Discussion:US-UK tax treaty question

I have a client with the following situation: he is a UK citizen and has lived in the US for 15 years. He has his US green card (so he is a permanent resident of the US).

He has started to receive a UK government pension on a monthly basis. Is this pension taxable in the US?

Per the US-UK tax treaty, article 19 para 2, it states that "a) any pension paid by, or out of funds created by, a Contracting State or a political subdivision or a local authority thereof to an individual in respect of services rendered to that State or subdivision or authority shall, subject to the provisions of sub-paragraph b) of this paragraph, be taxable only in that State; b) such pension, however, shall be taxable only in the other Contracting State if the individual is a resident of, and a national of, that State.

So far so good- he is not a US Citizen so it appears the pension is free of US tax.

However, the treaty contains the "saving" clause in Article 1 para 4 that states "Notwithstanding any provision of this Convention except paragraph 5 of this Article, a Contracting State may tax its residents (as determined under Article 4 (Residence)), and by reason of citizenship may tax its citizens, as if this Convention had not come into effect."

So it appears that because my client is a US resident- he can be taxed on the UK pension.

Further, Article 1 para 5 states: "The provisions of paragraph 4 of this Article shall not affect... (b) the benefits conferred by a Contracting State under... Article 19 (Government Service)... upon individuals who are neither citizens of, nor have been admitted for permanent residence in, that State."

Finally, the technical explanation of the treaty for Article 19 states "an individual who receives a pension paid by the Government of the United Kingdom in respect of services rendered to that Government is taxable on that pension only in the United Kingdom unless the individual is a U.S. citizen or acquires a U.S. green card".

So according to this if my client were a non-resident alien living in the US, the pension would not be taxable in the US, but because he is a permanent resident, the pension is taxable in the US.

Why am I pulling my hair out? Because when you go to IRS publication 901 pg 33 it states that "pensions paid by... the UK [govermnent]... are exempt from US income tax unless the recipient is BOTH a resident and Citizen of the US"

I also called the treaty office at the IRS and they told me the pension is not taxable in the US.

I know IRS publications and advice given over the phone are not the law (and IRS publications are sometimes wrong) but am I missing something here?

Sorry for the long post and thanks for your help!

Pete

You may still have to pay State taxes since the Treaty won't apply at State level.

Is there some other provision where the US has waived its right to tax these pensions?

The basic savings clause is Art. 1 sec. 4, that says that the treaty doesn't apply to people who are U.S. residents (as determined under the treaty).

Art. 1 sec. 5(b) (as amended by the 2001 protocol) is an exception to that, saying that Art. 1 sec. 4 does not apply, and therefore the substantive provisions of the treaty do apply, to "the benefits conferred by a Contracting State under paragraph 2 of Article 18 (Pension Schemes) and Articles 19 (Government Service), 20 (Students), 20A (Teachers), and 28 (Diplomatic Agents and Consular Officers) of this Convention, upon individuals who are neither citizens of, nor have been admitted for permanent residence in, that State."

A green-card holder is not an "individual[] who [is] neither [a] citizen of, nor...admitted for permanent residence in" the United States; therefore Art. 1 sec. 5(b) does not apply to him. Therefore he is governed by the normal savings clause. Therefore, if he is liable to tax in the UK by reason of his domicile, residence, citizenship, etc., and either (1) (a) does not have a substantial presence, permanent home or habitual abode in the United States and (b) is not a resident of a third state under another UK treaty, or (2) is considered a resident of the UK under the treaty's tiebreaker rules, then Art. 19 does apply to him and his government pension is not subject to U.S. tax.

Am I missing something this time?

I believe that Pete's original analysis above quoting the technical explanation said it all: "an individual who receives a pension paid by the Government of the United Kingdom in respect of services rendered to that Government is taxable on that pension only in the United Kingdom unless the individual is a U.S. citizen or acquires a U.S. green card."

An individual who is a United States citizen or an alien admitted to the United States for permanent residence (a "green card" holder) is a resident of the United States only if the individual has a substantial presence, permanent home or habitual abode in the United States and if that individual is not a resident of a State other than the United Kingdom for the purposes of a double taxation convention between that State and the United Kingdom.

However, I believe that an alien without a green card is automatically exempt from the savings clause as it applies to Article 19. See Technical Explanation, 7/19/02.

Publication 901 still mystifies me. It states that a UK government pension is exempt from US taxation unless the recipient is both a resident and citizen of the US. I found similar errors in Pub 901 in summaries of other treaties.

Unless I'm missing something else (which is very possible), I think that Pub. 901 accurately explains the treaty rule. It has a brief statement in the beginning about the effect savings clauses: "With certain exceptions, [treaties] do not reduce the U.S. taxes of U.S. citizens or residents." I think that is enough to make everything it says technically accurate, just confusing/misleading. It would certainly be nicer if the publication explained the meaning of "resident" under the treaties and repeated throughout that everything it says is subject to the savings clauses, but I don't think it's technically wrong as is.

I've advised them that the letter of the law is that the income is taxable. My client responded that if it ever came up, they would pay the tax and claim a penalty abatement due to incorrect advice given by the IRS!

What a shame- they are a great client but I don't think the position will succeed based on its merits. This basically means I should refuse to prepare the return under these circumstances, right?