Is a government pension from Japan taxable in the USA?
Is a government pension from Japan taxable in the USA? Like everything in the US Tax Code, it depends!
This fascinating question is brought to us by Sara, a US taxpayer living in Japan with a green card. Sara receives a pension distribution from the Japanese government and is concerned that the pension benefit might be taxable in the USA.
The concerns are legitimate as the US income tax implications of the pension depend on whether the USA <-> Japan Tax Treaty benefits are considered.
- Generally, USA Green Card holders report their worldwide income, including pension benefits, just like U.S. citizens.
- Unless excluded explicitly by the USA <-> Japan Tax Treaty, Sara must include the Japanese public pension benefits in USA taxable income.
Article 17 Pension states that:
Subject to the provision of paragraph 2 of Article 18, pension and other similar remuneration, including social security payments, beneficially owned by a resident of a Contracting State shall be taxable only in THAT contracting state.
What does Article 17 mean?
It means that subject to Article 18 paragraph 2, when pensions and other social security are paid to a resident of Japan, it will only be taxable in Japan.
For example, Sara is a Green Card holder who lives in Japan. Therefore, any government pension she receives as a resident in Japan should only be taxed in Japan.
Here is the twist
- If Japan does not necessarily tax that type of pension, Sara could potentially be obligated to report the Japanese pension to the USA as per the Savings Clause.
- The Savings Clause generally means income taxes will apply in the U.S. if the pension is not taxable in Japan.
- For Sara, her Japan pension is, in fact, taxable in Japan, so she is protected from the Savings Clause.
Article 18, paragraph 2 (a) states that:
Any pension and other similar remuneration paid by, or out of funds with contributions made by a contracting state or political subdivision or local authority thereof, other than payments made by the United States under the provision of the Social Security or similar legislation, shall be taxable only in THAT contracting state. However, such pension and other similar remuneration shall be taxable only in the other Contracting State if the individual is a RESIDENT of and a NATIONAL of that other contracting State.
Paragraph 3 The provision Articles 14, 15, 16, and 17 shall apply to salaries, wages, and other similar remuneration, and PENSIONS and other similar remuneration, in respect of services rendered in connection with a business carried on by a Contracting State or a political subdivision or local authority thereof.
What does Article 18 mean?
Paragraph 2(a) of Article 18 provides that if the pension paid is a public or government pension, then it is only taxable in the country that issues the retirement to a resident of the United States who is neither a citizen of the United States nor a person who has been admitted for permanent resident.
Because Sara is a green card holder who lives in Japan and earns a public pension from work performed in Japan, that pension benefit is only TAXABLE IN Japan. She respects Article 17 without disregarding Article 18, paragraph 2(a), and the Savings Clause does not apply to Sara.
The procedural tax compliance question is whether to file Form 8833
Whether Sara’s Japan pension is excluded from income reporting to the IRS on Form 1040 or whether a Treaty Based Return Position Form 8833 is in order disclosing the exclusion of pension income to the IRS has led to robust discussions in the tax practitioner community.
Some practitioners will confer that a best practice is to file IRS Form 8833, Treaty Return Position Disclosure, under IRC §7701(b) or §6114 attached to the electronically transmitted IRS Form 1040 asserting that Japan pension income will only be taxed in Japan.
My team and I drilled down and better understood the exceptions from reporting Form 8833 in US Treasury Regulation 26 CFR 301.6114-1 – Treaty-based return positions.
Provisions for which reporting is waived include:
- When a treaty reduces or modifies the taxation of income derived by an individual from dependent personal services, pensions, annuities, social security, and other public pensions, as well as income derived by artists, athletes, students, trainees, or teachers.
- When a Social Security Totalization or Diplomatic or Consular Agreement reduces or modifies income.
- When a treaty exempts excise tax imposed by IRC 4371 when certain conditions are met.
- When a treaty exempts from tax or reduces the tax rate on FDAP income.
- When a partnership, trust, or estate has disclosed a treaty position that the partner or beneficiary would otherwise be required to disclose.
Bottom line
NOT reporting Sara’s Japan pension benefit comports to a compliance standard spelled out in US Treasury Regulation 26 CFR 301.6114-1 – Treaty-based return positions
Final consideration
The eight-year Green Card Holder rule is the year you become dual status for income reporting purposes in the USA.
- Because Sara is a dual-resident taxpayer for the tax year 2022 and a long-term resident of the USA, asserting a Treaty-based return position is a deemed termination of US residency, which, if she was in the USA for more than eight years, causes an exploration into USA expatriation and all the nuances of filing IRS Form 8854.
- Fortunately for Sara, she has not held her Green Card for more than eight years, so this is not a concern.
