annetteangela

Hi everyone,

Next year I will be eligible for a small company pension from the UK and I can choose a "tax free" lump sum and small pension, or a larger pension with no lump sum. I have read that if you are resident in the US, you have to pay tax even on the lump sum - does anyone know the rules about this? I understand that I will have to pay tax on the income (although it's small enough to probably not be taxable), but will I pay that in England (if necessary), or will it be classed as American income? I am very confused as to the best way forward - ultimately I will have a British State pension, as well as a personal pension with an insurance company that I believe I can now take as one lump sum (25% tax free and the rest taxable). Any advice my fellow expats can give me on this would be very welcome. Thanks!

Jerseygirl

Welcome to BE. I have moved your thread over to our US Forum. Someone will probably be along soon to help you.

sir_eccles

What type of pension is it? Defined benefit?

annetteangela

Yes, defined benefit. Thanks, Jerseygirl, for moving my thread to the appropriate place.

nun

Interpretation of the US/UK tax treaty is key to your situation. If you are a US resident there is no UK tax on a UK pension paid to you. If your UK income falls under the UK tax free allowance you don't have to use the treaty, just claim your UK allowances ( assuming you are a UK citizen) by filing an R43 with HMRC and talk to your pension people about your UK non tax status. and there should be no UK tax. Alternatively you can use the treaty by filing a US-Undividual-2002 form.

On the US side you include any foreign pension payments on your 1040 line 16. If you get 25% of your pension as a tax free payment it is vital to distinguish between how HMRC and the IRS uses the term lump sum. For the IRS it means the entirety of an account paid out in a single year. So in my opinion you can assert Article 17.1 rather than the lump sum Article and the UK tax free 25% should also be US tax free. You can give that stance even more force by taking the tax free amount over a number of years. You would make a treaty claim under Article 17.1, include the total UK pension payment on 1040 line 16a then subtract the tax free amount from the total and enter the taxable amount on line 16b.

lansbury

nun have you or anyone else tested this theory, because until it has been tested and accepted by the IRS I think it is wrong to tell people that is what they can do. At best the theory should be outlined and people told to seek professional advice as to its legality

annetteangela

That's really useful, nun, thank you. I will have to decide whether to take the lump sum as one payment - I don't think I can take it over a number of years - so presumably that will all be classed as income next year? Can it be separated out as a tax-free cash payment? I need to read up on Article 17.1 to understand what you mean. I can see that it's all a potential minefield. I am a UK citizen and the income would fall within the tax-free allowance in the UK, but if I have it paid to a US bank account I will presumably have to add it to any income I might earn here in the US?

nun

No I have not tested the "lump sum" thing. But the IRS is clear on its definition of lump sum and 25% of a DB value taken over a number if years is clearly not an IRS lump sum. This reading if the treaty and IRS rules is the one being proposed by some tax professionals that are usually very conservative and are far more knowledgeable that me. Anyway doing it the way I suggest you declare all your income and make an argument for why a portion is US tax free. There is no deception and if the IRS disagrees they will get back to you.

Of course anyone would be foolish to take any advice form a public forum at face value. If they are doing their own taxes they are responsible for any positiona they take and they must be comfortable in justifying them. If they use a professional then it is the professionals responsibility.

Samxboy

You'll be aware I raised the same question a while back. To date I haven't been able to get any 'tax professionals' to even talk about it. Seems like it's an area they do not want to get involved.
Needless to say if the potential tax payable is 'low' then fine, I'd try it but I'm talking a lot of tax and I just can't see the IRS giving this argument up very easily, especially given the country's current finances. They're fining everyone they can identify at the moment.

durham_lad

I'm a US resident and have been receiving a UK private pension for a number of years now and, after filing form 2002, have it paid in gross to my UK bank with no tax withheld. I then put it as income on my US return and pay US tax on it.
I'm due another UK pension in 15 months with an option for a partial lump sum, but since this pension actually has a cost of living adjustment each year, and I'm not convinced of the US tax-free situation on lump sums, I will not be taking a partial lump sum.

lansbury

While I have the greatest respect for nun and the advice he gives here, and have found it very useful in the past, on this subject I am more cautious.

As you have found seeking professional advice shows what a minefield it is. The only clear advice I have ever received is that US tax is due on the tax free sum. Mention of the differing meanings of lump sum, receives the opinion that lump refers to a one off payment and is still income. In the end I didn't take the tax free sum but opted for the larger pension.

nun

The critical thing in all this is whether Article 17.1 applies or Article 17.2. The term "lump sum" is not defined in the treaty so if you are filing with the IRS it is sensible to use their definition which is the following

So the UK 25% tax free amount is not a lump sum as far as the IRS is concerned. The new UK pension rules also allow the UK 25% tax free amount to be taken over a number of years....so now it's a periodic payment as well....so I find it hard to see how Article 17.2 is applicable in those circumstances other than because someone is assuming HMRC and IRS terminology has the same meaning without actually looking at the definitions.

annetteangela

Thanks everyone for your comments and advice. I can see that this is not a clearcut issue. I wonder if it's worth phoning the Inland Revenue? They were always helpful when I lived in the UK. Surely someone there will have experience of this situation?

nun

This is why I suggest taking the 25% tax free amount as more than one payment.

durham_lad

I doubt that the Inland Revenue will have someone familiar with the US/UK tax treaty on the end of the line but it is worth a try.

Above you talked about the difference between having your UK pension paid into your UK or US bank. It doesn't matter which one you choose, the regular pension payments are taxable in the US and tax-free in the UK.