The IRS defines a foreign pension or annuity distribution as a payment from a plan received from a source outside the United States. For example, if you are a U.S. citizen retired in Costa Rica and receiving social security payments, the distribution is not considered foreign since the source is in the United States.
Typical foreign pension plans include payments from:
- foreign governments
- foreign social security system
- foreign retirement plan or pension
- foreign annuity or insurance company
The Internal Revenue Code looks to the gross distribution (how much you received) less the cost. Foreign pensions and annuity pensions are generally taxed the same as domestic payments but with several important exceptions.
Taxation of Foreign Pension Plans and Annuities – General Rules
First, always remember that foreign pensions and social security like payments generally don’t send 1099’s. Simply because you don’t receive a 1099 doesn’t mean the payment isn’t taxable.
Second, look to the treaties! Foreign pensions and annuities are also subject to specific tax treaties between the United States and the country that is the source of the payment. Most treaties allow the country of residence to tax the payment under its law. That means if you are living in the United States and receiving a pension from a foreign payor, the pension payments are probably subject to U.S. law.
Foreign Social Security Payments – Special Rules
If your offshore income is from foreign social security, special rules apply. Once again, refer to the specific treaties. Sometimes those payments are taxable by the country making the payment. In the absence of a treaty, however, those payments would be taxable by the IRS as if they were an ordinary foreign pension or annuity. That means they are not excludable from taxable income unlike U.S. social security payments.
Social security benefits paid by German and Canada to U.S. residents are treated as if they were paid by the United States.
Be very careful as not all treaties are the same and lump sum distributions often have different rules.
These treaties also apply if you are living in a foreign country and receive a pension or annuity from the U.S. government or payor. Generally, you can claim an exemption from U.S. withholding by giving the U.S. payor a W-8BEN form.
For some folks, the difficulty is determining tax residency. Generally, you must use the domestic laws of each country to determine residency for tax purposes but sometimes conflicts exist. If you qualify as a resident of two countries, the IRS has tiebreaker rules. Those rules ask:
- where is your permanent home?
- with which country do you have closer personal and economic ties?
- of which country are you a national?
The United States has treaties with Canada and the United Kingdom that address taxpayers holding U.S. green cards (resident alien status).
Because we live in such a mobile society, it is common for taxpayers to receive pension or annuity income from multiple countries. This is especially true with married couples who may have lived and worked in different countries prior to marriage.
Complicating the task are the IRS’ onerous rules for reporting foreign accounts. The discussion above has been with reporting income but since 1970, the United States has also required U.S. taxpayers (no matter where they live) to report their interests in foreign financial accounts including certain annuities.
Although not part of this discussion, it is important to remember that the rules for reporting foreign income are different from the FBAR rules regarding account reporting.
Confused? A good accountant specializing in offshore reporting can get you up to speed quickly. If you have failed to report foreign financial accounts, however, speak to a tax lawyer. The penalties for not reporting accounts are quite onerous and in certain cases, criminal.
Have questions about the taxation of foreign pension plans? Give us a call. Our offshore tax reporting lawyers can help with a wide range of offshore tax issues.