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As US citizen you are required to declare your worldwide income. Foreign pension is included in your taxable income and taxed according to domestic law in the country you reside.
According to tax treaty between US and UK, pension is taxed only in one country. If you’ve been given exemption status from the foreign jurisdiction you’ll need to report the pension income on your US return.
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First, there's no double taxation if the income is excluded from tax in UK and only taxed in US.
According to treaty: "the amount of any such pension or remuneration paid from a pension scheme established in the other Contracting State that would be exempt from taxation in that other State if the beneficial owner were a resident thereof shall be exempt from taxation in the first-mentioned State."
But there's a difference between tax exempt and tax excluded. Tax exempt is income that is exempt from taxes by the law, like government bonds, welfare, inheritance/gifts, distribution from Roth IRA/401K or VA benefits. Tax excluded is income that would normally be taxed but under certain circumstances is not included in taxable income, like nontaxable portion of social security income, foreign income or capital gains from the sale of your principle residence (if you qualify) My understanding here is that the pension would have been taxed if you didn't opt out for the lump sum but instead you would take monthly/regular distribution. Lump sum option is excluded from the income, not exempt. Pension income, by its nature, is taxable income.
I still believe the entire amount is taxable in US, the treaty clearly talks about tax exempt, not tax excluded income.
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