IRA distribution to U.S. citizen living in Switzerland – which country taxes it?
Date: February 2, 2010 CC:INTL:B1:CAEdson – POSTS-104955-10
to: Aziz Benbrahim Tax Attache LM:IN:OO:PARIS
from: M. Grace Fleeman Senior Technical Reviewer, Branch 1 (International) subject:
Taxability of Private Pensions under the U.S.-Switzerland Treaty
This memorandum responds to your request for clarification regarding the application of Article 18 (Pensions and Annuities) of the U.S.-Switzerland income tax treaty (the “Treaty”) to a U.S. citizen living in Switzerland and receiving distributions from his Individual Retirement Account (“IRA”).FACTS
Taxpayer is a U.S. citizen who has been living in Switzerland since * * *. Taxpayer worked only in the United States before retiring to Switzerland. He has rolled over his pension and profit-sharing plans to an IRA. As of * * *, Switzerland has begun fully taxing Taxpayer’s IRA distributions, advising him to get a foreign tax credit from the United States to alleviate double taxation.ISSUE
Whether the distributions that Taxpayer receives from his IRA are taxable in the United States, Switzerland, or both?CONCLUSION
Article 18(1) of the Treaty provides that Taxpayer’s state of residence, Switzerland, has primary taxing jurisdiction over his IRA distributions. The saving clause in paragraph 2 of Article 1 (Personal Scope) gives the United States the right to tax Taxpayer’s IRA distributions under the Internal Revenue Code (“Code”) as if the Treaty had not come into effect. Double taxation would be alleviated under paragraph 3 of Article 23 (Relief from Double Taxation), which requires the United States to allow a credit for the Swiss tax paid in respect of the distributions.LAW & ANALYSIS
I. Pensions Article Article 18(1) of the Treaty provides:Subject to the provisions of Article 19 (Government Service and Social Security), pensions and other similar remuneration beneficially derived by a resident of a Contracting State in consideration of past employment shall be taxable only in that State.The Treasury Department’s 1997 Technical Explanation (“TE”) to Article 18 explains, in relevant part:Paragraph 1 provides that private pensions and other similar remuneration derived and beneficially owned by a resident of a Contracting State in consideration of past employment are taxable only in the State of residence of the recipient. Although the Convention does not make explicit the fact that the term “pensions and other similar remuneration” includes both periodic and lump-sum payments, it is understood that this would be the case under the domestic law of both Contracting States. Treatment of such payments under the prior Convention is essentially the same as under the Convention, except that the rules of the prior Convention apply only to periodic payments. The term “pensions and other similar remuneration” includes amounts paid by all private retirement plans and arrangements in consideration of past employment, regardless of whether they are qualified plans under U.S. law, including plans and arrangements described in section 457 or 414(d) of the Internal Revenue Code. It also includes an Individual Retirement Account.As the TE notes, Article 18(1) applies to amounts distributed from an IRA. Furthermore, this result is generally the same as under the prior U.S.-Switzerland income tax treaty, which was in effect until 1998. 1 Thus, because Taxpayer is a resident of Switzerland, Article 18(1), standing alone, would prevent the United States from taxing Taxpayer’s IRA distributions. II. Saving Clause Paragraph 2 of Article 1 (General Scope) of the Treaty contains the “saving clause” found in every U.S. tax treaty in one form or another:Notwithstanding any provision of this Convention except paragraph 3 of this Article, the United States may tax a person who is treated as a resident under its taxation laws (except where such person is determined to be a resident of Switzerland under the provisions of paragraphs 3 or 4 of Article 4 (Resident)) and its citizens (including its former citizens) as if this Convention had not come into effect.The TE to Article 1 explains, in relevant part:The United States reserves its right, except as provided in paragraph 3, to tax U.S. residents and citizens (including its former citizens) as provided in its internal law, notwithstanding any provisions of the Convention to the contrary. For example, if a resident of Switzerland performs independent personal services in the United States and the income from the services is not attributable to a fixed base in the United States, Article 14 (Independent Personal Services) would by its terms prevent the United States from taxing the income. If, however, the Swiss resident is also a citizen of the United States, the saving clause permits the United States to include the remuneration in the worldwide income of the citizen and subject it to tax under the normal Code rules (i.e., without regard to Code section 894(a)).Because Taxpayer is a U.S. citizen, the saving clause permits the United States to tax his IRA distributions. Furthermore, Article 1(3) does not contain any exception from the saving clause for private pensions within the jurisdiction Article 18. Thus, the United States can tax Taxpayer’s IRA distributions under the Code as if the Treaty had not come into effect. III. Relief from Double Taxation Taxpayer’s IRA distributions are taxable in both Switzerland under Article 18(1) and the United States under Article 1(2). To alleviate double taxation, Taxpayer would look to Article 23 (Relief from Double Taxation) for one country to credit the tax paid to the other country. The TE to the saving clause in Article 1(2) provides, in relevant part:For special foreign tax credit rules applicable to the U.S. taxation of certain U.S. income of its citizens resident in Switzerland, see paragraph 3 of Article 23 (Relief from Double Taxation).Article 23(3) provides:Where a resident of Switzerland is also a citizen of the United States and is subject to United States income tax in respect of profits, income or gains which arise in the United States, the following rules apply:These provisions apply to Taxpayer as follows. Subparagraph (a) provides that Switzerland will provide a foreign tax credit to Taxpayer as if the amount of U.S. taxes paid in respect of the IRA distributions received were the amount of U.S. taxes paid by a Swiss resident not a U.S. citizen. Because Article 18(1) provides that the IRA distributions received by a Swiss resident are taxable only in Switzerland, Switzerland is not required to provide any relief. Subparagraph (b) provides that the United States will credit the income tax paid or accrued to Switzerland after the application of subparagraph (a). Because the income described in paragraph 3 is U.S. source income, subparagraph (c) deems the income to be from Swiss sources to the extent necessary to avoid double taxation of such income. As a result, Switzerland retains its primary taxing jurisdiction over Taxpayer’s IRA distributions, and the United States provides a foreign tax credit against U.S. tax for Swiss tax paid in respect of those distributions. Article 23 is not subject to the saving clause of Article 1(2), so the United States will allow a credit to its citizens in accordance with the Article, even if a credit were not available under the Code. To claim the foreign tax credit, Taxpayer should file Form 1116 (Foreign Tax Credit). Finally, note that as a U.S. citizen, Taxpayer is a U.S. person and not a foreign person. Code section 7701(a)(30)(A). As such, he cannot use Form W-8BEN (Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding) to claim an exemption from withholding. Furthermore, Taxpayer’s IRA distributions are in fact subject to U.S. tax under Article 1(2) of the Treaty. Taxpayer is only eligible for a refund of U.S. tax to the extent that the United States will credit the tax paid to Switzerland in respect of his IRA distributions received. If you have any additional questions, please contact Cheryl Edson at (202) 622-8555. FOOTNOTES: n1 – Article XI(2) of the prior treaty provided that private pensions derived from one of the Contracting States and paid to individuals residing in the other Contracting State shall be exempt from taxation in the former State (the country of source). See also PLR 8901053 (October 13, 1988).a) Switzerland will apply paragraph 1 as if the amount of tax paid to the United States in respect of such profits, income or gains were the amount that would have been paid if the resident were not a citizen of the United States; and b) for the purpose of computing the United States tax on such profits, income or gains, the United States shall allow as a credit against United States tax the income tax paid or accrued to Switzerland after the application of subparagraph a), provided that the credit so allowed shall not reduce the amount of the United States tax below the amount that is taken into account in applying subparagraph a); and c) for the purpose of subparagraph b), profits, income or gains described in this paragraph shall be deemed to arise in Switzerland to the extent necessary to avoid double taxation of such income; however, the rules of this subparagraph shall not apply in determining credits against United States tax for foreign taxes other than the taxes referred to in subparagraph 2 a) and paragraph 3 of Article 2 (Taxes Covered).
Hi Gary,
Stand by. Answer on Monday. I just arrived home from a long trip. I’m jet lagged. But I will post your answer on Monday after I get some serious sleep. 🙂
Riyadh to Dubai to Los Angeles. Ouch.
/Phil
How much tax will be withheld by a custodian in payment to a non US citizen living abroad?
Anna,
If you have no income, you have no technical requirement to file US tax returns because of income received.
But you might have to file a tax return for other reasons. E.g., if you have signature power over financial accounts outside the USA there are filing requirements. I am referring of course to the astonishingly execrable FBAR form — TD F 90-22.1. I would guess that you have a bank account in Switzerland. After all, paying normal expenses and living in a place makes that necessary. This means you are at risk for being penalized heavily for not having filed any FBAR forms. The US system of taxes is riddled with these hidden requirements designed to harm you in the option of an auditor’s whim.
If you receive alimony you will need to determine if it is taxable or not, and make the reporting accordingly in the US for tax purposes. I can’t tell what it will be, but you are correct to be cautious. Note also that even if it is not taxable income it might be that payments you receive are reportable in the USA for other reasons, e.g., as a gift on Form 3520. I can’t give definite feedback until the payment arrangements are defined.
/Phil
I am a US citizen and a Swiss citizen. I am married to a Swiss and currently living in Switzerland. I have two questions. First, I have not filed a US income tax return since we moved here 8 years ago because I have had no income to report. Was I required to file even though I had no income? Secondly, If I would divorce or separate and have an alimony income of $200,000, after paying the Swiss taxes, what would I have to pay to the IRS?
Many Thanks,
Anna
@Ljerka Miller,
The way the IRS will tax them is simple. Before the IRA custodian can make a payment to them the custodian has to get a form signed by the recipient. If the recipient indicates that he/she is a nonresident of the USA, then the custodian will deduct some tax from the payment due to your niece/nephew.
The reason this works so well is that the IRA custodian (Schwab, etc.) is in the United States. If they screw up the withholding of taxes on the payment, the IRS will come after the IRA custodian directly. Your nieces and nephews, of course, are happily outside the long arm of the IRS.
/Phil
Hi,
I am a U.S. citizen living in California.
My IRA beneficiaries are my nieces and nephews ranging in age from 30 to 40 years old and they all live in Croatia.
How IRS is going to tax the beneficiries?
Thank you.
Ljerka Miller
Phil,
Nothing new here.
(BTW: Why file a Form 8833? It is for announcing that treaty benefits are being claimed not that you woulda coulda shoulda had ’em but for the Savings Clause.)
The real issue for US citizens IRA recipients resident in foreign lands with the priority treaty right of taxation is how to explain an IRA to their LOCAL tax guy.
The US tax side is easy, the local side can be insane – assuming, of course, (ahem!) the US citizen is reporting his IRA investment activity and distributions to the local yokels.
The problem is not just local taxation of the distributions but taxation of income earned WITHIN the IRA (dividends, interest, gains, etc.).
On top of that US tax return preparers still have the unenviable task of just explaining the concept of an IRA to disbelieving local tax advisors, much less the ins and outs of contributions, basis, etc. People who have lived in dyed-in-the-wool socialist nanny states for so long that the very notion of personal responsibility and management authority for old-age retirement smacks of unreconstructed capitalist depravity.
The 2006 protocol to the US-Germany treaty clarified IRA matters wonderfully – but only prospectively. Lord knows what will happen if some bright-eyed college grad in the local tax office decides to ask what about all those years BEFORE the new treaty Article 18 came into effect?
Just another reason to get out of this business.
John Nolan
Frankfurt am Main