Korea Resident US Pension 401(k) Withholding Avoided by Tax Treaty

Korea-US Pension 401(k) Withholding Avoided by Tax Treaty

With the globalization of the world economy, it is not uncommon for taxpayers to have accrued pension benefits from several different countries across the globe. Take, for example, an individual who works in finance and they have been employed by four different companies across four different continents — each having its own foreign pension plan. For non-US persons who may have accrued pension benefits in the United States such as a 401(k), it could be very unfair from a tax perspective. That is because if the person is considered a non-resident alien, the United States is going to withhold 30% tax on the accrued income before distribution in accordance with FDAP rules (Fixed, Determinable, Annual, and Periodic). In order to avoid this unnecessarily harsh outcome, some non-residents who reside in a treaty country may be able to avoid withholding altogether. Let’s walk through the basics of how withholding tax on US pensions may be avoided by tax treaties.

US Pension NRA Withholding Rules

In general, the United States taxes non-resident aliens on FDAP 30% of the payment to the US government for tax. The purpose of this rule is that if the US government did not withhold any tax before remitting payment to the Taxpayer, there is a good possibility that the taxpayer living abroad may not pay US tax on the income. Oftentimes this has nothing to do with a fraudulent intention to seek to avoid tax — but rather the nonresident alien who has no other US-sourced income is simply not aware that they were required to pay tax.

What about the Saving Clause?

The saving clause would not prevent a non-US resident of Korea from taking advantage of tax treaty:

As provided by the technical explanation of the treaty:

• • • Paragraph (4) contains the traditional saving clause under which the United States reserves the right to tax its citizens and residents (as determined under Article 3 (Fiscal Domicile)) as if the Convention had not come into effect.

    • However, under paragraph (5), the saving clause does not apply in several cases in which its application would contravene policies reflected in the Convention. Thus, the saving clause does not affect the provisions with respect to relief from double taxation, nondiscrimination, social security payments, or the mutual agreement procedure.

    • Moreover, the saving clause does not affect the benefits of the Convention to teachers, students and trainees, and individuals performing governmental functions, who are neither citizens of, nor have immigrant status in, the Contracting State imposing the tax.

    • In the case of the United States, “immigrant status” means the individual has been admitted to the United States for permanent residence. The saving clause is reciprocal.

Korea Resident 401K NRA Example

For example, a resident of Korea is neither a US citizen nor a lawful permanent resident. They amassed a significant 401K balance when they worked in the U.S. on an H-1B visa in their younger years. To avoid withholding, they can take the opportunity to submit documents such as a W8-BEN in order to reduce and eliminate the withholding of taxes by the 401K pension administrator. That is because a private pension such as 401K is typically only taxable in the country of residence and not the country of source. Therefore, the United States (source country) would not have the opportunity to tax the income because according to the treaty it would only be taxable where the nonresident taxpayer resides, which is Korea.

Korea/US Tax Treaty, Article 23

As provided by the US-Korea Tax treaty:

(Pensions and Annuities)

• • • (1) Except as provided in Article 22 (Governmental Functions), pensions and other similar remuneration paid to an individual who is a resident of one of the Contracting States in consideration of past employment shall be taxable only in that Contracting State.

Article 23 Treaty Explanation

As provided by the technical explanation of the treaty:

• • • Except as provided in Article 22 (Governmental Functions), pensions and other similar remuneration paid to an individual who is a resident of a Contracting State in consideration of past employment will be taxable under paragraph (1) only in that Contracting State.

    • Thus, private pensions and similar remuneration derived from sources within one Contracting State by an individual resident of the other Contracting State in consideration of past employment are exempt from tax in the first-mentioned Contracting State.

    • The term “pensions and other similar remuneration” is defined in paragraph (3) as periodic payments made after retirement or death in consideration for services rendered, or by way of compensation for injuries received in connection with past employment. The term does not include social security payments covered in Article 24 (Social Security Payments).

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