In this video, Abhinav is talking about 401k/Traditonal IRA taxation especially from the point of view of Returning NRI from US.
Transcript of this video is given below. Please note that auto-generated transcription may contain errors.
Hello. This is Abhinav, and I welcome you. In an earlier video, I discussed about, what is 401k, and in one video, I discussed about IRA and, the taxation aspects in US. Right? So now in this video, I’m talking about 401k traditional IRA taxation in India.
Now the taxation aspect for both 401k and traditional IRA is almost the same. So I’m taking up both of this in one video. For Roth taxation in India, I will take it up in a separate video, so stay tuned for that. Okay. So let us start.
So basically, till the person is in a nonresident as till the person, who has 401k or traditional IRA investment is a nonresident or a resident and not ordinary resident of India, till that stage, there is no tax requirement in India. There is no reporting requirement in India. You don’t have to pay any income. You can do anything with your 401k or traditional IRA. Do whatever.
You don’t need to pay any tax in India. There is no reporting requirement in India anywhere. Right? Till the person is a nonresident as per the Indian tax law. Right?
Or the person may have returned back to India after a considerable stay in US, and there is a, like, 1 to 3 year period where the person can be a resident and not ordinarily resident. Right? For Indian tax law, then there is no tax law reporting requirement. Right? Now let’s come to where the person becomes a resident and ordinarily resident as per Indian tax law.
Right? Now the general rule is that worldwide income for a resident and ordinary resident, ROR, is taxable as in the in India. Right? So you have to disclose the incomes, in the Indian tax return, worldwide incomes, and pay the tax, and then you can claim the credit to certain extent. Right?
So after becoming ROR, what is the situation? Let us discuss. Now after we you become a ROR and you make any further contribution to your, to your 4 1 k or a traditional IRA, there is no tax taxable event because you are making a contribution. There is no such income. Right?
It’s a investment. It’s a contribution. So there is no tax in India. There’s right? Totally no tax in India.
Right? If you make a contribution, you may get a deduction from your US tax return. All that is different. But in Indian taxation, there is no impact for the contribution. Now let’s talk about the income that that is accrued in the fund.
Now understand this. See, 401k is recognized in the internal revenue code, right, in the US. Right? That’s why the name of the section is 401k. That’s why right?
Or the IRA plan, they are recognized as retirement plans in US, and there is a specified treatment right for those plans however in India there is no recognition to 401K. Yes, there is a recognition that was given in 2021 when section 89a was introduced and which prescribes that if you elect for it, right, only and only if you elect for it, then you can defer the tax at the till the time of withdrawal as per the what when the other country will tax it. Right? So depending on that, the taxation of any income because the see, there is, like, whatever amount, 100 rupees is there in the fund. Right?
A 100 rupees, a $100. There will be income in the fund. As per Indian tax law, Indian tax law doesn’t recognize 401k. For them, if you are a ROR, it’s a income for Indian tax authorities they will not want to leave that income just like that they will want to tax it because you are a ROR and your worldwide income is taxable they don’t care whether it’s a non taxable in India Now if in this case, there are 2 situations, you make a Rule 21AAA election. If you make now how you make that Rule 21AAA election by filing Form 10EE, right, Form 10EE.
I’ll make a separate dedicated video on form 10, double e, how to fill that form. Right? I’ll make you so stay tuned for that video. If you make a rule 21 AAA election in the year that you become in the 1st year that you become a resident or an ordinary resident, there’s no tax. So highly, highly advisable if you are returning back to India with your 401k or IRA contribution and you want to keep it till you’re 51 59.5 so that you want to avoid the 10% penalty in US, make the rule AAA election in the 1st year of your ROR.
When you do that, every year there will be no tax. Otherwise, if you don’t do that, if no rule, triple a election is made, then any income see, Indian government is considered with what? Income. In US, what they are concerned with is the entire withdrawal becomes taxable. Right?
Because the entire contribution was deductible, so they will tax the entire withdrawal. Here, it is different. Indian government will say simple, clear thing that you had invested 100 rupees, and you have earned 10 rupees on top of that 100 rupees as a income because the 100 rupees is invested in stocks and bonds and everywhere within the IRA. So Indian government doesn’t recognize the 401k, right, unless you meet the rule triple 21, triple a election, right, which is a very, very good development that happened, in 2021. Before that, there was there was even not such a rule.
So I remember I used to deal with, no, 4 one k, returning NRIs, and it was a it was a difficult thing computing all the taxation and everything. Right? But after this rule has come, things have become very easy for 401k traditional IRA. Roth, still it’s confusing. I’ll discuss in the different video.
So, basically, if you have not made a Rule 21AAA election, then it is taxable every year, whatever accretion in the fund is there. Now accretion may be 2 types. It may be either a dividend that particular stock issues a dividend, right, or there will be a capital gain. Right? Because this the there’ll be a churn that happens in the fund, and then securities are bought and sold, and there is a capital gain.
Now you so what basically you need to do is that you need to divide the accretion into dividend or capital gain. Right? And dividend is, again, taxed as for the Indian law, it is it gets there is no special tax treatment for dividend. It’s part of the income, other sources. Right?
Capital gain again, for capital gain, it is treated as unlisted share because it’s not listed on the Indian Stock Exchange, those shares. So it is treated as unlisted share. Any holding above 24 months will qualify as long term capital gain. So separate rules apply 20% with indexation. Or if it is within 24 months, then it is short term capital gain.
It’ll be added to your, slab added in tax added to your income and taxes as the slab rates. So that that computation has to be properly done. Right? And accordingly, the income has to be offered to tax. This is only to the extent of the withdrawal that you do, not the entire fund, obviously.
Only for the withdrawal, you need to make that division. Within the withdrawal, you need to first make the division between contribution and income. So contribution is not taxable. It is your own money. Indian government cannot tax that money.
Income is settled. Within income, you need to make a division between dividend and capital gain. The dividend, you need to add in the other sources. Capital gain, you need to add in capital gain depending upon short term, long term capital gain. Right?
Now income. Now this is foreign income. You are a resident, ordinary resident for India. It’s a foreign income. Now there are very, very, you know, stringent requirements on foreign income.
Every country has. US also has. Right? So in India, there is a requirement that the foreign income and the asset need to be reported in schedule FSI and FA. So you cannot opt for I tier 1, which is the normal I tier.
You need to go for I tier 2. And if you have business income, you need to go for I tier 3. Right? So only in those ideas you have these schedules. So you need to fill schedule FSI very carefully, FA very carefully.
Right? And accordingly, you need to disclose. If you don’t disclose, then there are stringent penalties in the under the black money law. Right? And under the black money law, the penalties can range from huge penalties, in terms of amount money wise or even a jail term, right, in some rare cases.
So you need to be very careful that you need to disclose the these particular, incomes very clearly as per the election that you have made. If you even if you have made Rule 21AAA election, then also you need to disclose the income in FSI and FA and put it as 0 tax payable as 0, and then you can mention it that you have taken a Rule 21AAA election. Right? So even the fact that you have made a rule AAA election doesn’t mean that you don’t disclose in FSI and FA. You need to disclose.
Right? Even your US bank accounts or any other investments in US. Right? All that have to be disclosed. Right?
So this is about the income. Now rollover. If you want if you do a rollover to another IRA now I’m not sure whether that is can be done. I’ve read somewhere that, rollovers cannot be done once you become a nonresidential. Right?
But I’m just mentioning it. Right? So if you do a direct rollover, it’s a trusted to trusted rollover, then there is no tax. Right? Again, this is my interpretation of the thing.
Right? This see, Indian tax law, nowhere says about 401k or IRA. So every CA will have his own opinion. Right? So, direct rollover where a trustee to trustee rollover is that you don’t get anything.
It’s just between trustee to trustee. There’s no tax. However, indirect rollover where the basically, the trustee gives you a check, and you deposit the check with the other trustee. Now, see, here, first of all, whether it is possible or not, I’m not sure as a nonresident alien for US tax law once you have returned back to India. But even if you do that, now as for the US tax provision is that if you do it within a period of 60 days, then it is not taxable.
Once a year, it is allowed. Right? However, as for Indian tax law, they will not recognize this. They will say you have redeemed the whole fund even if you put in the new fund. So the entire income from the total fund will be taxable in the year in which you do a indirect rollover.
Right? So that is my interpretation of the tax law, Indian tax law. Now let’s come to withdrawal. Right? You so as a as a person who has returned to India, you’ll want to withdraw the funds, whatever you because it represents a significant chunk.
Right? Now, again, withdrawal depends on whether you had made the route 2011 triple a election or not. Right? If you had made a route triple a 21 triple a election for tax deferred, what is route 21 triple a? That Indian government says that, okay.
We understand the fact that the withdrawal will be taxable to you in US. At the time of withdrawal, you will be taxed. So we also want to give you a deferral that till the time you withdraw, it is taxable in US, we will also not tax it. It is only that kind of a it’s a deferral. It’s not they don’t make it tax free.
Indian government says that from the 1st year that you become a ROR to, like, 20 years down the line that you attain 59.5 and you withdraw. They are not saying that for these 20 years, whatever is the accretion, we will make a tax. We know. Indian government is not that stupid. Right?
Indian tax authority is not stupid. They are just saying that for your convenience, we will not tax it because otherwise, what happens, the problem is effect mismatch in the tax credit. That means the income is taxed in India in every year, and the income and that the withdrawal at the time of withdrawal, it is taxable in US. So there is a mismatch of the year. So you cannot take the tax credit of the tax that is paid in US.
So they are trying to make things easy. They are saying you make the rule triple a election by filing form 10 double e. We will tax you at the time of withdrawal. Now if that rule triple 21 triple a election was made, only the income component of the withdrawal is taxable in the year of the withdrawal. Again, understand, you withdraw, like, $10,000.
Out of that, $8,000 was basically your contribution only, and only $2,000 was income. So only Indian government will tax you on the Indian government cannot tax you on the entire $10,000. You can argue before the Indian tax authorities that this is you can only tax on the income. See, income tax act is a tax on income, not on the full amount. Right?
So it’s only 2,000. Within that 2,000, you need to make a bifurcation between how much is income, from dividend, how much is income from capital gain, accordingly, show it in the tax return. Now you cannot claim FTC. Right? Because what is happening here that in the year of withdrawal in the year of withdrawal, there is a tax that you’ll need to pay in US on the full $10,000.
And for the $2,000, you need to pay tax. So on that $2,000, whatever tax you’re being a payment in India, you can claim a credit of the lower of the US and India tax rate on the tax that is paid in the US. Right? So that computation, that calculation needs to be done, and you can then claim the FTC. So, generally, you cannot claim 100% of the FTC.
There’s always be a gap between what, you know, you can claim what is claimable and what you can claim, but you can claim in this case. Right? Because there is the same tax year in which, the claim is being made. Now if you have not made rule triple 21 AAA election, then it’s a problematic thing because to the extent that the tax was paid on accrual because every year you’ve been paying taxes. Right?
This is, like, assumed because if you have not been paying taxes, then it’s a violation. Right? So to the extent that you have already paid tax on withdrawal, there’s no sub separate tax. It’s like the same thing as FD. Right?
So if I have a FD of, like, 1,000 rupees, and every year, there’s a, like, every interest of 100 rupees, and the net withdrawal, it’s accumulative FD, and 2,000 I get on the withdrawal. Then 100 100 100 100 100 every year I made given the tax return, paying tax on that. The 2,000 I get that 2,000 doesn’t become taxable. At the time, I received 2,000 the 1,000 interest cumulative doesn’t taxable because every year I have paid. Similarly, if you have paid the tax due on the accrual basis on the income component every year, then there is no tax on the withdrawal.
Right? Now FTC here is not possible. Foreign tax credit is not possible because here, what is happening is in India, you are paying taxes every year. However, in US, you are paying the taxes at the time of withdrawal, so there is a year mismatch. In case of year mismatch, you cannot claim the FTC.
That’s why highly, highly advisable. If you want to keep the, the 401k, in India till, like, for 59.5, always make Rule 21AAA election. That’s a very, very important tax benefit. Right? Okay.
So this is about 401k or traditional IRA taxation in India. I hope this was useful. Do please share your queries, your thoughts in the comment section. Thank you so much for watching this video. Thank you so much.