UK tax resident and has otherwise no US tax connection whatsoever.

She's thinking of closing the IRA and repatriating the funds to the UK. The broker (Charles Schwab) has advised that they will withhold 30% for federal taxes upon closure of account.

Will a UK tax liability arise? Based on §17(2) of the UK/US DTA and HMRC guidance DT19876a (payment of lump sums), I understand that there will be no additional UK liability. Correct?

Are further steps with regards to the US necessary? I understand that the 30% is a standard withholding for NRAs and should be complete and sufficient. Does the fact that it's an early withdrawal matter here?

Would appreciate any pointers.

Many thanks!

Firstly she would be liable for a 10% tax penalty for early withdrawal -on top of any tax owing.

However the 30% tax withheld is the legally mandatory withholding -it is NOT the amount of tax owed.

An IRA lump sum distribution according to the US-UK tax treaty is taxable only in the US. It should be taxed as ordinary income, and the tax on $20,000 would be much lower than 30%, even if you add  the 10% penalty.

Therefore filling in a 1040NR for the tax year in which the distribution is made will result in a tax refund of the difference between the 30% withheld, and the tax due (10% plus current US tax on $20,000 income  minus the approx $4000 personal allowance).

my understanding of the tax treaty is that Traditional IRA distributions to non US persons who are UK residents is taxable only in the UK. Roth IRA distributions are tax free in the UK.

Am I mistaken?

my understanding of the tax treaty is that Traditional IRA distributions to non US persons who are UK residents is taxable only in the UK. Roth IRA distributions are tax free in the UK.

Am I mistaken?

The tax treaty refers specifically to lump sum distributions as being taxable in the country of origin only, that is in the US for a US IRA. Lump sum distributions (by the IRS definition) are complete withdrawals of the entire amount of an account in one tax year.

ARTICLE 17
Pensions, Social Security, Annuities, Alimony, and Child Support
1. a) Pensions and other similar remuneration beneficially owned by a resident of a Contracting State shall be taxable only in that State.
b) Notwithstanding sub-paragraph a) of this paragraph, the amount of any such pension or remuneration paid from a pension scheme established in the other Contracting State that would be exempt from taxation in that other State if the beneficial owner were a resident thereof shall be exempt from taxation in the first-mentioned State.

2. Notwithstanding the provisions of paragraph 1 of this Article, a lump-sum payment derived from a pension scheme established in a Contracting State and beneficially owned by a resident of the other Contracting State shall be taxable only in the first-mentioned State.

Roth IRAs I agree - simply from reading other posts on this forum - are likely to be tax-free in the UK to the same extent as they are tax-free in the US, (but I'm no expert).

Hi - thanks for all the advice. Following-up on this: my sister has now liquidated her IRA. Had to fill out a disposal form from the broker and provide a W-8BEN.

However, for some reason (and against information given previously) the broker decided to withhold only 10% (instead of 30% as communicated), i.e., only the penalty for early withdrawal and no tax.

Naive question: Given that she's not holding any other US assets and has no connection to the US - does she need to actually fill out a tax return next year and pay the tax? I assume not doing so would constitute tax evasion, which could potentially be enforced should she ever travel back to the US...?

Thanks!

Yes your sister must file a 1040NR and pay any tax due to the IRS on the lump sum IRA distribution. As you point out, not doing so would be tax evasion. There will be no UK tax due.