A more detailed description is as follows:
On the surface any income, including pension income, that a U.S. taxpayer receives is taxable income on his tax return. This is true even though the income is retirement benefits from working overseas before he becomes a U.S. resident or citizen.
However, we have done some research and found that on a lump sum payment (which is the case here) if the foreign pension plan is like a qualified retirement plan in the U.S., then the tax could be deferred. Below is my e-mail to another individual on this subject:
I have done some more research to see if there is a way to avoid paying tax on the pension payment. The rules I quoted you before apply to pensions received in the form of an annuity (annual or monthly payment over a period of time) which must be considered taxable income in the year the pension is received. However, in the case lump sum pension payment, it could be handled differently.
If the foreign pension plan can be considered a “qualified retirement plan", then the pension payment can be rolled over into another qualified retirement plan (such as an Individual Retirement Account or IRA) in the U.S. Rollover will not trigger any tax. However, the tax benefit is tax deferral, rather than tax avoidance. All qualified retirement plans in the U.S. has to be taxed when it is withdrawn in the future. The withdrawn amount is included in that year’s income. But there is no requirement that withdrawal must take place until one reaches 70-1/2 years old, and the mandatory annual withdrawal is quite small (starts at about 3.3% each year). So it will be many years before one begins to pay tax on the pension money. You can go to the tax section of my website at http://www.moneyradio.org/showSubCategory.php?SCID=205 to learn the rules about mandatory IRA withdrawal.
The above is based on Internal Revenue Code Section 402 (d) which says:
(d) Taxability of beneficiary of certain foreign situs trusts
For purposes of subsections (a), (b), and (c), a stock bonus, pension, or profit-sharing trust which would qualify for exemption from tax under section 501(a) except for the fact that it is a trust created or organized outside the United States shall be treated as if it were a trust exempt from tax under section 501(a).
Section 501(a) describes the rollover and tax deferral procedures I mentioned above.
A CPA friend of mine had done research into the pension plans offered by the Hong Kong government and found that the plans would be considered qualified pension plan in the U.S. So the lump sum payment can be rolled over into an IRA and tax would be deferred.
It can only go into a traditional IRA, not Roth IRA. If you desire to convert your IRA to Roth IRA you can do so as long as you have less than $100,000 in adjusted gross income that year. But any amount you convert would have to be included as income and be taxed.
As for your monthly pension, that is income which has to be reported. This is the same whether the pension income is from a foreign entity or from an U.S. entity. But each couple has $24,000 in tax free income each year (standard deduction), so as long as your income (including this pension income) is less than $24,000 there is no income tax.