Dual Citizenship and Divorce

[tb]

The following question was posted on an expat forum recently by a lady
with dual U.S./Swiss citizenship who recently got divorced. I will try
to explain the situation the best I can, but I am by no means a tax pro
so I might use inexact or ambiguous terms...

The former couple share a retirement account in Switzerland and the
plan administrator has given two choices:

1) Transfer her share of money on a vested benefit account (held in
Switzerland) till her retirement.
* Will the IRS levy some sort of tax on this transaction? Any
paperwork that needs to be filled out for the IRS?
* She knows that she has to report interest earned on the account to
the IRS, but what will she need to do with the IRS at the time she
retires and will start withdrawing from the account?

2) Withdraw her share of the money. Switzerland will levy taxes on
this, but what about the IRS?

 

[Alan]

The following question was posted on an expat forum recently by a lady
with dual U.S./Swiss citizenship who recently got divorced. I will try
to explain the situation the best I can, but I am by no means a tax pro
so I might use inexact or ambiguous terms...

The former couple share a retirement account in Switzerland and the
plan administrator has given two choices:

1) Transfer her share of money on a vested benefit account (held in
Switzerland) till her retirement.
* Will the IRS levy some sort of tax on this transaction? Any
paperwork that needs to be filled out for the IRS?
* She knows that she has to report interest earned on the account to
the IRS, but what will she need to do with the IRS at the time she
retires and will start withdrawing from the account?

2) Withdraw her share of the money. Switzerland will levy taxes on
this, but what about the IRS?

Some facts are missing. 1. Is she a resident of Switzerland or the US?
2. Was this retirement plan derived from private industry or government
service (I am assuming it is not Swiss social security equivalent).

If the trustee of the account transfers the assets from the current
retirement plan to another Swiss retirement plan in her name, there are
no US tax consequences.

If she takes a distribution, then the tax treaty between the US and
Switzerland says the following:

Private Pension:

Any distribution whether in the form of an annuity or lump-sum derived
in consideration of past employment is ONLY taxable by the country in
which she is a resident.

Government Pension:

Any distribution that was derived in consideration of past government
service in Switzerland is only taxable by Switzerland except under the
following circumstance: If she is a resident AND citizen of the US, it
would ONLY be taxable by the US.

You state that Switzerland is going to tax any distribution she
receives. This tells me that she is a resident of Switzerland and not a
resident of the US or she is not a resident of Switzerland but know one
has informed the plan trustee of that fact and the treaty article.

Article 4 of the treaty provides the definition of which country you are
a resident. Too difficult to explain here. But suffice to say, if she
only has a permanent home in one country, then that country is where she
is a resident. If she has permanent homes in both countries, then she is
a resident in the country in which she has closer ties (the country that
is the center of her vital interests).

You can read the treaty at
http://www.irs.gov/Businesses/International-Businesses/Switzerland---Tax-Treaty-Documents

 

[tb]

Some facts are missing. 1. Is she a resident of Switzerland or the
US? 2. Was this retirement plan derived from private industry or
government service (I am assuming it is not Swiss social security
equivalent).

If the trustee of the account transfers the assets from the current
retirement plan to another Swiss retirement plan in her name, there
are no US tax consequences.

If she takes a distribution, then the tax treaty between the US and
Switzerland says the following:

Private Pension:

Any distribution whether in the form of an annuity or lump-sum
derived in consideration of past employment is ONLY taxable by the
country in which she is a resident.

Government Pension:

Any distribution that was derived in consideration of past government
service in Switzerland is only taxable by Switzerland except under
the following circumstance: If she is a resident AND citizen of the
US, it would ONLY be taxable by the US.

You state that Switzerland is going to tax any distribution she
receives. This tells me that she is a resident of Switzerland and
not a resident of the US or she is not a resident of Switzerland but
know one has informed the plan trustee of that fact and the treaty
article.

Article 4 of the treaty provides the definition of which country you
are a resident. Too difficult to explain here. But suffice to say,
if she only has a permanent home in one country, then that country is
where she is a resident. If she has permanent homes in both
countries, then she is a resident in the country in which she has
closer ties (the country that is the center of her vital interests).

You can read the treaty at

http://www.irs.gov/Businesses/International-Businesses/Switzerland---Tax-Treaty-Documents

Got some more information from the lady. Again, please bear in mind
that I am no tax professional so my choice of words might not be
perfect...

* She is both a U.S. and Swiss citizen currently residing in the USA.

* The share of pension plan that she is getting due to the divorce is
actually considered a vested benefit account. Her husband has a
pension plan in Switzerland (derived from private industry) and, under
Swiss law, whatever money is in the pension plan must be divided among
the divorcing couple. Her share will be transfered into a vested
benefit account in her name with a Swiss trustee. To the best of my
knowledge, this "vested benefit account" is the equivalent (more or
less) of a Rollover IRA here in the USA.

She would like to know the tax consequences (with respect to the U.S.
IRS) of such a situation. From what you've been saying there are none
till she starts withdrawing the money, am I correct? How are such
withdrawals taxed by the IRS?

 

[Alan]

http://www.irs.gov/Businesses/International-Businesses/Switzerland---Tax-Treaty-Documents

Got some more information from the lady. Again, please bear in mind
that I am no tax professional so my choice of words might not be
perfect...

* She is both a U.S. and Swiss citizen currently residing in the USA.

* The share of pension plan that she is getting due to the divorce is
actually considered a vested benefit account. Her husband has a
pension plan in Switzerland (derived from private industry) and, under
Swiss law, whatever money is in the pension plan must be divided among
the divorcing couple. Her share will be transfered into a vested
benefit account in her name with a Swiss trustee. To the best of my
knowledge, this "vested benefit account" is the equivalent (more or
less) of a Rollover IRA here in the USA.

She would like to know the tax consequences (with respect to the U.S.
IRS) of such a situation. From what you've been saying there are none
till she starts withdrawing the money, am I correct? How are such
withdrawals taxed by the IRS?

She is a US citizen and considered a US resident under the treaty.
Therefore, any distribution to her would only be taxable by the US as
pension income.

Once she has control of the account, she will be obligated to file an
FBAR (Report of Foreign Bank and Financial Accounts) if the FMV exceeds
$10K at any time in the year. Additionally, if the FMV on the last day
of the year exceeds $50K or exceeded $75K at any time in the year, she
would also have to file IRS Form 8938 with her tax return. If she does
not have a filing requirement, then she does not have to file the 8938.
She would still be required to file the FBAR. FBARs are a calendar
year report and have to be filed no later than 6/30 of the following year.

FBARs are filed electronically at:
http://bsaefiling.fincen.treas.gov/NoRegFBARFiler.html

The IRS explains FBAR filing at:
http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Report-of-Foreign-Bank-and-Financial-Accounts-FBAR

 

[tb]

She is a US citizen and considered a US resident under the treaty.
Therefore, any distribution to her would only be taxable by the US as
pension income.

Once she has control of the account, she will be obligated to file an
FBAR (Report of Foreign Bank and Financial Accounts) if the FMV
exceeds $10K at any time in the year. Additionally, if the FMV on the
last day of the year exceeds $50K or exceeded $75K at any time in the
year, she would also have to file IRS Form 8938 with her tax return.
If she does not have a filing requirement, then she does not have to
file the 8938. She would still be required to file the FBAR. FBARs
are a calendar year report and have to be filed no later than 6/30 of
the following year.

FBARs are filed electronically at:
http://bsaefiling.fincen.treas.gov/NoRegFBARFiler.html

The IRS explains FBAR filing at:

http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Report-of-Foreign-Bank-and-Financial-Accounts-FBAR

Thanks Alan.

My understanding of these foreign "rollover IRA" accounts is that the
IRS requires that taxes be paid on the yearly interest earned and
credited to such accounts. Taxes must also be paid when withdrawals of
the principal is made at the time of retirement.

1) I'm guessing that U.S. taxes paid on yearly interest earned and
credited to the foreign "Rollover IRA" account is at the current tax
bracket percentage. But what about withdrawals of the principal at the
time of retirement? Are such withdrawals taxed in the same manner as
those made from a U.S.-based 401(k) or U.S. Rollover IRA?

2) How does one avoid paying U.S. taxes twice on some of the money
withdrawn since principal and interests (on which U.S. tax has already
been paid!) are all together? How does one keep principal and
interests separate so that the IRS does not tax interests twice?

 

[Alan]

http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Report-of-Foreign-Bank-and-Financial-Accounts-FBAR

Thanks Alan.

My understanding of these foreign "rollover IRA" accounts is that the
IRS requires that taxes be paid on the yearly interest earned and
credited to such accounts. Taxes must also be paid when withdrawals of
the principal is made at the time of retirement.

1) I'm guessing that U.S. taxes paid on yearly interest earned and
credited to the foreign "Rollover IRA" account is at the current tax
bracket percentage. But what about withdrawals of the principal at the
time of retirement? Are such withdrawals taxed in the same manner as
those made from a U.S.-based 401(k) or U.S. Rollover IRA?

2) How does one avoid paying U.S. taxes twice on some of the money
withdrawn since principal and interests (on which U.S. tax has already
been paid!) are all together? How does one keep principal and
interests separate so that the IRS does not tax interests twice?

There is nothing in the treaty with Switzerland that allows for deferral
of current income in the Swiss trust (I assume the account is a Swiss
trust that allows for deferral of income tax to Switzerland.). As an
aside, the treaty with Canada allows for an arrangement to defer current
income on certain types of Canadian retirement accounts.

She would have to declare the current income (interest, dividend,
capital gain) on her US tax return. This will create a cost basis in the
foreign trust. How one calculates the taxable part of any future
distribution is debatable. What is not debatable, is that you can not
use the US IRA formula as this account is not a US IRA.

I am inclined to treat it as a nonqualified plan. Under this rule, a
nonperiodic payment made before the required start date is first
allocated to earnings. In this instance, we have earnings that have been
taxed (normally the earnings are the untaxed part). Therefore, I
conclude (someone else may conclude otherwise) that until any
distribution exceeds the amount she declares as taxable on her annual
tax returns, it would be tax-free. Only when she dips into the "rolled
over" amount would she have to include that amount in income. I would
include that amount on the pension line of the 1040.

It would probably be easier if she just withdraws the current income as
it is received. However, the trust may not allow for distributions until
she reaches a certain age.