U.S. Income Taxation of Cross-Border Pensions

Abstract

This article will explore the U.S. income tax rules applied to deferred compensation transactions that cross national borders; it will consider whether the rules that the U.S. has developed, as a source country and as a residence country, constitute both a coherent and administrable approach and one that meshes harmoniously with the laws of other countries. One objective in this context is to avoid erecting barriers to the free movement of employees across borders. Others are to avoid creating unwarranted loopholes for employees and to insure that the U.S. obtains its rightful share of tax revenues. This topic is of increasing significance because of the growth in cross-border movements of employees in recent years.
There are a number of troubling features of the U.S. rules for taxing cross-border deferred compensation that suggest the need for this exploration. The rules for U.S. source-based taxation are often complex and difficult to administer. In stark contrast to its stringent source-based taxation under the Code, the U.S. in its treaties completely surrenders source-based jurisdiction over "pensions." However, no such treaty relief is provided for other forms of deferred compensation; yet the term "pension" has not been defined by the IRS in an authoritative form, and the rationale for the special treatment of "pensions" remains unclear.
It seems doubtful that U.S. residence-based jurisdiction over "pensions" is exercised effectively, at least when the employer is not affiliated with a U.S. multinational. U.S. tax concepts employed in a domestic context are employed to characterize foreign retirement schemes even though the effects of such characterizations probably were not foreseen when the concepts were developed. The U.S. residence-based rules, even as supplemented by treaty, fail to take into account the manner of taxation by the source-country so as to guard against double taxation or inadvertent tax exemption.