Tax responsibilities as a US Citizen in the UK.

Often standard and sensible planning for a UK domestic taxpayer would include investing in an ISA (Individual Savings Account). For non-US citizen, it shields income and gains from UK income and Capital Gains Tax (CGT) forever, as long as the current rules remain in place. But for a US citizen? The IRS doesn’t recognise the tax-free nature of an ISA. In fact, it sees many UK investment products (including common funds and ETFs) as passive foreign investment companies (PFICs), which can trigger punitive tax treatment and extremely complex reporting.

Before opening any investment accounts, check with a cross-border specialist to make sure they’re compatible with both US and UK tax rules. At the very least go into the investments with full awareness and consider elections to alleviate some of the more punitive taxes. We would recommend finding an investment adviser used to dealing with US citizens in the UK.

Entrepreneurial expatriates sometimes set up UK limited companies without realising that the US treats foreign corporations very differently. The result can be duplicated reporting requirements, unexpected tax liabilities, and extra compliance burdens.

If you’re planning to start a business in the UK, speak to an adviser who understands both tax systems before you incorporate. Reporting of UK corporates for US tax purposes can be burdensome with a hefty compliance cost. Ensure all options are considered before pressing the button.

As soon as international travel or residence is involved ensure you have an adviser who is a specialist in dealing with overseas matters. Unless an adviser is used to dealing with those residents, travelling or investing overseas it is easy to get reporting wrong and store up major issues. When moving to the UK you need to have a UK tax specialist as well.

At Wilson Partners we are able to offer support with both US and UK tax returns and that tends to be where we offer clients most value.

If you hold aggregate maximum balances of more than $10,000 across your non-US bank accounts at any point in the year, you must file a Foreign Bank Account Report (FBAR). The penalty for not doing so can be as high as $10,000 per incorrect or late/non-filing. It is important you take appropriate advice and ensure reporting requirements are fully met. Whilst the form itself may be relatively straightforward it is easily missed for those who have not previously filed.

Whether it’s moving large sums, selling US property, or setting up a pension, decisions made without advice can cost thousands in unnecessary tax. Worse, some issues, like investing in PFICs, can’t easily be unwound. It cannot be emphasised enough that it is vital to check with an adviser before going ahead with any investment, sale or residence move. Don’t wait until it’s too late.

The US UK tax treaty is a formal agreement between the two governments that determines which country has the primary right to tax different types of income. In theory, this ensures that you aren’t taxed twice on the same income stream.

For example, if you’re working in the UK and paying income tax through PAYE, the treaty allows you to claim a foreign tax credit on your US return. This credit offsets your US tax liability on that same income, so while you’ll still file with the IRS, you typically won’t owe additional tax on that particular income.

The treaty breaks income down by type, and assigns “taxing rights” to one country or the other. There are exceptions and nuances so the below is rule of thumb rather than concrete advice to be relied upon. Below are some examples for a US citizen, resident and filing on worldwide basis of taxation in the UK.

Employment income: Taxed primarily in the country where resident, i.e. the UK. You report income in both places but use UK tax paid as a foreign tax credit on your US return. US workdays are typically treated as ‘foreign’ under treaty provisions. Care must be taken on State obligations where the treaty does not apply.

Interest: Taxed primarily in the country of residence (i.e. the UK), even if paid from the US. UK taxes on the income typically offset US tax due. Net Investment Income Tax (3.8%) can still apply in the US.

Dividends: If they come from a US company, the US gets taxing rights, typically up to 15%. The UK will then tax the dividend at UK rates and give you a credit for the US tax paid.

Rental income: The country where the property is located has first taxing rights. So, if you’re renting out a US home, you face Federal tax on that income, and the UK gives credit if you’re also taxed here. The US often does not have tax or the same level of net income due to more generous deductions for mortgage interest and depreciation. This can mean significant UK tax can still be due.

Capital gains: Generally taxed in the country of residence. However, there are exceptions, including gains from the sale of US real estate property which will still be taxable for Federal purposes and potentially a State with a foreign tax credit in the UK for US taxes.