11 minute read
Taxing Issues
Frequently Asked Tax Questions From Americans In Britain
Americans living and working in the United Kingdom encounter an added layer of complexity, even with respect to routine financial decision-making endeavours. Opening a bank account to buy groceries, owning a home, and saving for retirement will always need to be considered in the context of a framework created by the interaction of the two countries’ tax laws and incentives.
The following summarises general responses to basic questions American expatriates in the United Kingdom encounter while going about their day-today lives.
1. What Do I Need To Know About US Tax Reporting If I Open A Bank Account In The United Kingdom?
Accounts opened in the United Kingdom may need to be disclosed on one or multiple different reports, depending on the type of account and its value. Even if a separate disclosure is not required, American tax filers will need to check the appropriate box on Schedule B of their annual US tax return indicating that they do own a “foreign” account.
FinCEN Form 114, commonly known as the “FBAR”, must be filed annually if the value of non-US accounts exceeds $10,000 at any point during the year. This low threshold looks to the combined maximum balance of all accounts at any point during the year in determining whether a report must be filed. For example, an American with current and savings accounts with maximum balances of $5,000 and $5,001 respectively, would be required to file an FBAR disclosing both accounts.
Interest or other income produced in the account will be subject to tax under normal principles, but no tax is calculated on the balance of the accounts. The report is purely informational in nature, but strict penalties can apply in the event of noncompliance. Late filings could be penalised to the tune of $10,000 per unreported account per year, though there is currently some grey area with respect to how much latitude the IRS maintains in assessing such penalties.
Willful failure to file can attract penalties equal to the greater of $100,000 or 50% of the maximum value of the account. In recent years, the IRS has taken a more expansive view to what would be considered a willful failure to file, asserting that taxpayers have acted willfully if demonstrated that they had knowledge of the filing requirement or even acted recklessly in not knowing of their obligations. For example, checking “no” to the foreign account question on Schedule B could potentially be considered as a basis in asserting willfulness penalties against an American taxpayer. With the stakes being so high, diligence in this filing and taking a conservative approach as to what would need to be disclosed as a “financial account” is crucial.
The FBAR is filed electronically with the Financial Crimes Enforcement Network (FinCEN), separately from the tax return, and must be submitted by April 15th if an extension is not requested. As of the date of this publication, an extension form has not been released by FinCEN and Taxpayers are granted automatic extensions of time to file until October 15th.
Adding to the complexity, Americans in the UK will also need to consider the Statement of Specified Foreign Financial Assets on Form 8938, which may be required if the value of the non-US accounts exceeds $200,000 at the end of the year or $300,000 at any point during the year. These thresholds are doubled for married taxpayers filing jointly. The Form 8938 covers a broader range of nonaccount assets as well and is filed in conjunction with the annual US tax return. It comes with its own independent penalty regime, meaning that Americans who miss both filings could face compounding penalties across the various reports.
2. How Will Moving To The United Kingdom Impact My Social Security Benefits In The United States?
Living in the United Kingdom does not necessarily impact eligibility for US social security benefits. The same eligibility rules will apply, meaning that if you have over ten years of sufficient earnings in the United States, you will be eligible for benefits even if you are living permanently in the United Kingdom. American citizens are not subject to the presence requirement applicable to certain nonresidents and continue receiving benefits outside the United States.
While no restrictions exist on the ability to receive benefits while living in the United Kingdom, the calculation on the amount payable may be greatly impacted by UK coverage and the gap in contributions to the US system.
A bilateral social security agreement (known as a Totalisation Agreement) is in place between the United States and the United Kingdom to address dual coverage scenarios. The agreement provides in part, that an individual shall pay social security taxes in their country of residence, unless working for an employer from their home country for a period less than five years. In addition to resolving dual coverage discrepancies, the Totalisation Agreement contains provisions that create an avenue for covered individuals to still receive minimum benefits in scenarios where they have worked in both countries, but not for sufficient time to qualify independently.
The challenge comes for those independently qualifying for social security benefits in both countries. These individuals potentially face a reduction in US benefits based on the application of the Windfall Elimination Provisions (WEP). These frustrating rules are designed to address perceived overpayment in scenarios where pensions are calculated on safety net provisions that would not reflect coverage and participation in foreign countries.
To address this “windfall” Americans qualifying for a British state pension who have worked between 10-30 years in the United States will see their US benefits reduced. The reduction is limited by the lesser of 50% of the foreign benefit or a sliding scale offset, currently maxed out at $512 (2022).
This sliding scale looks to years of “substantial earnings” in the United States. Individuals who have between 20 and 29 years of relevant earnings face a reduction in the base benefit in an amount between 45% and 90%.
3. Are There Any Benefits To Owning My Own Home In The United Kingdom?
Owning your own home is a tremendous opportunity to build wealth, and both the United States and the United Kingdom offer robust protection against tax on gain from the sale of a personal residence. In this instance, the benefits offered by the UK are considerably more generous. The US rules require an individual to own a home and reside in it as a personal residence for two of the five-year period prior to sale. Qualifying taxpayers are granted an exclusion of up to $250,000 of gain ($500,000 for married taxpayers filing jointly). In the UK, the exemption from capital gains tax is unlimited, provided the property was used as a main home in the UK during the entire period of ownership. Gains from the sale of homes with partial use as a main home qualify for a prorated exemption from capital gains tax.
Clearly scenarios could arise whereby gain is fully or partially exempt from capital gains tax in the UK, but still taxed in the United States. In such a situation, both capital gains tax and net investment income tax (NIIT) could be due in the United States.
Gain or loss will reflect currency fluctuations between the dollar and the pound during the period of ownership. For US tax purposes, the cost of UK property would be figured in dollars using the prevailing exchange rate on the date purchased. Sales proceeds will be converted at the rate as of the date of sale. These currency rules can create even greater challenges for Americans with mortgages in the UK.
Mortgage interest paid to a British lender for a personal home in the UK is generally non-deductible in the United Kingdom but may still be deducted on a US tax filing by taxpayers who itemise. Nevertheless, a deduction that is available only in the “lesser-taxed” of the two countries will seldom produce material tax savings. The limited deduction available to US-based Americans for state property taxes is not available for local taxes and related fees in the United Kingdom.
4. My Company Is Giving Me The Option Of Contributing To A UK Pension, Should I Consider Doing This?
Private retirement savings options are broadly available to Americans with British employers. While financial investments can often be challenging for Americans abroad, retirement plan participation is broadly protected by the US/UK income tax treaty. The tax protected amounts per the treaty will be limited by the amount that can be contributed to a corresponding retirement arrangement in the United States. The combined employer and employee contribution limitation in the US is set at $61,000 (2022) and the annual pension allowance is currently £40,000 in the UK.
Certain American taxpayers who are funding British retirement arrangements and expect to eventually move back to the United States, may even be able to benefit from foreign tax credit planning strategies that would allow excess taxes paid in the United Kingdom during working years to offset US tax on distributions from the British retirement arrangement. Careful planning and recordkeeping is required to this end.
On the British side, the ability to reduce tax exposure on earnings and defer tax due on investments is obviously worth considering. An exemption from UK tax on lump sum distributions equal to 25% of the value of the pension is also available at retirement. Moreover, registered pension schemes are also treated favourably with respect to British inheritance taxes, an important consideration for many Americans who do not need to worry about estate tax on the US side. The lack of US tax limitations will allow you to prioritise tax savings on the British side in the retirement savings decision-making process.
But keep in mind that the limitations in place that impact higher earners and large account holders will be different across the two countries. In the United States, higher earners are prevented from directly contributing to Roth IRAs and Required Minimum Distribution (RMD) rules mandate annual distributions from non-Roth accounts once the owner reaches age 72. On the UK side, the annual pension allowance may be reduced for taxpayers with income over £200,000 and a lifetime exemption is in place applying additional tax on distributions from pensions beyond a certain amount, currently set at £1,073,100.
Another important distinction limits the ability to tap a British retirement scheme early. In the US, while almost always unadvisable, an early distribution can be taken from a US 401(k) or IRA arrangement at any point before reaching age 59½ by paying a 10% penalty, calculated on the taxable portion of the distribution. The same is not true in the United Kingdom. Amounts contributed to a private retirement scheme are locked in until age 55 without facing considerable penalties and additional fees.
Accordingly, while maximising UK retirement plan contributions can make smart financial sense for your family’s future, it should not be considered a “rainy day” fund or even an emergency savings account to be tapped as needed.
5. What Should Americans Know About ISA Accounts?
Individual Savings Accounts (ISAs) are the “rainy day” funds for British taxpayers and come in a variety of flavours, the most common being “cash” and “stocks and shares” ISAs. The ability to access funds at any point without penalty, and unrelated to the individual’s age, will generally make these arrangements ineligible as retirement schemes that would receive favourable US tax treatment under the treaty.
Accordingly, unlike with retirement savings, US tax considerations would need to be prioritised when thinking about opening an ISA. The biggest potential challenge with ISAs in the United States is that the tax exempt status in the UK and low interest rates available in cash ISAs can create an incentive to actively trade holdings within “stocks and shares” ISAs. For US tax reporting purposes, the ISA is disregarded, and income and gains from the underlying assets would be reported individually as if it were a taxable brokerage account. In addition to reporting challenges and complexity, American Taxpayers with this type of activity within an ISA account may be trading unit trusts or mutual funds and run into the dreaded Passive Foreign Investment Company (PFIC) trap, and punitive tax calculations and compliance charges that ensue.
With relative rates of tax being higher in the United Kingdom, an ISA may still make sense despite the potential tax hit in the United States. Nevertheless, US tax implications need to be top of mind to avoid an unfortunate tax outcome that would largely undermine financial savings goals. If these priorities are not appropriately managed, after paying US taxes the amount you had set aside for a rainy day may end up being just enough to cover you for a short afternoon rain shower in London!
The following is designed to provide general tax information for Americans in the United Kingdom and does not constitute legal advice. As with all legal issues, seeking tailored advice from qualified counsel is advisable.
