Japan taxation of US retirement income

[picklerick]

I am contemplating retiring in Japan with all of my retirement income coming from US sources. If you are a US retiree in Japan living off US income sources, do you find that you owe additional taxes compared to if you had retired in the US?

I spent a few days looking into this, and here is what I found so far. Any thoughts are appreciated.
1. My US taxes should be the same whether I retire in the US or Japan. This is based on the treaty's statement that US reserves right to tax citizens regardless of treaty provisions.
2. Japan should consider my 401(k) and my US private pension as retirement income for taxation purposes. This is based on the US Treasury Department's technical explanation of the tax treaty.

Also, I tried to use this information to estimate my Japan taxes using the Japan NTA Income Tax Guide, but I think I will need to consult a professional to make sure I understand it correctly. I assume I can just hire a Japanese tax preparer to create a hypothetical return.

Any advice or applicable experiences would be appreciated!

Mike

[Tokyo]

This topic was covered a few months back by Gulliver in the Foreign Pension Tax Ramifications thread. As you will read, you will probably owe next to no national tax but will have to pay prefectural and city taxes, as well as compulsory national health insurance and aged care premiums.

[picklerick]

Thanks! I am reading that thread with great interest.

Also, if anyone reads my original post, I think I may be incorrect about item #2, so don't quote me on that. I think it is actually talking about how the contributions to the pension fund is taxed, not the distributions.

[Tkydon]

As my post to the other relevant thread;

I had cause to check the Tax Treaties with various countries today, and it is Very Simple.

Article 17 of the US-Japan Tax Treaty clearly states:
Paragraph 1 - Pensions and other similar remuneration, including social security payments, beneficially owned by a resident of a Contracting State (Japan) shall be taxable only in that Contracting State (Japan).
Paragraph 2 - Annuities derived and beneficially owned by an individual who is a resident of a Contracting State (Japan) shall be taxable only in that Contracting State (Japan).
The term “annuities” as used in this paragraph means a stated sum paid periodically at stated times during the life of the individual, or during a specified or ascertainable period of time, under an obligation to make the payments in return for adequate and full consideration (other than services rendered).

Therefore my previous email stands. If you are a Permanent Resident of Japan for Tax Purposes i.e. have been in Japan for more than 1826 days in the last 10 years, any US derived pensions and 401k will only be taxable in Japan, as I explained, with the deductions and allowances I explained.

[picklerick]

Thanks for the reply. I've also been reading the tax treaty in detail. I agree with what you said.

I would add one clarification that the tax treaty states in an earlier article that the US retains the right to tax its citizens. So I will owe taxes for my retirement income in both countries, but can use foreign tax credits to avoid double taxation. So effectively, I will owe taxes in the country which has the higher taxation. And surely that country will be Japan.

On a related subject, I am also looking into the tax treaty provisions for resolving double residency. Another subject for another time.

[emikami]

As my post to the other relevant thread;

I had cause to check the Tax Treaties with various countries today, and it is Very Simple.

Article 17 of the US-Japan Tax Treaty clearly states:
Paragraph 1 - Pensions and other similar remuneration, including social security payments, beneficially owned by a resident of a Contracting State (Japan) shall be taxable only in that Contracting State (Japan).
Paragraph 2 - Annuities derived and beneficially owned by an individual who is a resident of a Contracting State (Japan) shall be taxable only in that Contracting State (Japan).
The term “annuities” as used in this paragraph means a stated sum paid periodically at stated times during the life of the individual, or during a specified or ascertainable period of time, under an obligation to make the payments in return for adequate and full consideration (other than services rendered).

Therefore my previous email stands. If you are a Permanent Resident of Japan for Tax Purposes i.e. have been in Japan for more than 1826 days in the last 10 years, any US derived pensions and 401k will only be taxable in Japan, as I explained, with the deductions and allowances I explained.

However, in article 1, paragraph 4, US Savings clause applies for U.S. Citizens and U.S. green card holder, U.S. can tax the same income unless it is listed as an exception in paragraph 5.

[emikami]

I am contemplating retiring in Japan with all of my retirement income coming from US sources. If you are a US retiree in Japan living off US income sources, do you find that you owe additional taxes compared to if you had retired in the US?

I spent a few days looking into this, and here is what I found so far. Any thoughts are appreciated.
1. My US taxes should be the same whether I retire in the US or Japan. This is based on the treaty's statement that US reserves right to tax citizens regardless of treaty provisions.
2. Japan should consider my 401(k) and my US private pension as retirement income for taxation purposes. This is based on the US Treasury Department's technical explanation of the tax treaty.

Also, I tried to use this information to estimate my Japan taxes using the Japan NTA Income Tax Guide, but I think I will need to consult a professional to make sure I understand it correctly. I assume I can just hire a Japanese tax preparer to create a hypothetical return.

Any advice or applicable experiences would be appreciated!

Mike

Unfortunately, things aren't that simple. It seems you are interpreting the treaty as if the U.S. Savings clause in article 1, paragraph 4 is something that will help you more than it can hurt you. The reality is that it can only hurt you. It isn't giving U.S. exclusive rights to tax you for anything. What it is stating is despite the income being taxable in Japan, you as a U.S. Citizen can be taxed on the same income unless it is specifically excluded in paragraph 5. However, in article 23, foreign tax credit, it explains the complicated rules of claiming foreign tax credit from one country or the other or a little bit of both to reduce or eliminate the double taxation. However, each country has its own rules on the limits of the foreign tax credit that you can claim in the tax year.

Article 23 paragraph 1 covers Japanese foreign tax credit.

Article 23 paragraph 2 covers U.S. Foreign tax credit.

Article 23 paragraph 3a states Japan will only give tax credit that it would give for income that would have been taxed by the U.S. if you were not a U.S. Citizen. From a practical manner, it means the usual U.S. retirement account distribution and U.S. bank interest and capital gains on stocks has 0% tax withholding so Japan will give no foreign tax credit for those income. For dividend on common stocks, the withholding rate is usually 10%. So for dividends, you must claim foreign tax credit in the Japanese tax return for the first 10% of your U.S. income tax and if the tax exceeds 10%, you must claim that from the U.S. tax return on Form 1116, certain income re-sourced by treaty category.

Article 23 paragraph 3b states explains U.S. will provide foreign tax credit which could not be claimed from Japan under paragraph 3a within its rule.

Article 23 paragraph 3c states U.S. will allow reassigning the portion of U.S. income that could not be credited by Japan in paragraph 3a to the extent the foreign tax credit can be claimed within its rule if the excess tax was a result of the U.S. savings clause in article 1 paragraph 4. In other words, if you're taxed by the U.S. more than a non-U.S. citizen living in Japan, that excess is creditable by certain income re-sourced by treaty category in IRS Form 1116.

It sounds great so far doesn't it. In a perfect world, no double taxation will happen as explained but the issue is that the way the limit of foreign tax credit works, you end up with carry back and carry forward on unused foreign tax credit for the credit you couldn't claim for any given year. For U.S., it isn't that bad 1 year back and 10 year carry forward but practical reality is that once you start carrying back and your tax situation doesn't change a lot, the odds of getting these unused carry forward to expire eventually is very high and when that happens, you're double taxed.

On the Japanese side, you have a bigger problem. You claim foreign tax credit against shotoku zei first (national income tax) and if you cannot claim everything at that level, it goes to City (shimin zei) and Prefecture government (kenmin zei) at 12% and 18% of what you claimed on shotoku zei. In other words, you can only claim up to 1.3 times your shotoku zei and rest are carried forward for the next 3 years before it expires. This creates a big problem for people with lower shotoku zei in relationship to the local government taxation.

In the best case scenario, you are able to use every foreign tax credit and you end up paying the higher of the two tax as your total tax burden plus few thousand dollars for tax accountant to do this hopefully correctly. But average case is it'll be higher due to unused foreign tax credit expiring.

For national health insurance, the rates and limits vary depending on municipality but for those age 40-64, it is about 12% + a fix amount per person and for those age 65+ it is about 10.2%. The difference is that those age 40-64 pay extra 1.8% for kaigobun (long term care insurance). The limit before the premium reaches maximum varies but 600,000 yen to 850,000 yen seems common. While this is a tax and it is based on income, it is a tax with a service aspect to it (health insurance). Therefore, it is not eligible for foreign tax credit. But it is counted for shakai hoshyo hoken ryo kojo (Social insurance tax deduction) on your Japanese tax return. If you're under age 60, you must pay into their social security even if you aren't working but those payment are also counted as Social insurance tax deduction on Japanese tax return.

Side note: Obamacare premium model is very similar to Japanese National health care system. I wonder if Obamacare copied the Japanese system? In the U.S., most enroll in Medicare Part B and drug coverage thus their premium is going to be somewhat standardized and not increase until the income level reaches somewhere around $88,000 (single filer) or $176,000 for (married filing jointly). In the Japanese, system, the income based premium continues forever. 65+ is different from age 40-64 and there's also an age 75+ category as well but you still pay based on income level.

[TokyoWart]

Side note: Obamacare premium model is very similar to Japanese National health care system. I wonder if Obamacare copied the Japanese system? In the U.S.,

Obamacare is based on the Massachusetts healthcare insurance mandate created under then governor Mitt Romney. No one is looking to Japan to model internal insurance policies because the Japanese market doesn’t work like the rest of the world.