The U.S.-Japan Tax Treaty

A pertinent question for many retired U.S. citizens (or “green card” holders) living in Japan is whether Japanese public pension benefits are taxable by the U.S. The simple answer is that, unless specifically excluded by the U.S.-Japan Tax Treaty, they must be included in taxable income. This follows, from the general rule that U.S. citizens are taxed on all their income, whatever its source, and wherever in the Universe they may live.

So let’s take a look at the Treaty. Article 17(1) holds that “…[P]ensions and other similar remuneration, including social security payments, beneficially owned by a resident of a Contracting State shall be taxable only in that Contracting State.” On first glance, things look promising. Restated, this bit of code simply says that taxation of pensions or Social Security benefits is allowed solely to the country of residence. Neither the country of source, nor the country of citizenship, is relevant.

This first glance interpretation of the Treaty is, in fact, the correct one for the retired Japanese citizen. For example, if a Japanese citizen resides in the U.S., the Japanese government may tax neither his Japanese pension nor his U.S. “Social Security” benefits. And, in the same way, if he resides in Japan, it means that the U.S. may tax neither his Japanese pension nor his U.S. “Social Security” benefits.

Unfortunately, the first-glance interpretation does not hold, vis-a-vis the U.S. government, for U.S. citizens living in Japan. The otherwise delectable Article 17 is rendered impotent by Article 1(4)(a), which states that, subject to a few minor exceptions (in which Article 17(1) is NOT included), “…nothing in the treaty has any affect on the taxation by the U.S. government of its citizens.”. This means that, not only are U.S. citizens denied the benefits of Article 17 regarding pensions, but are denied most of the other Treaty benefits as well.

U.S. tax treaties always bring a smile to my face. After all, isn’t the cavalier U.S. treatment toward its citizens abroad rather comedic? No other countries that I know of have such one-sided tax treaties against their own citizens!

Now, this is not to say that the Japan-resident U.S. citizen who has Japanese pension income will be doubly-taxed by both Japan and the U.S. on that same income. There are double-taxation-avoidance procedures in effect whereby the U.S. will allow a tax credit for Japanese tax paid on Japanese pension income. However, as is the case with the U.S. and its “Social Security”, Japan taxes its national pension very lightly (in the cases where it taxes it at all). This means, unfortunately, that there will usually not be much of a tax credit available. Also, the U.S. does not grant Japanese pension income (or any offshore pension, for that matter) the favorable tax treatment that it provides for “Social Security” benefits. So, although U.S. citizens residing in the U.S. pay little or no tax on their “Social Security”, and Japanese citizens in Japan pay very little tax on their national pension, a U.S. citizen, wherever he lives in the world, will usually end up paying a hefty tax to the IRS on his Japanese retirement benefits.

The treatment of pensions as provided for in the U.S.-Japan Tax Treaty is just one of the many one-sided tax benefits available to Japanese citizens living in the U.S., vis-a-vis the Japanese government, but denied to U.S. citizens living in Japan, vis-a-vis the U.S. government. Nevertheless, the Treaty is an important document for U.S. expatriates in that it does outline certain specific procedures for the avoidance of double taxation. I will discuss these in a future article.