# Lump sum Pension Commutation and IRS



## Cousin Jack (Feb 6, 2016)

Hi everyone, not sure where to post this so.

I left UK police service in 1999 and moved to the States. Therefore my UK Police pension payment was deferred until I am 60. That time is fast approaching!

I have dual US/UK citizenship now resident back in UK with my US family who is currently going through the immigration (ILR next:clap2

Am planning to take the full 25% commutation from my police pension and its tax free in the UK.

I think I am right that this lump will *not* be taxable by the IRS but need to know for sure as if it is that could change my mind how much lump sum (if any) I take!

Read somewhere about completing IRS form 8833 but looks pretty complicated.

Maybe there is someone out there that has a similar experience who can explain it in more detail or someone who understands and can guide me or point me in the right direction. 

I use Turbo Tax to file my US taxes and am up to date on my FABAR FATCA etc.
My wife and I joint income including the commutation is less than $100k (if that helps).


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## Jca1 (Aug 7, 2019)

It's pretty confusing, but if you read through the technical explanation of the US-UK treaty here you'll see this in the notes about article 17:



> *Paragraphs 2 and 4 of Article 17 also are subject to the saving clause. Accordingly, a
> U.S. citizen who is a resident of the United Kingdom will be subject to U.S. tax on a lump-sum
> distribution from a pension scheme or an annuity, notwithstanding the rules in those paragraphs
> that give exclusive taxation rights to the State of source or residence, as the case may be.*
> ...


So that makes it seem clear that the treaty was intended to be written in such a way to make a lump-sum distribution to a US citizen taxable by the IRS. 

I've heard from some pension administrators that US citizens have taken a lump-sum distribution without being taxed on it, but that might just mean the taxpayer reported it as a non-taxable distribution on form 8833 and the IRS didn't question it, or they simply omitted it from their US tax return. If their return were under more scrutiny in the future, it's possible they'd owe tax with interest and possibly penalties.


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## Jca1 (Aug 7, 2019)

Jca1 said:


> It's pretty confusing, but if you read through the technical explanation of the US-UK treaty here you'll see this in the notes about article 17:
> 
> 
> 
> ...


See also this on HMRC's site:



> Lump Sums
> 
> Under the old Agreement, a lump-sum payment from a pension scheme was taxable only in the country of residence. So if an individual moved from the US to the UK before receiving a lump sum from a US pension scheme, they would be taxable on the lump sum neither in the US (because of the treaty) nor in the UK (which does not tax lump sums anyway).
> 
> ...


A counterargument I've seen is that "lump-sum" means a 100% distribution under the IRC, so the 25% tax-free amount is not a lump-sum distribution under US law and therefore isn't taxable by the IRS for a US citizen residing in the UK. Private letter rulings from the IRS have not supported this position. As far as I know, no one has tested this counterargument in the US Tax Court, but I doubt it would be accepted.


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## Cousin Jack (Feb 6, 2016)

I was directed to this (below) that was entered into force March 2003 (the Dept of Treasury letter you refer to was dated July 2002)

My understanding (so far) is this:

The contracting State (UK) and myself as the resident of the UK states that because I am a resident of the UK and because the pension was contracted in the UK, then it shall only be taxable in the UK (contracted State). 
Para 2 specifically states that a lump sum from the (UK) pension scheme and owned by me (as resident in the UK) shall only be taxable in the UK ('first mentioned State).

I also interpret this to mean that in addition to the lump sum, all and any other annual payments are also exempt from US taxes.

Welcome to discuss.



*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.

3. Notwithstanding the provisions of paragraph 1 of this Article, payments made by a Contracting State under the provisions of the social security or similar legislation of that State to a resident of the other Contracting State shall be taxable only in that other State.

4. Any annuity derived and beneficially owned by an individual (“the annuitant”) who is a resident of a Contracting State shall be taxable only in that State. The term "annuity" as used in this paragraph means a stated sum paid periodically at stated times during the life of the annuitant, or during a specified or ascertainable period of time, under an obligation to make the payments in return for adequate and full consideration (other than in return for services rendered).

5. Periodic payments, made pursuant to a written separation agreement or a decree of divorce, separate maintenance, or compulsory support, including payments for the support of a child, paid by a resident of a Contracting State to a resident of the other Contracting State, shall be exempt from tax in both Contracting States, except that, if the payer is entitled to relief from tax for such payments in the first-mentioned State, such payments shall be taxable only in the other State.*


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## JustLurking (Mar 25, 2015)

Cousin Jack said:


> {Article 17} Para 2 specifically states that a lump sum from the (UK) pension scheme and owned by me (as resident in the UK) shall only be taxable in the UK ('first mentioned State).


When reading the US/UK tax treaty, did you also notice the following clause, article 1 paragraph 4 (emphasis is mine)? This is the US's so-called 'saving clause'.


> 4. Notwithstanding any provision of this Convention except paragraph 5 of this Article, a Contracting State may tax its residents (as determined under Article 4 (Residence)), and _by reason of citizenship may tax its citizens, as if this Convention had not come into effect_.


Paragraph 5 lists exceptions to paragraph 4:


> 5. The provisions of paragraph 4 of this Article shall not affect:
> a) the benefits conferred by a Contracting State under paragraph 2 of Article 9 (Associated Enterprises), sub-paragraph b) of paragraph 1 and paragraphs 3 and 5 of Article 17 (Pensions, Social Security, Annuities, Alimony, and Child Support), paragraphs 1 and 5 of Article 18 (Pension Schemes) and Articles 24 (Relief From Double Taxation), 25 (Nondiscrimination), and 26 (Mutual Agreement Procedure) of this Convention;
> and
> b) the benefits conferred by a Contracting State under paragraph 2 of Article 18 (Pension Schemes) and Articles 19 (Government Service), 20 (Students), 20A (Teachers), and 28 (Diplomatic Agents and Consular Officers) of this Convention, upon individuals who are neither citizens of, nor have been admitted for permanent residence in, that State."


Article 17 paragraph 2 is not one of the listed exceptions to article 1 paragraph 4.

Overall, the situation for UK tax-free pension commencement lump sums has always been unclear for US citizens. There are arguments both for and against it being US taxable, and (predictably, and typically) the IRS has never bothered to clarify anything.


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## Jca1 (Aug 7, 2019)

There's also a private letter ruling here that explains how the treaty shows that lump-sum distributions are taxable. (Note that the treaty defines 'resident' in a way that would include US citizens residing anywhere.)

How/whether to report the distribution and whether the IRS will notice and ask you to pay tax (plus interest and penalties) are separate questions. I just don't want to encourage people to think the treaty supports this being nontaxable, when it's pretty clear that it doesn't.


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## Jca1 (Aug 7, 2019)

Cousin Jack said:


> I was directed to this (below) that was entered into force March 2003 (the Dept of Treasury letter you refer to was dated July 2002)


What I quoted from was the technical explanation of the treaty, which was written after the treaty but before the treaty was entered into force. I quoted the technical explanation because it often skips to the point, whereas otherwise you have to read the treaty as a whole, including the articles, the saving clause, the exceptions to the saving clause, the amendments, and the technical explanation, in order to figure out what the treaty actually does. It's pretty tedious and confusing.


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## Nononymous (Jul 12, 2011)

Ask yourself a different question. Not, "is it reportable?" but rather "is it detectable?"


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## Jca1 (Aug 7, 2019)

And I'd guess the answer is "probably not," especially if your pension is with an institution that doesn't do FATCA reporting at all and you aren't doing something else that's likely to lead to an audit.


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## Cousin Jack (Feb 6, 2016)

Thank you for all your replies. 

Rather than find myself justifying my position to the IRS and the potential of paying legal fees and/or taxes (and maybe penalties), in my circumstances its easier and more cost effective to not withdraw the lump sum and instead claim 100% of my monthly benefits. IRS tax would be negligible and in the long term I (and my spouse) would be better off.


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## Bevdeforges (Nov 16, 2007)

Cousin Jack said:


> Thank you for all your replies.
> 
> Rather than find myself justifying my position to the IRS and the potential of paying legal fees and/or taxes (and maybe penalties), in my circumstances its easier and more cost effective to not withdraw the lump sum and instead claim 100% of my monthly benefits. IRS tax would be negligible and in the long term I (and my spouse) would be better off.


One minor consideration is that, if you were working in the US long enough to get a US SS pension, you'll have to submit a "benefits letter" (i.e. the initial letter from your UK pension saying how much you'll be receiving). Thanks to the WEP (Windfall Elimination Provision) they will take away a little bit of your US SS benefits, based on the amount of the foreign pension you will be receiving. The reduction is limited to no more than one-half the amount of the foreign pension (but of course there is a horrifically complicated calculation involved). It's definitely worth claiming (age 62 is the earliest you can claim, though the payment increases if you wait until age 66 or later).


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## Cousin Jack (Feb 6, 2016)

Bevdeforges said:


> One minor consideration is that, if you were working in the US long enough to get a US SS pension, you'll have to submit a "benefits letter" (i.e. the initial letter from your UK pension saying how much you'll be receiving). Thanks to the WEP (Windfall Elimination Provision) they will take away a little bit of your US SS benefits, based on the amount of the foreign pension you will be receiving. The reduction is limited to no more than one-half the amount of the foreign pension (but of course there is a horrifically complicated calculation involved). It's definitely worth claiming (age 62 is the earliest you can claim, though the payment increases if you wait until age 66 or later).


Thanks for that. I will take it on board :juggle:


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## Jca1 (Aug 7, 2019)

I thought some of you might read with interest this related post in the British Expats forum, where a taxpayer explains that he was able to argue that a 25% distribution from his UK pension was not a lump sum under IRS definitions and received a refund on tax paid on the distribution.

https://britishexpats.com/forum/usa...d-uk-us-tax-treaty-894492/page7/#post12796830

I'm still unsure whether this argument would prevail under further scrutiny, but it is interesting (and good news for the taxpayer) nonetheless.


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## Cousin Jack (Feb 6, 2016)

Thank you for posting this link. I see the OP was a green card holder and wonder if this argument could still be used in my circumstances as a dual citizen, although his main argument is the wording of 'lump sum'. :fingerscrossed:


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## Jca1 (Aug 7, 2019)

I'm not sure, and your situation is probably different since you have a government pension instead of a SIPP. I would be wary of consulting the lawyer mentioned in that thread. There are some questions about his licensing and he has a history of litigating against people who have questioned his reputation. Another thing to keep in mind is that the IRS may not have understood or accepted the argument in the amended return, just verified that the numbers add up.


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## Moulard (Feb 3, 2017)

Cousin Jack said:


> Thank you for posting this link. I see the OP was a green card holder and wonder if this argument could still be used in my circumstances as a dual citizen, although his main argument is the wording of 'lump sum'. :fingerscrossed:


From a US taxation perspective there is no difference between the taxation of a US citizen and a US greencard holder unless it is protected by the savings clause in the tax treaty. 

The 2001 US treaty savings clause Article 1 paragraph 5(a) and (b) protects a US citizen being taxed as if the treaty was not in effect for

Article 17 (Pensions) paragraphs 1 (b); 3 and 5
Article 18 (Pension Schemes) paragraphs 1 and 2
Article 19 (government Service) 

Article 17 of the treaty deals with the taxation of private (i.e., non-government service) pensions. As yours is a government pension, Article 17 is not relevant.

Article 18 deals with cross-border pension contributions. Given you state you left the police force and then moved to the US I don't believe this is relevant.

Article 19 on the other hand.. is relevant..

In its glory...



> a) any pension paid by, or out of funds created by, a Contracting State or apolitical subdivision or a local authority thereof to an individual in respect of services rendered to that State or subdivision or authority shall, subject to the provisions of sub-paragraph b) of this paragraph, be taxable only in that State;
> b) such pension, however, shall be taxable only in the other Contracting State if the individual is a resident of, and a national of, that State


Its important to note the AND in paragraph B.

You are a US national, but once your return to the UK you are not a resident of the US, and therefore your Police Pension would only be taxable by the UK.

It is still reportable as income, its just not taxable income.


As an added bonus, it is worth noting that IRS form 8833 is NOT required - so you can just report it as non-taxable pension income

Per Treasury Regulation, 26 CFR § 301.6114-1 treaty based filing is waived 



> (c) Reporting requirement waived.
> (1) Pursuant to the authority contained in section 6114 (b), reporting is waived under this section with respect to any of the following return positions taken by the taxpayer:
> ...
> (iv) That a treaty reduces or modifies the taxation of income derived from dependent personal services, pensions, annuities, social security and other public pensions, or income derived by artistes, athletes, students, trainees or teachers;


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## Jca1 (Aug 7, 2019)

Moulard said:


> The 2001 US treaty savings clause Article 1 paragraph 5(a) and (b) protects a US citizen being taxed as if the treaty was not in effect for
> 
> Article 17 (Pensions) paragraphs 1 (b); 3 and 5
> Article 18 (Pension Schemes) paragraphs 1 and 2
> ...


Are you sure about this? Article 1 paragraph 5(b) appears to be saying that the benefits conferred by article 19 are protected only for non-US citizens.



> b) the benefits conferred by a Contracting State under paragraph 2 of Article 18
> (Pension Schemes) and Articles 19 (Government Service), 20 (Students), and 28
> (Diplomatic Agents and Consular Officers) of this Convention, *upon individuals who
> are neither citizens of, nor have been admitted for permanent residence in, that State*


Here is how the technical explanation of the treaty explains article 1 paragraph 5(b):



> Subparagraph (b) of paragraph 5 provides a different set of exceptions to the saving
> clause. The benefits referred to are all intended to be granted to temporary residents of a
> Contracting State (for example, in the case of the United States, holders of non-immigrant visas),
> *but not to citizens or to persons who have acquired permanent residence in that State.* If
> ...


Altogether it's convoluted enough that there are probably few people at the IRS who understand what the treaty read as a whole says about US tax treatment of UK pensions.


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## Moulard (Feb 3, 2017)

Yep. 

To paraphrase Blackadder...

I was wrong wrong wrongity wrong.

And to make matters worse the UK treaty clause follows the US model treaty on that clause


As a consequence, Article 17 is key - as it was in the British forum link.


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## Jca1 (Aug 7, 2019)

There's a debate between CPAs and tax attorneys in this thread about the lump sum issue and UK pensions, if anyone is interested:

https://www.taxprotalk.com/forums/viewtopic.php?f=8&t=3780


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## Cousin Jack (Feb 6, 2016)

Exceptions from reporting (8833)...
.....
• That a treaty reduces or modifies the
taxation of income derived by an
individual from dependent personal
services, *pensions*, annuities, social
security, and other public pensions, as
well as income derived by artists,
athletes, students, trainees, or teachers;

What does this mean?


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## Jca1 (Aug 7, 2019)

Form 8833 is used for stating that you're taking a position on a tax return that relies on a tax treaty modifying how your income is taxed. The instructions for the form appear to say that you don't need to file that form to state that a treaty modifies how your foreign pension is taxed, but for reasons unclear to me some lawyers and CPAs think it should be filed anyhow.


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## Moulard (Feb 3, 2017)

> but for reasons unclear to me some lawyers and CPAs think it should be filed anyhow


Pretty simple.. because it is a way of drumming up business.. it is a scary form in that you really do have to understand the IRC, regulations and treaties.

As such form 8833 is really for obscure and business returns, most normal stuff that follows the model treaty and does not require it.. 

Treasury Regulation 26 CFR § 301.6114-1 (Treaty-based return positions) defines when you must report a treaty based position (using Form 8833) and when it is waived.

The quote was from paragraph (c)(iv).


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## Cousin Jack (Feb 6, 2016)

Moulard said:


> Treasury Regulation 26 CFR § 301.6114-1 (Treaty-based return positions) defines when you must report a treaty based position (using Form 8833) and when it is waived.
> .


Why do they make it so complicated

Seems I have several options:

1. Invoke the tax treaty position and report it on a 8833 myself or pay extra $$'s and hire a tax attorney. If treaty is not accepted then not only are there taxes to pay but interest and penalties. A tax attorney quoted me an amount that equates to about 1/3 of my estimated tax (see 2 below), worth it if the position is accepted but additional $$'s if not!

or

2. Decline any treaty position and just report and pay the tax owed as unearned income (about 20%). I can do this myself and no need to pay tax attorney or CPA fees.

or

3. Take the position that the treaty can be waived and pension is not reportable. Be prepared to defend my position if audited ($$'s for tax professional?) pay penalties, interest, and taxes if unsuccessful.

or

4. Option 2, pay tax then make a subsequent amendment to claim tax treaty myself and if successful get a refund.This should avoid penalties and interest if not successful as tax was already paid.


Going off the radar is not an option and its too late to renounce citizenship and avoid tax.


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## Moulard (Feb 3, 2017)

Reply to my own post here...

I think that the 8833 requirement can be a bit grey in some cases and you probably would have to dig into the intent of the regulation. An example, might be the tax treatment during the accumulation or growth phase -- technically at that point it is not a pension...


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## Cousin Jack (Feb 6, 2016)

Moulard said:


> Reply to my own post here...
> 
> I think that the 8833 requirement can be a bit grey in some cases and you probably would have to dig into the intent of the regulation. An example, might be the tax treatment during the accumulation or growth phase -- technically at that point it is not a pension...



Yes, that adds another dimension that could prove just as costly. A part of me thinks that just declaring it as unearned income and sucking up to paying the tax owed is less of a headache.


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