Spanish Pension Plan U.S. Tax Rules
US Taxation of Spain Pension Plans: For U.S. persons with foreign pension plan income from Spain, the U.S. has developed unnecessarily complicated tax and reporting rules. In Spain, the pension systems follows the very common three (3) Pillar system.
These “pillars” are in reference to the World Bank Five Pillar Framework regarding pension systems.
In Spain, the pension includes:
- First Pillar: Social (Government)
- Second Pillar (Occupational)
- Third Pillar (Private)
The U.S. and Spain have entered into a Bilateral Tax Treaty, in addition to the FATCA Agreement and Totalization Agreement.
Let’s explore the IRS general guidelines involving US Taxation of Spanish Pension and if Spain Pension Plan Taxable in the US?
*We have a separate article for questions involving reporting Spain Pension on forms such as FBAR, FATCA, 3520 and 8621.
Pension Plan System in Spain
As we mentioned above, Spain follows a Three-Pillar pension system.
The system works as follows:
First Pillar Public Pension (Social Security)
Social Security is mandatory in Spain.
It involves contributions from both the employer and employee. In Spain, the employer contributes 29.90%, while the employee contributes 6.35%.
The total max out salary contribution rate is 4,070.10 EUR per month.
As with most countries, there are some exceptions and limitations based on the totalization agreement, and self-employment status.
U.S & Spain Totalization Agreement
The U.S. and Spain have entered into a Totalization Agreement. It provides in pertinent part:
“While you work—If your work is covered by both the U.S. and Spanish Social Security systems, you (and your employer, if you are employed) would normally have to pay Social Security taxes to both countries for the same work. However, the agreement eliminates this double coverage so you pay taxes to only one system (see the section on “Coverage and Social Security taxes“).
When you apply for benefits—You may have some Social Security credits in both the U.S. and Spain but not have enough to be eligible for benefits in one country or the other. The agreement makes it easier to qualify for benefits by letting you add together your Social Security credits in both countries. For more details, see the section on”Monthly Benefits“.
Before the agreement, employees, employers and self-employed persons could, under certain circumstances, be required to pay Social Security taxes to both the United States and Spain for the same work.
Under the agreement, if you work as an employee in the United States, you normally will be covered by the United States, and you and your employer will pay Social Security taxes only to the United States. If you work as an employee in Spain, you normally will be covered by Spain, and you and your employer pay Social Security taxes only to Spain.
On the other hand, if your employer sends you from one country to work for that employer or an affiliate in the other country for five years or less, you will continue to be covered by your home country and you will be exempt from coverage in the other country. For example, if a U.S. company sends an employee to work for that employer or an affiliate in Spain for no more than five years, the employer and the employee will continue to pay only U.S. Social Security taxes and will not have to pay in Spain.
If you are self-employed and reside in the United States or Spain, you generally will be covered and taxed only by the country where you reside.”
Second Pillar Occupational Pension (Employment)
The Occupational Pension is provided by the employer.
In general, the pillar 2 in Spain is funded through the employer and is limited to about $10,000 per year. If the insured is self-employed, they can establish their own pension through a local bank or financial institution.
Third Pillar Private Pension (Private)
The third pillar pension is a private and voluntary pension. There is no obligation for an employee to submit to the voluntary pension for Pillar 3.
Spain & US Tax Treaty Analysis
1st Pillar Contributions
Since contributions to U.S. social security by employees is non-deductible, neither would be payments into the Spanish tax system (on a U.S. Tax Return).
*For a self-employed person, there may be a deduction available for employer portion and/or making an 8833 election (see below).
1st Pillar Distributions
As provided by Article 20 of the U.S. Spain Tax Treaty, presuming that the 1st pillar is social security equivalent:
Subject to the provisions of Article 21 (Government Service):
(a) 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; and
(b) social security benefits paid by a Contracting State to a resident of the other Contracting State or a citizen of the United States may be taxed in the first-mentioned State.
Presuming that the First Pillar is social security, then only the country paying the social security benefit can take the benefit (with an additional clarification for U.S. Citizens).
2nd Pillar: Occupational Pension
The 2nd Pillar is managed by the employer or by the self-employed, if applicable.
2nd Pillar is Similar to U.S. Pension
The 2nd Pillar is equivalent to a 401K. It is not social security, as it is in addition to the 1st Pillar, and benefits can be paid-out as a lump sum or annuity. In Switzerland, the pension it is mandatory, whereas the equivalent in the U.S. such as a 401K is not mandatory.
Are 2nd Pillar Contribution Payments Deductible?
Based on the treaty, there is no carve-out for pension contributions as dediuctible from income as there is in the UK treaty for example.
Are erd Pillar Distributions Payments Taxable in the U.S.?
As with most tax treaties, the taxation of pension income will be based primarily on the residence of the taxpayer.
3rd Pillar: Private Pension
Pillar 3 are self-funded and designed to further supplement the Pillar 1 and 2 and contributions are not deductible from gross income.
Are 3rd Pillar Contribution Payments Deductible?
Based on the treaty, there is no carve-out for pension contributions as deductible from income.
Are 3rd Pillar Distributions Payments Taxable in the U.S.?
As with the 2nd Pillar, th the taxation of pension income will be based primarily on the residence of the taxpayer.
Form 8833 For Pension in Spain
If a person wants to take a tax treaty position on their tax return regarding pension contributions, distributions, etc., then they will file a Form 8833 with their tax return, unless they meet one of the exceptions.
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