Using Income Tax Treaties to Convert Taxable Income Into Nontaxable Distributions

The United States taxes its citizens on their income, no matter where they live in the world. Top-earning taxpayers are taxed at a rate of 39.6 percent. However, there are some exceptions to this rule, such as the I.R.C. §911 earned-income exclusion and the exclusion available under I.R.C. §933 for certain “bona-fide residents of Puerto Rico.

One way to save on taxes is by using a Roth IRA, which is a retirement account where contributions are made with after-tax dollars and the earnings grow tax-free. When you take money out of a Roth IRA, it usually isn’t taxed. However, there are restrictions on who can contribute to a Roth IRA and how much you can contribute each year. Also, you can’t transfer property to a Roth IRA without triggering certain taxes.

In summary, the U.S. taxes its citizens on their worldwide income, but there are some ways to reduce or eliminate taxes, such as using a Roth IRA. If you have a retirement plan from another country, you may have to pay U.S. federal income tax on the contributions and distributions. However, tax treaties between the U.S. and other countries can change how pensions are taxed, and in some cases, you may not have to pay any tax at all. Keep in mind that each treaty is different, so it’s important to understand how it applies to your specific situation. The U.S. Treasury has a model income treaty that it uses when making tax treaties with other countries. In 2006, the model treaty included a new rule about pensions, which was likely created to protect Americans who have Roth IRAs. This rule says that if another country would not tax its own residents on pension distributions, then it can’t tax Americans living there either. This rule also works the other way – if an American gets money from a pension in another country, the U.S. can only tax it if the other country would tax its own residents on that money. In modern treaties, there are provisions that prevent both countries from taxing the income from pensions until it is actually paid out to the person who will receive it. This means that the person can delay paying taxes on their pension income until they actually start getting the money. The US also has a rule that allows it to continue taxing its citizens, but there are some exceptions for pensions from other countries. This means that the US can only tax the pension money to the extent that it would have been taxed in the other country. So, in some cases, the US can’t tax the pension money at all until it is paid out, and even then, it can only tax it if the other country would have taxed it too. The United States and Hungary have a tax treaty that affects how pension income is taxed for U.S. citizens living in Hungary. Under this treaty, if a U.S. citizen participates in a Hungarian pension plan, neither country can tax the income of the pension until a distribution is made. When a distribution is made, the United States may only tax the distribution to the extent that it would be taxable under Hungarian law.

In Hungary, the tax on pension distributions depends on how long the pension has been held. If the pension is held for at least 20 years before a distribution is made, all distributions are completely exempt from income tax. If it’s held for between 10 and 20 years, some of the distribution will be taxed at a 16 percent rate, and if it’s held for less than 10 years, the entire distribution is taxed at 16 percent.

If a U.S. citizen participates in a Hungarian pension plan for 20 years, they can effectively distribute all of the assets tax-free in both Hungary and the United States. The United States has income tax treaties with different countries, but the terms of these treaties vary. For example, in the case of Poland, the U.S. can tax income accumulated in a Polish pension plan, but not the distributions made to U.S. beneficiaries. In the cases of Chile and Belgium, the U.S. can tax the distributions to some extent based on the treaty provisions. However, the treaty with Malta provides very favorable tax treatment for pensions. Under the U.S.-Malta income tax treaty, a pension plan in either country can qualify for treaty benefits as long as more than 75% of its members are residents of the United States or Malta. This means that a Maltese pension plan with mostly U.S. and Maltese members can receive benefits under the treaty. Article 18 of the Malta Treaty covers a wide range of income without restrictions. Article 17(1)(b) limits U.S. taxation on distributions from Maltese pension plans. This can be beneficial for U.S. taxpayers. Maltese pension plans allow for unlimited contributions and can include various types of assets. Contributions to a Maltese pension fund generally do not trigger adverse U.S. tax consequences. In Malta, people can start taking money out of their pension plans when they turn 50. When Cristina turns 50, she can take out $60 million from her pension without having to pay any taxes in Malta or the United States. Cristina can make tax-free withdrawals from her foreign pension plan starting in year four, but the amount she can take out without paying taxes is based on her “sufficient retirement income” determined by Maltese law. If her pension plan has more money than her retirement income, 50% of the excess can be withdrawn tax-free each year. This is because of a treaty between the United States and Malta. Even though these benefits may seem too good to be true, they are allowed because of the treaty. This treaty was negotiated by the United States and approved by Congress. So, the United States should continue to honor it. Eritrea has a special tax for citizens who live outside the country. The IRS has certain rules about taxes for pension plans from other countries, and there are treaties with some countries that affect how pensions are taxed. If you transfer money from a foreign pension plan to the US, you might have to report it to the IRS. Two tax partners at a law firm in Miami wrote an article about tax implications for pension plans. They both received advanced degrees in tax law and are members of The Florida Bar. The article was published on behalf of the Tax Law Section of The Florida Bar. The purpose of The Florida Bar is to teach its members about duty and service to the public, improve how the law is practiced, and advance the study of law.

 

Source: https://www.floridabar.org/the-florida-bar-journal/using-income-tax-treaties-to-convert-taxable-income-into-nontaxable-distributions/


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