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  1. “…add a LARGER cost burden on the IRS…”. Which the IRS may respond to by making efiling mandatory and passing the costs back down to you. They have already proposed mandatory efiling for FBAR starting next year.

    So you should probably get your revenge in quick, while you still can.

  2. I just found out about the OVDI yesterday. It appears as though it only garners the interest of Canadian National News services when it threatens to counter Canadian Banking/Privacy law. Anyway.. it appears as though I’m too late.
    But.. if it’s any consolation.. I know that my filling and the fillings of most of the 1 million Canadians who are affected by this change in policy will only add a LARGER cost burden on the IRS as most folks will not be required to pay.
    Ahhh.. the subtle revenge of the Medium to Low middle-class.

  3. @Anonymous,

    Got it. Very clear explanation. So an ISA holder moving from the UK to the US really does have a mess on his/her hands. Nasty. Unintentional, I’m sure, but unintended consequences are often the worse.


    As I said above, I don’t know anything about ISAs, but Anonymous seems to know a lot, and his/her explanation of the ISA problem rings true, and fully explains Mr. Hodgen’s clear angst about it.

  4. As to why an ISA isn’t tax free in the US but an IRA is tax free in the UK… I believe the whole thing rests upon the presence of the magic word “retirement” in the expansion of IRA, and its absence in the expansion of ISA.

    When choosing a retirement vehicle in the US there’s a broad choice between a taxed-later-but-not-now traditional IRA and taxed-now-but-not-later Roth IRA. In the UK there’s pretty much the same decision, between a taxed-later-but-not-now SIPP or similar and a taxed-now-but-not-later ISA. Unfortunately, because the ISA’s not “primarily” a retirement account – one could also use it to save for a house, for college, for children – it falls outside the tax treaty. (The Canadian equivalent would be the TFSA, also not recognized by the US. Can Canadians use TFSAs in place of RRSPs? If so, it sounds like they’ll be in an even worse position than RRSP holders…)

    Now, because an ISA usually holds mutual funds, once it falls outside the tax treaty it’s quite likely to then be covered by PFIC rules. So… after holding an ISA for a few years while in the US (and remember, this is an account set up for retirement saving) the unfortunate holder might find himself with an effective US tax rate of 100% of the gains, thanks to the miracle of the PFIC interest and compounding rules. Compare with 0% if that same individual had not gone to the US, and with 0% of a US citizen living in the UK with a Roth IRA, and you can see just how badly the US can treat UK retirement savings, how utterly the UK/US tax treaty fails in places and why UK citizens are discouraged by US tax laws from working in the US, even temporarily.

  5. Careful Taxpayer

    Thanks for your reply. For people interested in international taxes (like me), that is very interesting reading.

  6. @Wada,

    I’m sorry, my language was unclear. I should have said that withdrawals/distributions in retirement from an ISA are tax-exempt in the UK (I think, that’s what I’ve heard, and don’t have an ISA so I don’t really know), like a Roth IRA. Accumulation of value in the ISA through appreciation of assets, interest, dividends, etc is tax-exempt in the UK, as it is for all approved pension plans. The US/UK tax treaty should therefore make those internal accumulations of value tax-exempt in the US, too, as it is for all approved pension plans. The problem is, I think, that withdrawals/distributions from an ISA are taxable income for a US citizen or resident, because of the treaty savings clause.

    The same issue exists for tax-free (in the UK) lump sum distributions from a pension scheme. The savings clause very clearly makes those taxable for a US citizen or resident. Amazingly, I’ve seen the exact opposite advice on the internet, proving how dangerous it is. I might be wrong, too :-). But you have to read the treaty carefully: there are clauses that invalidate other clauses, and you have to drawa diagram of what the end result is. The savings clause (which is itself modified and weakened by the subsequent clause) is the killer here.

  7. @Wada,

    I’m NOT a tax pro, not even close. With that disclaimer, I don’t see why an ISA wouldn’t be covered by the US/UK tax treaty: the UK government recognizes it as a pension arrangment. I believe that there are two issues:

    1. Employer plan trusts seem to be exempted from 3520 reporting; the Treasury regs seem clear on that point. But an ISA isn’t an employer plan trust, and one would assume requires 3520 reporting.

    2. An ISA is tax-exempt in the UK, but the treaty saving clause would seem to make the ISA taxable in the US for a US citizen/resident.

    Perhaps Mr. Hodgen can comment on whether I’ve got this right. For goodness sake, don’t rely on my non-professional opinion, or ANY random internet blog comment, when doing your taxes!

  8. Just for information’s sake – what specifically is there about a UK ISA that makes it non qualified for the treaty ?

  9. Yep, we’re on the same page here.

    I’m not drawing on my UK pensions yet. But it seems that the paperwork to get the treaty exemptions isn’t that bad: a US residency certification from the IRS and a form filed with the UK HMRC to avoid UK withholding. Then it’s a “simple” case of figuring the US$ value of each pension payment and reporting it on your 1040. And filing an FBAR. Oh, and FATCA requirements coming soon to a tax return near you. Maybe you’re right: the paperwork is onerous. IRS Pub 901 explicitly excludes Form 8833 filing requirements for pension treaty benefits, so that’s one less thing to worry about.

    The ISA case seems very, very hard to deal with. The overall intent of the US-UK treaty with respect to pensions is clear and good, but the savings clause blows up the tax-exempt status of the ISA. It’s a pity that there’s no simple way for the IRS to address issues like this in a sensible way. I’m pretty certain that there are many IRS employees (many, many of whom are decent, reasonable people) who would look at the ISA situation, pronounce it silly and would fix it if they could. They did it for RRSPs (a simpler case), so it’s not impossible. But the IRS is bound by the law. The issue is with our lawmakers, and foreign pension holders don’t have much of a voice with them.

  10. For pensions that’s mostly true, though even there the paperwork pain just to obtain one’s legal rights provided by the tax treaty is beyond belief. And the penalties for paperwork footfault can be retirement destroying.

    The huge problem case is ISAs. These are used by many in the UK as alternatives to traditional retirement plans, and are almost 100% equivalent to Roth IRAs. Yet Roths are tax exempt in the UK, but ISAs are not tax exempt in the US. This is just one way in which a move from the UK to the US can endanger ones retirement.

  11. The UK/US tax treaty is very clear that UK pension schemes are treated in the same way as US schemes, i.e. taxed by the state of residence only on withdrawal. The definition of a pension scheme is clearly spelled out in the “protocol” (i.e. side letter) to the treaty: it’s anything that the UK government classifies as a pension scheme. It’s a very reciprocal treaty. So a UK citizen moving to the US has many of the same tax advantages for his/her pension scheme(s) as a US citizen moving to the UK. I think that the discussion here is around Form 3520, which affects some UK personal pension plans and is hugely painful to generate each year. Employer pension schemes, whether in trust or not, seem to be explicitly exempted from Form 3520 filing requirements.

  12. Hmpf. The UK Treasury must have been sleeping on the job to not negotiate similar treatment for their own retirement accounts in return for granting this treatment to US tax deferred accounts.

  13. It just makes one sick to think they are quite happy to take 25% from retirement savings in the name of compliance for those that were never the target of this program to begin with. UGH!

    IF this description of the objective doesn’t fit you,

    Then I would fight back and consider Opt Out or TAS appeal. Don’t roll over easily, even if you have joined the OVDI.
    Just my opinion, and based upon my experiences in the OVDP.

  14. @DIY filer,

    Thanks for this.

    They’ll give you the ability to make a treaty election to protect the RRSP income from taxation — something that the Service doesn’t have the ability to deny anyway. And they’ll take 25% of your retirement savings in return.

    Interesting result. For certain defined values of “interesting.”

  15. FWIW, on our recent (last Saturday) phone conversation with the OVDI hotline we were told that they will allow a late election for RRSP no problem (no PLR required) but they will include the RRSP amounts in the penalty base.

  16. @Anonymous,

    Good point. I was just looking at the inbound (from the U.S. perspective) side. Those are the people who come to me for remedial work.

    I have conversations with Britons living in the US and all of this tax mess stuff. Sometimes these discussions cause the individual to seriously consider giving up U.S. residency–the tax “unknown” is just too big.

    And for what it’s worth, the Ogden Service Center (where Form 3520 goes) seems to have developed some sort of tic. A late-filed Form 3520 seems to trigger an automatic computer-generated “WTF is this and why is it late?” letter. Not very reassuring for those of us who want to help people proactively clean up their situations.

  17. “But these countries do not grant similar reciprocity to 401(k)s, IRAs, etc etc.”

    The UK certainly does. The US/UK tax treaty specifically provides that IRAs, 401k’s and the like are taxed by your state of residence only on withdrawal, and Roth IRAs grow and can be withdrawn without tax just as in the US. So a US citizen moving to the UK sees no threat to retirement plans that they might have before the move. A UK citizen moving to the US, on the other hand…

  18. @Wada,

    Yeah I know that people send in Form 1040X with a late Form 8891 attached. I also know that the Austin Service Center has processed these things just fine in the past. I was even told the code they placed on these things to process them (which I have forgotten now).

    I also know that this is flat out wrong and and they shouldn’t be doing it. 🙂 And they’ve been told that they’re doing it all wrong.

    The “you’re doing it all wrong” process, however, would be my preferred solution. Just let people file amended tax returns, attach a delinquent Form 8891, and carry on. Simple. Logical. No harm, no foul.

  19. FWIW, people send in delinquent 8891 forms all the time for RRSP accounts without asking for PLRs. I have never heard of a late election being denied.

  20. The IRS knows what it is doing is hurting innocent people. They also know that they could change it with a word. Why do they continue to aggressively attack Canadians with RRSPs, when such accounts are legal and covered under the tax treaty? Because the IRS is led by an evil man, and the president, who could likewise change this policy, is also evil. Americans who voted for hope and change, is this what you expected? Did you expect your government to hound innocent people?

    Ron Paul has said that a wall on the Southern border could be used to keep Americans trying to escape in the country. Is there any doubt he is right?

  21. ‘The IRS should extend the same thinking that they developed in the RRSP situation to similar pension plan arrangements from other countries.’

    But these countries do not grant similar reciprocity to 401(k)s, IRAs, etc etc. Income in these is taxable if you reside in those countries. I think it would be a good idea for Treasury to ask for similar conditions in tax treaties (there is almost always some provision for pensions), but those generally involve a lot of complicated stuff relating to corporate taxation etc etc. so I think this gets left out.

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Tax laws change over time, and the information in this post above may be less accurate today than it was at the time of the last revision. This post is not tax advice for your specific situation. Please contact an international tax professional to get personalized advice for your situation.