Foreign Pension Lump Sum Payment Taxation. Rules for Contributions Made While Nonresident.

[HelloNYC]

My wife is 65 years old and received a lump sum pension (equivalent of US 401K plan) from her employer in Japan. It was a plan, where she contributed 100% of funds, the employer was not participating financially. She stopped working there in 1995, but still she was making small contributions monthly.  According to Japanese law, only 50% of her income would be normally taxed in Japan, if she lived there, but because she is a US person and lives in the US, she was told by the Japanese Tax Authority to pay tax in the US.

She mostly contributed to that plan when she was working in Japan, at that time she was not living in the US and she was not a US person. She was a nonresident for US tax purposes. She became a US person in 1999. My question is, does she have to pay tax on whole amount (even on contributions while she wasn't a US person for tax purposes) or only on income after she became a US person (from 1999)? Also, if she has to pay tax on whole pension income here, would the 50% Japanese pension credit apply? I know it's not an easy topic, but maybe there are professionals here who can answer my questions. Thank you, Paul

I found an interesting article (especially last part), but I'm not sure if this this would apply to my wife's pension.

https://www.irs.gov/businesses/the-taxation-of-foreign-pension-and-annuity-distributions

[NCperson]

as I read that last paragraph, the contributions she made prior to 1999 are not taxable by the US since she was not a US person at that time.  presumably she paid taxes on those contributions way back when,

The 50% pension credit wouldn't apply because she didn't pay it to Japan.  If she had that could be a different story.  

why don't you think that last paragraph applies?

let's see what others say. 

[HelloNYC]

I'm not sure, that's why I'm asking professionals. I do not understand meaning of the last sentence: (but only if the contribution would have been taxable if paid as cash compensation when the services were performed).

My wife's pension is 100% her contributions not employer, after she quit her job in 1995 she kept contributing her personal money, she was allowed to do that by her ex employer. She stopped contributing in July 2019 and in September 2019 took a lump sum.

[NCperson]

 (but only if the contribution would have been taxable if paid as cash compensation when the services were performed).

what it refers to is whether those contributions by your wife are now taxable, even though she was not a non resident alien at the time.  So if she made those contributions with after-tax monies way back when,  then you can exclude them from the lump-sum payment she recently received.  But if those were pre-tax contributions way back when, then they remain part of the lump payment.

In a nutshell,  you shouldn't be taxed on those contributions twice.  the IRS is saying, either those contributions were from her earnings after she had paid taxes to Japan way back when but if she didn't then they are subject to tax now. 

[HelloNYC]

I understand, that she shouldn't be taxed on her contributions, our main concern is the income on those contributions. Let's say she contributed $70,000 of her money to her high yield retirement, employer sponsored account over past 40 years and received in 2019, $120,000 lump sum amount. Her income is $50,000, does she have to pay tax on whole $50,000 or only on income she made after 1999 when she became a US person for tax purposes. Another words, majority of contributions and income was made when she was a nonresident (when she worked in Japan before 1999). Thank you.

[NCperson]

at this stage, probably worth getting local help that is knowledgeable in foreign tax treaties - that stated, here is the Japan / US treaty.

https://www.treasury.gov/resource-center/tax-policy/treaties/Documents/japantreaty.pdf

 if you read simply the title of the treaty from this link, it's all about ensuring you are not double taxed nor avoiding paying tax 

So I would expect that, in your example, the $70,000 is a return of her after-tax contributions, so not taxable at all (she paid any tax due when she earned it, either in Japan or the US). 

However, the $50,000 of earnings / profit is taxable now because she never paid taxes to either Japan or the US and to not pay on it would be the avoidance described in the title of the treaty. 

[HelloNYC]

I understand, that she would have to pay tax on earnings, but in Japan she would only have to pay tax on 50% of those earnings. Additionally, majority of those earnings were accumulated before 1999 when she was a US nonresident person.

[NCperson]

three options

1)  report earnings on $50,000 (from your example) 

2) report what you believe is right - risk an audit from the IRS

3) find / pay a tax attorney that is an expert in  US / Japan tax treaty.

good luck! 

[HelloNYC]

Quite honestly, the US/Japan tax treaty is not helping here, it basically says that the tax should be paid in a country of residency, I spoke to a Japanese CPA in the US, he couldn't provide a clear answer either. I'm running out of options here, as far as I know, foreign retirement pension issues are very tricky. Thanks for your time and answers, you've really tried to help me.

[HelloNYC]

I was wondering if there is a pension tax specialist on this forum who could answer my question. Thank you,

[SusanY1]

With minimal exceptions, foreign pension income received while living in the U.S. is fully taxable in the U.S. for a citizen or resident alien. 

In cases where the United States has a tax treaty (such as Japan), pension income is generally taxed in the country where the taxpayer resides.  In this case, the United States. This would explain why Japanese authorities indicated that your wife should pay the tax here, in the U.S.  

A quick review of the Japan tax treaty and a few reliable resources doesn't give me any indication of any special exceptions for Japanese pension income that would apply for your wife.  

From the link provided in the original post regarding the contributions made in Japan: 

Just as with domestic pensions or annuities, the taxable amount generally is the Gross Distribution minus the Cost  (emphasis added).

Your contributions and your employer's contributions are not part of your Cost (emphasis added) if the contribution was based on compensation for services performed outside the United States while you were a nonresident alien.

You cannot deduct the amounts contributed while working in Japan from the cost, therefore making the entire distribution taxable.  

The Japanese system for taxing pension income is tiered like ours, but backward.  The first JPY 3.6 million is taxed at 25% before the rate begins to drop - so, in the end, the tax is likely similar and potentially lower depending on your overall tax rate.

Please note that matters involving foreign tax, especially foreign tax treaties, can be quite complex and this is intended to be a very general overview and not specific advice. 

[HelloNYC]

Hi Susan,

Thank you for the response. Is there a CPA in NYC area who specializes in taxation of foreign pensions? We really don't know how to approach this issue. Some CPAs I spoke to had no idea how to report this, We understand that she would have to pay tax in the U.S., the question is how much tax. Some say that she shouldn't be taxed on her contributions while she was working in Japan and she wasn't a U.S. person for tax purposes. Also, the employer didn't make any contributions, she contributed 100% of funds. We are getting mixed signals here.  I've tried to contact the IRS, but the person I spoke to had pretty much very little idea what I was talking about. The time is running out and we are getting desperate. Thank you.

[KarenJ2]

I would suggest that you go online and do a research for someone that specializes in the taxation of foreign pension distributions..

[NycTaxPension]

If you manage to find a good NYC based CPA, who specialize in taxation of foreign pensions, please let me know.

I'm looking at pension earned in Hong Kong as well as Japan same as you and I'm truly not sure how it should be taxed. 

[Ytax2021]

Hi. I know is almost a year after you posted this topic, but I have the same question at this moment. I will get a lump sum of my pension oc my native country, and I would like to know if I have to pay taxes for it. Please, can you tell me, if you found answer?, Did your wife paid taxes?, if so, is any percentage?