US IRA income for US citizen CA resident

[karkub]

I have a US citizen that is a Canadian resident and is receiving periodic payments from an IRA. According to the U.S. Canada Income Tax Treaty Article XVIII 2(a), the tax charged shall not exceed 15 per cent of the gross amount of the pension. Is this true and with the new stacking rules for taxation in the US are there instructions for the mechanics of the 15% tax?

[nelsona]

First off, by Article XXIX (3), the article you refer to does not apply to US citizens, so there is no treaty-based cap on the tax a US citizen would pay on US-sourced pension income.

Even if there were, unless your effective tax rate (US tax/gross income) is greater than 15%, you would not have exceeded this threshhold anyways.

If a treaty threshhold would apply (a good example is the Social security benefits, which must be taxed at 0% for US citizens living in Canada), the mechanics of ensuring 0% US tax is by the re-sourcing category of form 1116, as it always has been. One would then attach a 8833 statement outlining what they did, based on article ###

Most people don't do it this way (they simply remove the Soc. Sec income from their return, or they attach a note requesting that their final tax figure be reduced by a certain amount), but technically that is how one accounts for tax caps on 1040.

So, in general, you cannot determin whether a specific type of income has been taxed at a rate higher than a cap until you have at least completed a first-pass (ie. without accounting for foreign tax credits) of the 1040, including any FEIE.

[karkub]

I would refer back to a response that was posted Mar 17, 2005 by "nelson non grata" regarding a US citizen that is a resident of Canada, the response stated that systematic periodic withdrawals would only be taxed 15% by US, by treaty Article XVIII.2

[nelsona]

If you could refer back to the actual url, that might help me correct it.

In any event, we evolve.

My current response is right out of the treaty:

Article XXIX
Miscellaneous Rules

1. The provisions of this Convention shall not restrict in any manner any exclusion, exemption, deduction, credit or other allowance now or hereafter accorded by the laws of a Contracting State in the determination of the tax imposed by that State.

2. Except as provided in paragraph 3, nothing in the Convention shall be construed as preventing a Contracting State from taxing its residents (as determined under Article IV (Residence)) and, in the case of the United States, its citizens (including a former citizen whose loss of citizenship had as one of its principal purposes the avoidance of tax, but only for a period of ten years following such loss) and companies electing to be treated as domestic corporations, as if there were no convention between the United States and Canada with respect to taxes on income and on capital.

3. The provisions of paragraph 2 shall not affect the obligations undertaken by a Contracting State:

(a) under paragraphs 3 and 4 of Article IX (Related Persons), paragraphs 6 and 7 of Article XIII (Gains), paragraphs 1, 3, 4, 5, 6(b) and 7 of Article
XVIII (Pensions and Annuities), paragraph 5 of Article XXIX (Miscellaneous Rules), paragraphs 1, 5 and 6 of Article XXIX B (Taxes Imposed by Reason of Death), paragraphs 2, 3, 4 and 7 of Article XXIX B
(Taxes Imposed by Reason of Death) as applied to the estates of persons
other than former citizens referred to in paragraph 2 of this Article,
paragraphs 3 and 5 of Article XXX (Entry into Force), and Articles XIX
(Government Service), XXI (Exempt Organizations), XXIV (Elimination
of Double Taxation), XXV (Non-Discrimination) and XXVI (Mutual
Agreement Procedure);

[nelsona]

The saving clause I outlined above is often overlooked when trying to determine US tax on its citizens. its effect is to invalidate many of the treaty provisons that, for example, Cdns who once worked in US and now return to canada enjoy.

Note that the methodology I oultined above will have the effect of reducing the US tax to 15%, even if the treaty clause is not in effect.

Say the overall taxrate detrermined is 18%, which is over the 15% pension limit. canada will only credit 15% (that is by Article XXIV (4) which allows canada to only credit a US citizen living in Canada for the US tax he would have paid if he wasn't a US citizen) . US will credit, by re-sourcing enough of the pension as foreign , to reduce the US tax to 15%. This is by Article XxIV (6).

The same applies to other US-source income received by US citizens living in Canada.

The purpose of the "re-sourcing" category in form 1116 is to counteract the savings clause.

Your guess is as good as mine as to why the US insists on a savings clause, and then provides the mechanism to overcome it in most cases.

But in answer to your original question, Article XVIII.2 does not limit IRS tax on US-sourced pensions paid to a US citizen living in canada. Article XXIV (6) does, by allowing a US citizen to claim the tax in excess of 15%, for which canada will not give credit, by re-sourcing sufficient pension to canada.

The new FEIE regs have had no impact on these (other than, of course, to generally raise the taxrate.

You should note, too, that most cross-border types, given the need to now use 1116 as well as 2555 to do IRS taxes, as simply moving using 1116 exclusively.

Just a thouight.