Can a German government pension be subtracted from Illinois taxable income the same way a Canadian pension can?

Subject

Pensions – Foreign Pensions

Plain-English summary

The Illinois Department of Revenue answered a taxpayer who was trying to figure out whether their parents' German government pension could be subtracted from Illinois taxable income, the same way the taxpayer had already been told Canadian pensions could be. The taxpayer's family had only been deducting the U.S. pension their parents received, not the German one, and wanted a clear answer.

This is a General Information Letter (GIL), not a Private Letter Ruling -- meaning it is not a statement of Department policy and is not binding on the Department. Because the taxpayer didn't specify exactly what type of "government pension" their parents receive from Germany, the Department said it could not give a definitive answer: the U.S.-Germany tax treaty Protocol covers several different categories of pensions, and they aren't all treated the same way under Illinois law.

The Department did explain the two relevant Illinois subtraction provisions and how they interact with the treaty:

• IITA Section 203(a)(2)(F) lets taxpayers subtract certain retirement distributions described in Internal Revenue Code Sections 402, 403, 406, 407, and 408 -- but those IRC provisions are keyed to U.S. employee trusts and plans "created or organized in the United States." A German public pension covered by Paragraph 5 of Article VIII of the treaty Protocol does not fit those categories, so it does not qualify for the Section 203(a)(2)(F) subtraction.
• IITA Section 203(a)(2)(L) lets taxpayers subtract Social Security and railroad retirement benefits. Under Paragraph 5 of Article VIII of the Protocol, a German public pension of that specific type, paid to a U.S. resident, must be treated by the U.S. as though it were a U.S. Social Security benefit. Because of that treaty-driven equivalence, the Department said it "appears" such pension income would qualify for the Section 203(a)(2)(L) subtraction.

The Department stopped short of a full answer because it did not know whether the parents' pension was the type covered by Article VIII, Paragraph 5 (public/social-security-type pensions) or the type covered by Article 19 (pensions for government service, which are governed by different, more complex rules involving residency and nationality).

What this means for you

Individuals with a German pension

If a family member receives a German government pension and you're deciding whether to subtract it on an Illinois return, the label "government pension" isn't enough to know the answer -- you need to identify which treaty article governs that specific pension. A German public pension that falls under Article VIII, Paragraph 5 of the Protocol (treated like a Social Security benefit) appears to qualify for the IITA Section 203(a)(2)(L) subtraction. A pension tied to government service, addressed instead by Article 19 of the Protocol, is governed by separate rules turning on the recipient's residency and nationality, and this letter does not resolve those.

Taxpayers with pensions from other countries

This letter is specific to the U.S.-Germany treaty Protocol's particular wording. The Department noted it had already confirmed Canadian pensions are deductible, and here explained why a comparable result can apply to some German pensions. Don't assume the same subtraction automatically applies to a pension from a different country -- each U.S. tax treaty has its own pension articles, and you'd need to check the specific treaty language (and, ideally, request a ruling) for that country.

Accountants and tax preparers

When a client asks about subtracting a foreign government pension under IITA Section 203(a)(2), first determine which IRC sections or treaty provisions actually describe the payment. Section 203(a)(2)(F) subtractions track IRC Sections 402(a), 402(c), 403(a), 403(b), 406(a), 407(a), and 408, which are all anchored to U.S.-based plans and trusts -- foreign public pensions typically won't qualify there. Instead, check whether the governing treaty (here, the Article VIII, Paragraph 5 protocol language with Germany) requires the pension to be treated as a Social Security-equivalent benefit, which can unlock the Section 203(a)(2)(L) subtraction instead. If the facts are unclear, remember that only a Private Letter Ruling request (with the eight items of information required under 2 Ill. Adm. Code 1200.110(b)) can get a binding answer.

Common questions

Q: Is a German government pension deductible on an Illinois tax return?
A: It depends on the type of pension. The Department could not give a definitive answer here because the taxpayer didn't specify the exact kind of "government pension" involved, since the U.S.-Germany treaty Protocol covers multiple pension categories with different tax treatment.

Q: Why doesn't the German pension qualify for the same subtraction as a 401(k) or IRA distribution?
A: IITA Section 203(a)(2)(F) subtracts distributions described in Internal Revenue Code Sections 402, 403, 406, 407, and 408, all of which relate to U.S. employee trusts, annuities, and retirement accounts "created or organized in the United States." A German public pension under Article VIII, Paragraph 5 of the treaty Protocol doesn't fit those IRC categories, so it doesn't qualify for that particular subtraction.

Q: So how could a German pension still be deductible?
A: Through a different route. Paragraph 5 of Article VIII of the treaty Protocol requires that certain German public pensions be treated by the United States as though they were U.S. Social Security benefits. Since IITA Section 203(a)(2)(L) allows a subtraction for Social Security and railroad retirement benefits, the Department said such German pension income "appears" to qualify for that subtraction instead.

Q: Does this letter apply to pensions for former German government employees?
A: Not clearly -- that's a separate category. Article 19 of the treaty Protocol (Paragraphs 2 through 5) addresses pensions "paid by, or out of funds created by" a governmental body in respect of services rendered to that government, with rules that can shift based on the recipient's residency and nationality. This GIL didn't resolve how those pensions are treated because the taxpayer's letter didn't specify which type of pension was at issue.

Q: Can I rely on this letter as a definitive answer for my own situation?
A: No. This is a General Information Letter, not a Private Letter Ruling. It is designed to provide general information, is not a statement of Department policy, and is not binding on the Department. If you want a binding answer for your specific facts, you can request a Private Letter Ruling by submitting the information required under 2 Ill. Adm. Code 1200.110(b), provided you are not currently under audit.

Source

• Landing page: https://taxarchive.illinois.gov/research/legal/letter-rulings/income-tax/2021.html
• Original PDF: https://tax.illinois.gov/content/dam/soi/en/web/taxarchive/research/legal/letter-rulings/income-tax/2021/it21-0011-gil.pdf

Original ruling text

IT-21-0011 11/23/2021 PENSIONS – FOREIGN PENSIONS
Some German pensions governed by U.S tax treaty with Germany may
qualify for subtraction modification found in IITA Section 203(a)(2)(L).
(This is a GIL.)
November 23, 2021
Re:

Illinois Income Tax

Dear NAME:
This is in response to your letter dated March 12, 2021, in which you request
information regarding Illinois income tax. The nature of your request and the
information you have provided require that we respond with a General
Information Letter, which is designed to provide general information, is not a
statement of Department policy and is not binding on the Department. See 86 Ill.
Adm. Code 1200.120(b) and (c), which may be found on the Department's web
site at www.tax.illinois.gov.
Your letter states as follows:
I was directed to this office regarding deduction of foreign pensions. I had
submitted my parents IL1040 to their local office and was told by the clerk
that foreign pensions may be tax deductible on Illinois taxes. I have only
been able to verify that Canadian pensions are tax deductible but my
parents receive a government pension from Germany.
I would like to get a definitive answer as we have not been deducting their
German pension only their US pension.
RULING
Section 203(a)(2)(F) provides the following deduction in the computation of an
individual’s Illinois base income:
An amount equal to all amounts included in such total pursuant to the
provisions of Sections 402(a), 402(c), 403(a), 403(b), 406(a), 407(a), and
408 of the Internal Revenue Code, or included in such total as
distributions under the provisions of any retirement or disability plan for
employees of any governmental agency or unit, or retirement payments to
retired partners, which payments are excluded in computing net earnings
from self employment by Section 1402 of the Internal Revenue Code and
regulations adopted pursuant thereto.
Section 402 of the Internal Revenue Code deals with distributions from employee
trusts exempt under Section 401(a) of the Internal Revenue Code, which
provides an exemption for certain employee trusts “created or organized in the
United States.”

Section 403(a) of the Internal Revenue Code deals with annuities described in
Section 404(a)(2) of the Internal Revenue Code, which describes certain
annuities purchased by employee trusts exempt under Section 401(a) of the
Internal Revenue Code.
Section 403(b) of the Internal Revenue Code deals with annuities for employees
of exempt organizations.
Sections 406 and 407 of the Internal Revenue Code deal with employee benefit
plans under Section 401 that cover overseas employees of affiliates of the
employer that created the plan.
Section 408 of the Internal Revenue Code deals with individual retirement
accounts.
Section 203(a)(2)(L) provides the following deduction in the computation of an
individual’s Illinois base income:
For taxable years ending after December 31, 1983, an amount equal to all
social security benefits and railroad retirement benefits included in such
total pursuant to Sections 72(r) and 86 of the Internal Revenue Code;
Paragraph 5 of Article VIII of the Protocol Amending the Convention between the
United States of America and the Federal Republic of Germany Signed at Berlin
on June 1, 2006 (the “Protocol”), states as follows:

5. Social security benefits paid under the social security legislation of a
   Contracting State and other public pensions (not dealt with in Article 19
   (Government Service)) paid by a Contracting State to a resident of the
   other Contracting State shall be taxable only in that other Contracting
   State. In applying the preceding sentence, that other Contracting State
   shall treat such benefit or pension as though it were a social security
   benefit paid under the social security legislation of that other Contracting
   State.”
   Paragraphs 2 through 5 of Article 19 of the Protocol, state as follows:
6. a) Notwithstanding the provisions of paragraph 1, pensions and other
   similar remuneration paid by, or out of funds created by, a Contracting
   State or a political subdivision, local authority or an instrumentality
   thereof to an individual in respect of services rendered to that State or
   subdivision, authority or instrumentality shall be taxable only in that
   State.
   b) However, such pensions and other remuneration shall be taxable
   only in the other Contracting State if the individual is a
   aa) resident of, and a national of, that State; or
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bb) the pension is not subject to tax in the Contracting State for
which the services were performed because the services were
performed entirely in the other Contracting State.

3. Pensions, annuities, and other amounts paid by one of the Contracting
   States or by a juridical person organized under the public laws of that
   State as compensation for an injury or damage sustained as a result of
   hostilities or political persecution shall be exempt from tax by the other
   State.
4. The provisions of Articles 15 (Dependent Personal Services), 16
   (Directors’ Fees), 17 (Artistes and Athletes), and 18 (Pensions, Annuities,
   Alimony, Child Support, and Social Security) shall apply to salaries, wages
   and other similar remuneration, and to pensions, in respect of services
   rendered in connection with a business carried on by a Contracting State
   or by a political subdivision, local authority or an instrumentality thereof.
5. In this Article, the term "instrumentality" means any agent or entity
   created or organized by a Contracting State, one of its states or a political
   subdivision or local authority thereof in order to carry out functions of a
   governmental nature which is specified and agreed to in letters exchanged
   between the competent authorities of the Contracting States.”
   The Department of the Treasury Technical Explanation of the Protocol Signed at
   Berlin on June 1, 2006 Amending the Convention between United States of
   America and the Federal Republic of Germany (“Technical Explanation”), states,
   in part:
   In applying its tax, the residence country will treat the benefit as though it
   were a benefit paid to a resident under its own social security system.
   Thus, for example, if a U.S. resident receives a German social security
   benefit, he would include only one half of the benefit or such other portion
   as he would if the benefit had been a U.S. social security or railroad
   retirement benefit.
   Your letter indicates that your parents received government pensions from
   Germany. The letter does not specify the form of the “government pension” your
   parents receive or if they both receive the same type of pension. The Protocol
   and the Technical Explanation reference multiple types of pensions. Therefore, a
   definitive answer cannot be provided without a specific description of the
   government pensions at issue.
   The lack of detail notwithstanding, the Department can provide further
   information with regards to pensions governed by Paragraph 5 of Article VIII of
   the Protocol. The provisions referenced in IITA Section 203(a)(2)(F) do not
   appear to apply to a Paragraph 5 of Article VIII pension, as a result, such pension
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income would therefore not qualify for subtraction under IITA Section
203(a)(2)(F).
According to the Protocol, German pensions governed by Paragraph 5 of Article
VIII received by a U.S. resident shall be treated as a U.S. social security benefit,
and therefore, it appears as if such pension income would be qualify for the
subtraction under IITA Section 203(a)(2)(L).
As stated above, this is a general information letter which does not constitute a
statement of policy that applies, interprets or prescribes the tax laws, and it is not
binding on the Department. If you are not under audit and you wish to obtain a
binding Private Letter Ruling regarding your factual situation, please submit all of
the information set out in items 1 through 8 of Section 1200.110(b). If you have
any further questions regarding this letter, you may contact me at (217) 7822844.

Sincerely,

Michael D. Mankowski
Associate Counsel (Income Tax)

cc:

Daily File
Correspondence file:

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