My wife and I are retired US citizens living in Portugal and are tax residents here. All our financial assets are in the US, which include IRAs and investment accounts. We qualified under the NHR tax regime here in Portugal, which lasts 10 years. During this period, most US source income is exempt from taxation in Portugal, except that private pensions (including distributions from IRAs) are taxable at a flat rate of 10%. After the 10-year NHR period, all world-wide income becomes taxable at normal rate, which very quickly exceeds 50%.
To prevent falling into these very high tax brackets in the future, I am planning to draw down my Traditional IRAs to ensure that there are no RMDs after the NHR period. I plan to move some of that into taxable accounts and some into Roth IRA accounts. Since Roth withdrawals are also taxable in Portugal, we need to be careful to only move to Roth the amount that we don't expect to need while in Portugal.
So here is the question - if we withdraw from traditional IRAs and convert to Roth IRA, can we claim the 10% of tax paid in Portugal for foreign tax credit on Form 1116 in the category of Income resourced by treaty? While the treaty is quite clear that the amount of tax paid to Portugal can be claimed for foreign tax credit to avoid double taxation, I am not clear if Trad to Roth conversion is covered under this clause. Any expert advice will be much appreciated.
