A deductible individual retirement account (IRA) contribution often can be an interesting investment for foreign nationals working in the U.S., not only because they usually are not allowed to participate in a U.S. company's pension plan, but because they may receive favorable U.S. tax treatment if living in a treaty country on receipt of an IRA distribution. Treaties frequently state that a pension distribution is taxable only in the taxpayer's country of residence. However, the determination of which treaty article to apply to a distribution is sometimes troublesome. In the U.S.-Canadian tax treaty, it is clear that the pension article is used. However, Letter Ruling 9253049 stated that, generally, an IRA is not a pension, but could be treated as one if the IRA amounts came from a pension rollover and the recipient was at least 59 1/2 years old. If the IRA failed to be classified as a pension, the "Other Income" article of the treaty was to be used to determine the treatment. (This ruling involved a U.K. citizen and resident who previously resided in the U.S.)
Letter Ruling 9806012 seems to indicate a change in the IRS's approach, particularly when the treaty does not specifically refer to IRAs. Under this ruling, if the treaty does not specifically address IRAs, the "Pension" article is used, provided certain conditions are met.
In the ruling, a U.S. citizen had an IRA established through a rollover from a Sec. 401(k) plan and others created with deductible contributions. On her death, her beneficiary was a German resident.
The IRA distributions were income in respect of a decedent; if the estate was required to distribute the income currently, the beneficiary would pay the tax. If there were no treaty, there would be 30% withholding under Secs. 871(a) and 1441(a), because the income from an IRA is fixed and determinable.
Article 18(1) of the German Convention and Protocol states:
Subject to the provisions of Article 19 (Government Service; Social Security), pensions and other similar remuneration derived and beneficially owned by a resident of a Contracting State in consideration of past employment shall be taxable only in that state.
The Service had to determine whether the IRA payments were pension distributions. The Treasury's Technical Explanation of the U.S.-German Treaty states that both periodic and lump-sum payments qualify as pension payments under Article 18(1), but otherwise no specific definition of pensions appears.