Foreign Pension Plan Contributions – When are they Taxable under US Tax Laws

If you are a US Expatriate employed by a foreign employe you are allowed to make contributions to a foreign pension plan. These foreign pension plans usually have advantageous tax treatment under local tax laws. Regrettably, these foreign pension plans normally don’t meet the “qualification rules” of America. Consequently, the advantageous treatment under local laws are not made available to American citizens working overseas.

Qualified or deductible deferred compensation under US Tax Laws

Pension plans sponsored by US employers meet the criteria for special treatment under the US tax laws. Contributions by the employers are tax deductible; benefits from the plan are exempt from tax; and the employees are only taxed once they’ve received the benefits of the plan upon withdrawal or retirement of the funds. But these tax benefits only become available if the plan meets the particular conditions of the US IRS law.

Non-deductible deferred compensation under the US Tax Laws

Your decision to include the amounts deferred under a non-deductible deferred compensation plan as part of your gross income will rely on the circumstances and facts of the plan and the particular section of the code that applies to these facts.

IRC § 402(b)

Non-deductible deferred compensation plans sponsored and funded by the employer are typically covered by the terms and conditions of IRC § 402(b). If you are a US taxpayers who is covered by this plan you are taxed on the value of your employer’s contribution once the benefits are given to you and such benefits are not bound by a considerable threat of penalty. If you are a high earner, or you belong to the top 20% of high earner employees or you earn more than $105,000, you will be taxed both on the contribution as well as on the earnings of the plan yearly up to the amount of the benefits authorized. If you are not a high earner you won’t be taxed on the earnings on the plan but you will be taxed when the earnings are distributed.

IRC § 409A

The stipulations of IRC § 409A are relevant to deferred compensation plans which are not contained in IRC § 402(b). These are deferred compensation plans that are under a tax treaty or compensation plans of foreign employers that are accessible on a wide base to the employees of foreign employers. But this is only up to the extent of the contribution of the employer and non-elective deferrals as regulated by the tax laws of America.

If the deferred compensation plan does not conform to the conditions of IRC § 409A, and you’re an employee covered by this deferred compensation plan you will be taxed under the individual income tax law, and subjected to interest charges and a 20% penalty tax. To conform to the conditions of IRC § 409A, the compensation plan must make a provision that distributions from the plan are permitted only upon the following circumstances; 1)death and separation from service within a particular time frame or with a set schedule; 2) if there are changes in corporate control; or 3) there are unforeseen emergencies that will occur; or 4) if the employee become disabled.

The compensation plan may possibly not consent to the acieration of the benefits, unless it is provided by law. The plan should include a provision that payment for services rendered on a tax year may be held off or deferred at your option only when the option to postpone or defer is not later than the end of the previous tax year, or at some other time according to regulations or laws.

The manner and the categorical time of distribution should be specified when the original deferral is made.
Tax treaty provisions on pensions

The standard US income tax regulations could be changed if there are appropriate treaty conditions such as the UK and US Income Tax Treaty. The said treaty does not exclusively provide that either the US’s or UK’s qualified pension plans will be considered as qualified plans by each country. The treaty, in effect, provides for tax reductions or tax deferrals but limited by some restrictions.

If you are a US citizen employed by a UK employer and are a participant to a pension plan .set up by your UK employer, the conditions are that you could exclude or deduct contributions made in your behalf as well as the benefits that accrue to the plan from your taxable income. The treaty additionally provides that the exclusion or deduction conditions only applies to the amount of the benefits or contributions that are eligible for tax relief in the UK and that such tax relief should not be more than the reliefs that are allowed in the US domestic laws.

As to the distribution, the accepted rule under the Treaty is that a benefit received as pension by a resident of one country can only be taxed by the country where the employee resides. In case of lump sum payments, the accepted rule is that the distribution may be taxed only by the country where the plan was created. But, like in other treaties, the US maintains the privilege or right to impose tax on its nationals on both lumps sum and periodic distributions. By applying the foreign tax credit regulation, double taxation is precluded.

Treatment of contributions to foreign pension plans

If you are an employee who is a US citizen and you’re covered by a foreign pension plan, it’s highly possible that the plan does not qualify or does not meet the qualification regulation of the US. Consequently, you will be imposed tax on the contributions as well as its growth plan. If you reside in a country where the tax rates are higher than what is imposed under US tax laws, it is possible that you have accumulated enough foreign tax credits. These tax credits can be applied to make up for tax imposed by the US on income from foreign sources. These excess tax credits could wipe out or lessen the US tax that could be imposed on your deferred compensation.

If the excess foreign tax credits come from deferred compensation that is considered income from foreign sources, the existing US tax on said income could be fully or partially offset. One more option is for you is to invoke an appropriate treaty between the US and the country of your employer. If such treaty also has a provision for pension, and the contribution to the pension plan does not exceed the limitations of the US plan, the contributions and the growth plan must not be imposed US income taxes. If there is no existing treaty between the US and the country where you live, then there won’t be any pension contribution deferral by your foreign employer.

If you are a US taxpayer who work and live outside of the US, you can opt to use your excess foreign tax credit or use an appropriate tax treaty to avoid paying the existing income taxes imposed by the US on the contribution or growth rate of the plan. Your choice will depend on several factors that could vary for each case.

Reporting requirements

There are several reporting obligations that could be relevant to you besides your individual income tax return. This could include filing Form 3520 and 3530A that pertain to reporting returns on foreign trust and Form TD F 90-22. 1, the Treasury report on Foreign Bank and Financial Accounts. Form TD F 90-22. 1 should be filed when your foreign accounts is more than $10,000, the highest yearly balance when the accounts, not only bank accounts but also other financial accounts are combined. It should be filed on or before June 30 yearly without any extensions. A sizeable penalty such as criminal consequences could also be applied for non filing.