# Reporting UK pension lump sum to IRS



## dogsby (Jul 1, 2017)

My wife is a US citizen now long-term resident in UK (over 20 yrs). (I do her IRS filings for her - she files as "Married, filing separately", as I am a Brit with no US income at all, also resident in UK).
Up till now filing has been pretty straightforward: she takes the foreign earned income exclusion to deal with her UK employment income (giving no net tax), and then the small amount of US-derived income is always below the standard deduction, so overall no tax has ever been liable.
But in 2020 she started receiving payments from a UK employer's defined benefit pension scheme, plus an initial lump sum payment (tax free as far as the UK side is concerned).
I have read many of the conversations on this forum regarding whether it is necessary to report such foreign pension income to the IRS, which has been extremely enlightening. We've decided that it is not necessary to report the monthly pension payments (as these seem covered by the tax treaty). Regarding the lump sum payment, I am aware of the arguments for and against reporting it at all (and the near impossibility of getting clarity on the issue). We are planning on including the lump sum on the 1040 (the amount is small enough that overall income will still not exceed the standard deduction, so no tax will be liable anyway, so see no downside in including it). 
My question is where - exactly - on the 1040, should this lump sum value be indicated? The "obvious" place is line 5a and 5b, or should it be treated as "other" (line 8)? The problem with "other" is that Schedule 1, line 8 is already filled with the Form 2555 FEIE value.
Would welcome your thoughts. Thanks.


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## Nivie (Apr 22, 2021)

Hi. I went through a similar process 2020 tax year. I am a USC resident in the UK and I received an employer lump sum pension (tax free in the UK) together with monthly pension from same scheme plus I also cashed in a couple of other small UK employment pensions. I researched my tax strategy a couple of years before it happened and looked at all options and included advice from various tax professionals. I really was in two minds what to do.
Pension is classified as UNEARNED income and not subject to the Foreign Income Exclusion. 

The Tax Treaty does give an exception to pensions but does not appear to include lump sum withdrawl when you get into the fine details

Its all very complicated and I agree there is no clarity but what I found out tipped the balance against me. I was going to challenge but if I was wrong then the IRS penalties plus interest and fees for hiring a tax lawyer could significantly add up and in my circumstances it was not worth the risk.
Best of luck

One thing, you mention that its not necessary to report pension withdrawls because they are exempt, but be careful, as was explained to me, they only become exempt when reported correctly. My annual employer pension is reported and disclosed on 8833 Treaty Disclosure.

PS I ended up using a well known online tax advisor to file for me to make sure it was done properly.


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## dogsby (Jul 1, 2017)

Many thanks Nivie, very interesting to hear your experience of this.
I am, though, a bit unclear as to what you actually did in the end. Did you try to take the position that the lump sum was not taxable by the US (and that's why you used the 8833 form)? I confess that I wasn't even aware of form 8833, so thanks for that information (every day seems like a school day when it comes to IRS filing). I must read up on 8833 - is it always necessary to file this to get any benefit from the treaty, or just in complicated situations...?

Because the lump sum in our particular case is not enough to trigger any tax liability, I am thinking of simply including it as (in theory, taxable) pension income on 1040, without trying anything as sophisticated as you did. 
Thanks again.



Nivie said:


> Hi. I went through a similar process 2020 tax year. I am a USC resident in the UK and I received an employer lump sum pension (tax free in the UK) together with monthly pension from same scheme plus I also cashed in a couple of other small UK employment pensions. I researched my tax strategy a couple of years before it happened and looked at all options and included advice from various tax professionals. I really was in two minds what to do.
> Pension is classified as UNEARNED income and not subject to the Foreign Income Exclusion.
> 
> The Tax Treaty does give an exception to pensions but does not appear to include lump sum withdrawl when you get into the fine details
> ...


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## Moulard (Feb 3, 2017)

Nivie said:


> The Tax Treaty does give an exception to pensions but does not appear to include lump sum withdrawl when you get into the fine details


This is correct. Article 17(2) specifically deals with lump sum payments you are right does not give the same exemption as it does to regular pension payments. According to the technical memorandum that accompanies the new treaty, this clause was specifically added to address the double non-taxation of lump sums that could result when a US pension plan did a lump sum distribution to a UK resident.



> 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.


This paragraph is not protected by the savings clause and thus the per Article 1(4) the US may tax it as if the treaty was not in effect as only paragraphs 1,3 and 5 of Article 17 are protected. 

Given the US may tax this income as if the treaty were not in effect, it is dependent on US definitions of things like Lump Sum distributions ...from Pub 575..



> A lump-sum distribution is the distribution or payment in 1 tax year of a plan participant's entire balance from all of the employer's qualified plans of one kind (for example, pension, profit-sharing, or stock bonus plans). Additionally, a lump-sum distribution is a distribution that was paid:
> 
> Because of the plan participant's death;
> After the participant reaches age 59½;
> ...


I would want to read the IRC and Treasury Regulations carefully, but on first parsing of this, a distribution from a UK pension plan could never be defined as a lump sum payment (under US tax law at least) because it is from a non-qualified plan by definition.


How it is treated, will therefore depend on how you reported the contributions into the scheme in the first place and a closer reading of treasury regulations than I currently have time for and whether or not it gets absorbed into the pensions clause - and indeed you should probably read article 18 carefully too which covers pension schemes in the accumulation phase -this article is unique to the UK treaty and perhaps others that have been recently re-written.

I would expect that all income will end up being taxed once... so how you reported employer contributions becomes important... For example if you treated employer contributions as income in the year that it was received then only that portion distribution which has not already been taxed would be taxable income. If you ignored employer contributions (or they were never actually vested or constructively received by you because the nature of the scheme) then the whole sum would likely be taxable income.

Of course if you relied on the "not withstanding" part, and the fact that it was only a partial disbursement one might be able to try to argue that it was covered under Article 17(1)



dogsby said:


> I must read up on 8833 - is it always necessary to file this to get any benefit from the treaty, or just in complicated situations...?


No. It is not always necessary. Form 8833 is really there to ensure that people using, shall we say, creative interpretations of the treaty declare that they are doing so. Certain treaty claims are specifically exempted from having to declare the position because the tax treatment of them is generally quite well understood and not considered controversial. The treatment of pension income has had its reporting requirements waived under 26 CFR § 301.6114-1 - Treaty-based return positions



> (c) Reporting requirement waived.
> (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;


Of course you can still use the form, but it is not actually required that you do so.



> I am thinking of simply including it as (in theory, taxable) pension income on 1040, without trying anything as sophisticated as you did.


Yep. You could add it as taxable pension income, or alternatively you could add it as other income. Other Income supports a host of different income types... the line on the 1040 would pull in from schedule 2 (I think it is) a negative number from the FEIE and a positive number from the lump sum.

But as Nivie has stated, this income is considered not earned, and thus you could not use the FEIE to offset any US tax liability on the income - and this could well result in a US tax liability if you have not been using foreign tax credits for passive category income up to now. 

If sums are large, and deductions (standard or otherwise) will not be enough to offset any US tax liability then it may well be worth getting professional advice.


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## Nivie (Apr 22, 2021)

dogsby said:


> Many thanks Nivie, very interesting to hear your experience of this.
> I am, though, a bit unclear as to what you actually did in the end. Did you try to take the position that the lump sum was not taxable by the US (and that's why you used the 8833 form)? I confess that I wasn't even aware of form 8833, so thanks for that information (every day seems like a school day when it comes to IRS filing). I must read up on 8833 - is it always necessary to file this to get any benefit from the treaty, or just in complicated situations...?
> 
> Because the lump sum in our particular case is not enough to trigger any tax liability, I am thinking of simply including it as (in theory, taxable) pension income on 1040, without trying anything as sophisticated as you did.
> Thanks again.


Hi
I was going to take the position that the tax free lump sum was not taxable quoting my interpretation of the tax treaty. I did have tax consultants who said they would submit it for me with promises that they would challenge it (no cost fee) but I would ultimately still be liable for IRS penalties and interest. I also considered taking the same position and submitting myself without a tax advisor. Had all the paperwork completed and a long addendum outlining my legal arguments but at the last minute bottled and decided not to take a Treaty position and pay the tax due on my pension lump sum.
End of story? Maybe not. I do have the option of submitting an amended return within three years to claim a treaty position. If its accepted then I could receive a tax refund. If its declined, I at least have no penalties or interests to pay.


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## dogsby (Jul 1, 2017)

Thanks Moulard 


Moulard said:


> I would want to read the IRC and Treasury Regulations carefully, but on first parsing of this, a distribution from a UK pension plan could never be defined as a lump sum payment (under US tax law at least) because it is from a non-qualified plan by definition.
> 
> How it is treated, will therefore depend on how you reported the contributions into the scheme in the first place and a closer reading of treasury regulations than I currently have time for and whether or not it gets absorbed into the pensions clause - and indeed you should probably read article 18 carefully too which covers pension schemes in the accumulation phase -this article is unique to the UK treaty and perhaps others that have been recently re-written.
> 
> I would expect that all income will end up being taxed once... so how you reported employer contributions becomes important... For example if you treated employer contributions as income in the year that it was received then only that portion distribution which has not already been taxed would be taxable income. If you ignored employer contributions (or they were never actually vested or constructively received by you because the nature of the scheme) then the whole sum would likely be taxable income.


OK, thanks, that is something I'll need to think about more - so far we've just ignored employer contributions. I guess the silver lining to the sums involved being relatively small is that we can still list them as taxable but still fall under the standard deduction.



Moulard said:


> Form 8833 is really there to ensure that people using, shall we say, creative interpretations of the treaty declare that they are doing so. Certain treaty claims are specifically exempted from having to declare the position because the tax treatment of them is generally quite well understood and not considered controversial. The treatment of pension income has had its reporting requirements waived under 26 CFR § 301.6114-1 - Treaty-based return positions


OK, that is what I was hoping was the case...



Moulard said:


> Yep. You could add it as taxable pension income, or alternatively you could add it as other income. Other Income supports a host of different income types... the line on the 1040 would pull in from schedule 2 (I think it is) a negative number from the FEIE and a positive number from the lump sum.


That's useful to know, thanks.


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## dogsby (Jul 1, 2017)

Thanks Nivie, that's interesting - I'd characterise that as a sensible strategic retreat (rather than "bottling it") !
Your position of paying up first then reconsider down the line sounds like a reasonable approach - good luck if you try it!



Nivie said:


> Hi
> I was going to take the position that the tax free lump sum was not taxable quoting my interpretation of the tax treaty. I did have tax consultants who said they would submit it for me with promises that they would challenge it (no cost fee) but I would ultimately still be liable for IRS penalties and interest. I also considered taking the same position and submitting myself without a tax advisor. Had all the paperwork completed and a long addendum outlining my legal arguments but at the last minute bottled and decided not to take a Treaty position and pay the tax due on my pension lump sum.
> End of story? Maybe not. I do have the option of submitting an amended return within three years to claim a treaty position. If its accepted then I could receive a tax refund. If its declined, I at least have no penalties or interests to pay.


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## Lancashire_Lass (Jul 27, 2021)

You could of course decline the lump sum and take a larger pension instead which would avoid this? That is my plan as I don’t need the cash from this pension. Just a thought.


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