Are Foreign Pension Plans Taxable in the US (6 Key Facts)

Are Foreign Pension Plans Taxable in the US  

With the globalization of the US economy, it is very common for US persons to earn income from foreign sources — including income from overseas pension plans. Whether the US person is a US Citizen, Lawful Permanent Resident, or Foreign National who meets the Substantial Presence Test — there may be US income tax implications when earning foreign pension plan income. When income is received from foreign pension sources, there are various factors to consider, such as whether or not there is a tax treaty with the foreign country; is the pension plan making distributions (or accruing income), and is the pension plan an employment-based pension or a personal pension plan. Let’s review six (6) important facts about US taxation of foreign pension plan income.

Foreign Pension Distributions are Taxable

In general, the United States Taxes individuals on their worldwide income. Therefore, if a person is considered a US person and they are receiving distributions from a foreign pension plan, the default position is that the distributions are taxable. Some Taxpayers may qualify to make certain tax treaty elections in order to reduce or eliminate withholding, and/or some tax treaties may even exempt certain types of pension income from taxation — but from a baseline perspective, distributions from foreign pension plans are taxable by the US government.

What if There is No Tax Treaty?

In general, when there is a tax treaty in place, the income accrued in a foreign pension plan may avoid tax until the income is distributed — but the rules are different when there is no tax treaty. The United States has entered into about 60 bilateral income tax treaties, and most, if not all treaties have language involving pension plan taxation. But, if there is no tax treaty in place, as with Singapore, Malaysia, or Hong Kong — the general rule is that the accrued income in pensions such as CPFs, EPFs, and MPFs are taxable even if the income is not distributed. The reason for the harsh income tax implications is that there is no treaty preventing the immediate taxation of pension accruals — and thus accrued or distributed income can be considered taxable income.

A Tax Treaty May Reduce or Eliminate Taxation or Withholding

A Tax Treaty may be used in different ways to either minimize or eliminate US tax on foreign pension income. Sometimes, the tax treaty will exclude certain types of pension payments from being taxed in one or both countries that are parties to the treaty (subject to the Saving Clause). In other situations, the US Person may elect to be treated as a foreign person under the tax treaty — which would minimize their US tax obligations. In addition, some treaties may also provide for reduced withholding for certain income, such as pension distributions.

Foreign Tax Credits May Apply

If the US person paid taxes abroad on the foreign pension income distributions, they may be able to apply foreign tax credits to reduce or eliminate their US tax liability.

Employment Pension vs Personal Pension

In many foreign countries, it is common to invest in personal pension plans — which are a type of personal investment retirement account that may not be not derived from employment. The tax rules involving the taxation of personal retirement/pension schemes are more complex than employment-based pensions. Recently, the United States published a Competent Authority Agreement involving the perceived misuse of the Malta Tax Treaty on matters involving non-employment retirement schemes.

Rollovers into US Funds

While a person may be able to rollover a US retirement or pension plan into another type of qualified plan, the same rules do not typically apply to foreign pension plan ‘rollovers.’ The reason why is that the foreign pension plan is usually not a qualified plan and therefore does not qualify for rollover protection.

Current Year vs Prior Year Non-Compliance

Once a taxpayer missed the pension tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, taxpayers should consider speaking with a Board-Certified Tax Law Specialist that specializes exclusively in these types of offshore disclosure matters.

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