# 8854 Part IV Section B 7a



## stmac79

Hello everyone,

I have a question on the dreaded 8854.

Scenario.
UK citizen
Recently returned from the US to the UK and surrendered US green card
LTR Covered Expatriate subject to exit tax rules - yes the worst scenario
Mark to Market is not an issue since my gains are within the allowance ($668,000)
The issue is eligible deferred compensation (US pension and 401k)
I am not currently taking any distributions from my pension or 401k.

In 8854 Part IV Section B 7a the dreaded 8854 states:

Do you have any eligible deferred compensation items? Checking the “Yes” box is an irrevocable waiver of any right to claim any reduction in withholding for such eligible deferred compensation item under any treaty with the United States.

That is really scary!!! The US is not abiding with international treaties and standards.

My dilemma is this:

If you select "Yes" then the US (actually the payor of my pension and 401k) is going to withhold 30% because the IRS told them to (W8-CE). However reading the above this is just tax WITHOLDING that you cannot claim any reduction for. Tax withholding is not the same as ACTUAL tax in my eyes. So when you submit future 1040NRs do you get the tax that was withheld back? I've been told you do but I don't know under what rule. I'm looking for verification. If you do then I guess I'm reluctantly okay with that. A pointless exercise but at least you are not double taxed. I would of course pay tax in the UK according to the dual taxation agreement since I am resident in the UK. i.e. This is not an exercise in avoiding tax. It is an exercise in avoiding DOUBLE taxation. If you don't get the US tax back then can you deduct foreign tax (US) paid on your UK return in order to avoid double taxation.

BTW if you select "No" to the question then you get hammered as the US steals a large part of your pension and 401k at your marginal tax rate. Then as I see it you would get hit again in future years by the UK as you take distributions from your 401k for example. So the US first takes a chunk out of your tax deferred accounts then the UK comes along and takes another chunk when you eventually take distributions. Double taxation.

Anyone understand this stuff?

I've a lot more faith that the UK will do the right think and not double tax me but who know about the US. The tax code is just baffling. I've spent countless hours trying to understand it. Like everyone else I have discovered that the IRS will not answer any questions on the subject.

Can anyone help?

Stuart


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## Bevdeforges

I'm not all that familiar with the 8854 - but when they are talking about "deferred income" plans, they are generally talking about IRAs (traditional IRAs) and 401K plans, where you deducted your contributions from income when you made them and then don't pay taxes on the earnings your account makes until you take a "distribution" (or withdrawal) from the fund at retirement.

Most foreign governments treat the distributions as a transfer of capital, not as income. So for your country of residence at the time of the distribution, it's just a transfer of capital, as if you were taking money out of your bank account. Because they are US deferred income plans, you will pay US income tax on the distribution as though it was regular income. As a non-US citizen, you will have 30% withheld, but you can claim back any excess withholding when you file a 1040NR. That's not a treaty provision, so shouldn't be affected by your 8854 filing.

A pension isn't considered to be a deferred compensation system. But if the US government is the one paying your pension, it would normally be taxed by the US and somehow exempted or excluded from taxation in your country of resident. Private pensions could be handled differently.

Not sure if that answers the question you were asking, but it might help a bit.
Cheers,
Bev


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## BBCWatcher

I agree with your interpretation, Stuart. That question appears to mean you'll be subject to 30% withholding and cannot (like the general population of Canadians, for example) claim a treaty right to a lower withholding percentage. Then you settle the tax bill, and you pay more or receive a partial refund depending on the actual tax rate. In the latter event you'll be providing the IRS with an interest free loan.

If there is no U.S.-U.K. treaty provision that would reduce your withholding rate then this is a moot point, but it highlights one of the advantages of U.S. citizenship (no automatic withholding on capital gains, interest, dividends, and retirement plan distributions). Withholding is particularly painful with Roth 401(k) and Roth IRA withdrawals because qualified withdrawals are U.S. tax free, and you'd have to wait up to a year or more to get that 30% withholding back. This can cost up to another couple hundred basis points, give or take, due to the time you lose use of those funds.

Anyway, I interpret this as "We'll treat you as the worst case alien," which makes sense but something to think about since it'll effectively reduce the value of the distributions from those accounts. Be sure to factor that impact into your calculus.


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## stmac79

Bevdeforges,

Thanks for the reply.

8854 classifies an IRA as a "Specified Tax deferred account". My understanding for IRAs is that you are treated as having received your entire interest in the IRA on the date of expatriation even though you do not actually take the money out of the IRA. i.e. You will be taxed. Then the cost basis of the IRA is adjusted and you continue on. Fortunately for me I only had a small IRA.

A 401k counts as an eligible deferred compensation plan. I think a workplace pension also falls under that category although I'm not so sure. The rules for an eligible deferred compensation item are different than IRAs. If you select "No" to the question then I think the treatment is the same as for the IRA. You just have no choice with the IRA unlike the 401k. If you select "YES" then you are not taxed immediately but get the tax withheld at 30% on distribution.

Now article 17 1. a.) of the dual taxation agreement states:

a) Pensions and other similar remuneration beneficially owned by a
resident of a Contracting State shall be taxable only in that State.

i.e. In my case since I am a resident of the UK I would expect any pension to be taxed in the UK and NOT in the US according to the dual taxation agreement. So I would have expected to claim 0% tax for pensions on 1040NR line schedule NEC line 7. However now we have that 8854 statement talking about waiving dual taxation treaties so is article 17 1 a.) still valid or not. 

I will read your comments on distributions again.

From article 17 2. of the dual taxation agreement:

-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.

So if you regard distributions from a 401k as lump sums then it would be taxable in the US and not the UK in which case I can see that might fit in with the 30% withholding. However previously I was interpreting lump sum to mean cashing in the entire 401k.


Stuart


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## stmac79

BBCWatcher,

So we agree that it is 30% withholding (not actual tax owed) and there will be a great reckoning at the end of the year to determine what the actual tax will be at the end of the year. I would maintain that it is 0% to the USA according to article 17 1 a.) of the UK/US dual taxation treaty. That means at the end of the year I would get my 30% back. So yes the US got a interest free loan. Seriously though I think I can recover cope with the interest free loan what really worries me is any double taxation. I also do not like the fact that I have to file a return every year to get the money back. I'm not sure I can keep up all these 1040NRs as I get older. They are wearing me out now. I think that is what the US is counting on so they just get to keep the 30% when someone doesn't file a 1040NR.

BTW if you are a US citizen you may get away without the 8854 and 30% withholding but you have the 8938 and the TDF90.22 (now the new FinCen 114) every year instead. You lose either way.

Stuart

Stuart.


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## BBCWatcher

One of those losses is financial (interest/gains lost on your free loans to the IRS), the other is non-financial reporting time (the cost of your time). The former is substantially more consequential to me than the latter -- I'm posting here, aren't I?  -- but your situation may vary.

I agree with your interpretation, that you are waiving any possible treaty right to a nonstandard withholding (key word) percentage, then yes, you settle up after the tax year ends.

Note that Congress could in the future change withholding and tax rates. There's nothing magic about the 30% rate or any other rate, so don't be too shocked if your free loans get more expensive in the future. Quite significantly there's nothing in that language that fixes the withholding rate at 30%. Also, if U.K. (in particular) interest rates go up -- if the time value of that money increases, basically -- then those free loans can also get more expensive. This is all part of the overall calculus. It's a reasonable bet that the 30% withholding rate and today's low interest rates are the best case, and I think it's reasonable to assume some increase in the cost of these free loans to the IRS in the future -- and reasonable to toss that increase into your overall calculus.

This hurts the most with U.S. tax free distributions, as I mentioned. U.S. citizens still have to pay estimated quarterly taxes, so that makes your free loans comparatively less expensive than the citizen privileges for taxable distributions but still somewhat more expensive. And you've still got to file substantial paperwork to retrieve the free loan, so it's hard to say what the total impact is to your paperwork burden. If you plan only to take occasional distributions (not every year), you'll probably have less paperwork. If you will take at least annual distributions, or if you're required to (required minimum distributions), or the pension plan operates that way, then it's much less clear.


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## Bevdeforges

I'm basing my comments on what I know of the situation for non-US citizens who have IRAs or 401Ks in the US. As it turns out, the UK tax treaty is a bit different from some of the others (say, France), in that US social security is (I think) actually taxable in the UK rather than in the US. But, if they require you to give up your rights to fall back on the tax treaty...

Then again, if you're subject to the expatriation tax, they may expect you to pay tax on your deferred retirement plans as though you were cashing them out. (Another of the financial considerations of renouncing.) 

Back in business school, they stressed the idea that you shouldn't make any major decisions based solely on the tax consequences. I'd say renunciation definitely falls into this category.
Cheers,
Bev


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## BBCWatcher

Bevdeforges said:


> Back in business school, they stressed the idea that you shouldn't make any major decisions based solely on the tax consequences.


Though India may be challenging that rule of thumb lately.


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## stmac79

In my case I was never a US citizen, only a green card holder so I don't feel I had anything to renounce. If I had simply left the US then after 1 year I would lose my green card anyway. In my case I did things properly , filed the I407 and surrendered the green card.


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