Whats the trouble with foreign pensions in the USUS taxpayers with foreign pension plans face a number of highly complex filing requirements, sometimes with draconian penalties for non-compliance even when there is no intention of wrongdoing.
In today’s global economy, millions of individuals work outside their home country at some point in their careers. Many of these individuals save for retirement through employer and personal retirement plans. While these non-US pension plans are often granted a special tax-advantaged status in the country in which they are established, the US generally doesn’t recognise the foreign jurisdiction’s tax treatment of pension assets. US taxpayers who have an interest in such plans (including both US persons who move abroad and establish a foreign pension and foreign nationals who have a foreign pension and later move to the US) can find that foreign pension plans can create quite a US tax headache.
US income taxation of foreign pension plans
Very few foreign pension plans, whether employer plans or personal pension plans, are treated as ‘qualified’ plans in the US. They therefore do not receive the same US tax benefits as US-based plans generally do. There are only a few countries – for example Canada and the UK – where a bilateral income tax treaty may allow for foreign pensions to be treated for some purposes, as US qualified plans. Otherwise, the US owner of such a plan may be currently taxable in the US.
Generally, if a US taxpayer is vested in a funded foreign employer pension plan, even if he or she cannot currently take distributions from the plan, the US may tax current year employer contributions. If the employee is considered a ‘highly-compensated employee’, ie individuals who earn more than US$115,000 per year, the earnings and accretions in the foreign pension plan may also be taxable in the US in the current year, in addition to the employer contributions.
The taxpayer will get ‘basis’ in the plan for US purposes for the amounts included in current year taxable income, and may therefore not be taxed again for US purposes at a later date on these amounts. However, the foreign jurisdiction’s laws may not provide for an increase in tax basis in the plan for amounts that were taxable in the US, as the employer contributions and earnings within the plan had not been taxed in the foreign jurisdiction (often not until distributions are taken from the plan). The result is a potential for double taxation. This is usually negated by the use of foreign tax credits, which offset US income tax liabilities by the amount of foreign income taxes paid. However, it is possible that the timing mismatch between the dates on which each country determines that the individual has received taxable income prevents the use of foreign tax credits.
A US taxpayer who has a foreign personal pension plan may face similar US taxation on a current year basis. A foreign individual retirement pension plan is generally taxed by the US as if it were a normal taxable account. Earnings and accretions within the individual pension plan may be taxable in the US in the current year, even if they are tax-free in the country where the plan is located.
The US tax implications of owning a foreign pension plan become even more serious if the plan holds foreign mutual funds. While a full review of the US tax treatment of foreign mutual funds is beyond the scope of this article, it generally does not make sense for US taxpayers to hold these funds.
Beyond taxing – additional US reporting requirements
Ownership of a foreign pension plan by a US taxpayer presents more trouble than ‘just’ the annual income tax charged in the US. There are several other issues and obligations that may be imposed on individuals holding foreign pension plans. Many are complex and carry significant penalties for failure to file.
For more information, contact:
The Wolf Group, USA
T +1 703 502 9500