Each year there are several threads about how Americans are taxed when living abroad. I’ve read those and asked some questions previously but never got a clear answer to a basic question. This might have to do with the fact that those Americans living overseas who use a tax preparer/CPA/accountant don’t actually see the methods used to calculate taxes. If one is doing taxes oneself, it is necessary to understand the correct process. So…

I’m a dual citizen USA/UK, retired, and looking at the tax consequences should I decide to return home to the UK in future. As we know, one of the unfortunate consequences of being an American is that the USA reserves the right to tax its citizens on their worldwide income, no matter where they live. The UK, like most countries, only taxes those who are resident in the UK. To reduce the effect of dual taxation, the USA and UK have a tax treaty. This spells out which country has the right to tax each category of income. Some of the provisions of the treaty are very clear. For example, state pensions/social security are taxable only by the country of residence. But many sources of income are covered by the infamous treaty ‘savings clause’ which overrides whatever the treaty says, giving the US the right to tax certain types of income no matter what. Am I correct?

If so, which tax system has the first claim on this income? Let’s take an example of distributions from my IRA in the USA. My understanding is this income is taxable in the USA (thanks to the savings clause) and also in the UK if I am living there. I see two ways of computing and paying taxes on this income:

1) First, declare this income on my IRS 1040, compute the tax and pay the IRS. Next, declare the income on my HMRC self-assessment, compute the tax due, subtract what I paid the IRS as a tax credit and pay the difference to HMRC.

Or the other way round….

2) First, declare this income on my HMRC self-assessment, compute the tax and pay HMRC. Next, declare the income on my 1040, compute the tax due, subtract what I paid HMRC as a tax credit and pay the difference (if any) to the IRS. If UK taxes are higher than the US, there might well be nothing owing to the IRS.

From the IRS’ perspective, method (1) is probably their preferred method because the income came from an IRA which is tax-deferred in the USA and the IRS expects to get something back eventually when I take distributions from it, and method (2) probably gives them nothing.

So, what’s the general approach for income falling into the 'savings clause' pot? Does US-sourced income get preferentially taxed by the IRS, and UK-sourced income preferentially taxed by HMRC?

I am a dual citizen living in the UK and I can tell you how my private pensions are treated. (I don’t have IRA distributions just Roth distributions which are tax free in both countries)

I have 2 US private pensions and 2 UK private pensions and they are all taxed by both countries. When I file my US taxes I use foreign tax credits paid to HMRC applied to my US return to reduce my taxes.

So that would be option (2) in my example, for both your US-source and UK-source income. You are giving HMRC the first right to tax all of it, regardless of source. Seems reasonable since you are living in the UK, but I can't decipher the tax treaty (nor its notes) to figure out if that is actually the correct way to do it.

For an IRA/401k it just seems to me that the IRS would want its taxes first without any foreign tax credit deduction, since it let me accumulate that account tax-free for 30 years. Hopefully someone with an IRA or similar US tax-deferred savings scheme can chime in.

It is not my interpretation of the treaty, it is that of my expensive dual qualified tax preparer.

My approach to my, and my wife’s IRAs, was to take lumps sums every other year and convert them to Roth IRAs, paying only US taxes each time. We had started doing that the year we retired in 2004 and continued to do so after we moved to the UK in 2016. The last lump sum conversion was in 2022 so we are now 100% Roth. Even if you do not plan on Roth conversions you take lumps sums instead of periodic withdrawals.

Those are my concerns. I have an IRA composed of Vanguard mutual funds, have had them since my retirement in 2013. Am I too old to even convert them to a Roth at this point(I’m 68)? If I could, would I have to wait five years to draw any money from them?

And like the OP, I’m wondering which of the two is the least painful option. I pay roughly 15% on each “draw” from them now; bottom line, I could absorb a little more tax bite US/UK combined, but significantly more than that, it’s a dealbreaker and I couldn’t go to Wales.

Any input appreciated!

What is the significance of this statement about lump sums? To the IRS, an IRA distribution is treated the same tax-wise whether it's a lump sum/ad-hoc or periodic. It's just taxable income in the year it was distributed. Are you implying there is some advantage from the HMRC side to doing timed lump sums?

What should happen using tax credits (and tax treaty rules for state pensions and any other income streams specifically not overridden by the savings clause) is that you will just pay the higher of whichever system has the highest tax rate for your specific situation. In general, if UK taxes are higher, your UK tax bill should completely eliminate any US tax liability. I think.

HMRC don't tax a lump sum from an IRA, the IRS will tax it fully. the most I ever paid was 17% on my IRS return. If I was taxed by HMRC it would have been taxed at 40%.

The wording the tax account uses on my HMRC is along these lines.During the 2017 calendar year, I received a lump sum from my IRA Pension Fund

totalling $xxx. Since this is a lump sum from a US plan, it is subject to US

tax only and exempt from UK tax and has therefore not been included in this return.

Thanks, thought it was something like that. Which of course might also be a dealbreaker because of the UK tax jump from 20 to 40% past 50something a year..? Anyway, defo need to consult a tax expert before proceeding, but this forum is helpful.

See now I'm confused. Your first reply said "I don’t have IRA distributions just Roth distributions which are tax free in both countries". But now you just gave an example of how your accountant characterizes a lump sum from your IRA. So you do (or did) have an IRA?? Can you point me to the paragraph of the tax treaty where it says lump sum IRA distributions are not taxed by the UK? And come to think of it, I remember there was some discussion somewhere about what a 'lump sum' actually is. I think in IRS parlance this is a 100% distribution of the entire account, whereas to HMRC a partial withdrawal can be called a lump sum. Something like that.

So if you are only letting the IRS tax your IRA - you are using Method (1) from my original post for that source, and Method (2) for your pensions.

This is exactly why these threads keep popping up - many of us are never confident which way to do the calculations!

No wait - correction to my previous post. This is not Method (1) as I described, this is a new "Method (3)" whereby you don't offset US tax paid with a credit on the UK side, you don't even declare it to HMRC. Besides the statement by your accountant, did he call out the tax treaty paragraph? That would be really helpful.

Yes the main tax bands are personal allowance, followed by 20% followed by 40% and I think there's a 45% somewhere too. Do a workup of what your taxes would be assuming its all taxed by HMRC. Compare with the US equivalent, including medical insurance and deductibles etc. If you plan to use the NHS only that's worth a lot in savings vs the US. My retirement calcs show that staying in the US, my medical costs will be larger than my combined Fed + state taxes. For comparison purposes, I add medical to my US tax liability to come to a something approximating the 'equivalent total tax' US vs UK.

If you read my post above you will see that the year was 2017, the last time I did a Roth conversion. Since then I have started taking Roth distributions. An IRA to Roth conversion is a 2 stage process, withdraw a lump sum from the IRA and pay taxes but instead of moving those funds into a taxable account you are allowed to put all or part of it into a Roth IRA. I always chose to pay the taxes out of existing taxable savings to maximize the Roth advantage. (One could pay the taxes out of the IRA distribution)

Article 17 paragraph 2 covers lumps sums.

https://assets.publishing.service.go...-_in_force.pdf

Ok I think I see it more clearly now. So taking, say, 20 annual distributions at some random time during the year rather than on a set schedule would count as 20 lump sums? Or is that stretching the definition of 'lump sum'?

That should work for now, doing 1 lump sum per year. HMRC seem to accept that, although being married, I was able to do a lump sum for me one year and then a lump sum from my wife’s IRA the following year.