TAXING ISSUES Important Tax Considerations For Americans Moving To The United Kingdom

The following is designed to provide general tax information for Americans contemplating a move to the United Kingdom and does not constitute legal advice. As with all legal issues, seeking tailored advice from qualified counsel is advisable.

Americans who relocate to the United Kingdom will encounter an income tax system with many similarities to the one they have grown to know and loathe in the United States. Nevertheless, continued US tax obligations, combined with new tax responsibilities in the United Kingdom, create a landscape characterised by both opportunities and pitfalls.

1. Tax Reporting Obligations And Remittance-Basis

Similar to taxation policy in the United States, UK tax residents will generally owe tax to Her Majesty’s Revenue and Customs (HMRC) on worldwide income. But unlike the US system, many taxpayers do not need to file an annual tax return (known as a “Self-Assessment”) with tax responsibilities being largely satisfied through withholdings. For example, an individual earning UK wages as their only source of income would not need to file a tax return unless earnings for the tax year ending April 5th were greater than £100,000.

Importantly, Americans who are in the process of moving to the United Kingdom should be aware of potential tax savings through election of remittancebasis taxation. This tax status has no corresponding policy in the United States and creates an opportunity to protect non-UK investment income from UK tax for a limited time following a move.

While there are rigid guidelines to be followed and good advice is crucial, in essence, investment income from non-UK sources earned during the remittance period is not subject to taxation in the United Kingdom unless funds are remitted into or otherwise spent in the UK. US tax would continue to be due, but Americans with short-term plans in the United Kingdom who earn considerable investment income would be wise to analyse possible tax savings that would be produced through this strategy.

The remittance basis can only be used for seven years after arriving in the United Kingdom after which time an annual charge of £30,000 applies. This annual charge then increases to £60,000 for those who are resident in 12 of the prior 14 years, and is not available once deemed domiciled, which applies after 15 years of residence during the prior 20-year period. Please note, domicile determinations can be challenging, and if strong connections are not maintained outside the United Kingdom, there will always be risk of a determination that UK domicile has been established by choice, thus eliminating protection of remittance basis.

Irrespective of UK status and filing obligations, US citizenship status will require that annual tax returns and foreign bank account reports continue to be filed back home. Because of these continued US tax obligations, many provisions are in place to eliminate exposure to double taxation for an American living in the UK, but cracks in the foundation do exist.

2. Tax Rates

Outside of remittance basis taxation, tax will generally be assessed in the United Kingdom at a rate higher than the corresponding rate that would be due on that same amount of income in the United States. Income from salaries or self-employment, pensions, interest, and rental income will face a “basic” tax rate of 20% after the application of a personal allowance of (£12,570 in 2023/24). A “higher” tax rate of 40% applies to income in excess of £50,271 and an “additional higher” rate of 45% is applied to income over £125,140, recently reduced from £150,000.

By comparison, the progressive tax system in the US contains over twice as many rate bands and a top rate of 37%, which in 2023 does not kick in until total income reaches $578,125 ($693,750 for married taxpayers filing jointly). Americans who are resident in states with high rates of income tax, such as California, Hawaii, or New Jersey, will tack on an additional state tax charge and face rates closer to those encountered in the United Kingdom. But a permanent move from Texas, Florida, or another state with no personal income tax will always come with a hefty increase in the overall income tax bill.

3. Tax Incentives For Pensions And Investments

UK tax policy incentivises investment and offers a wide range of tax protection opportunities for British taxpayers working to fund their retirement or just save for a rainy day. To offset the brutality of the rates described above, tax incentives on investment and retirement are often considerably more generous than those offered in the United States. But unless specifically provided for in the United States – United Kingdom Income Tax Treaty, American citizens will continue to pay US tax on their tax-protected UK income.

UK Individual Savings Accounts (ISAs)

Participation in retirement savings schemes in the UK is largely protected by this Treaty; however, the Individual Savings Account (ISA) designation will be disregarded for US tax purposes as the accounts do not qualify as retirement plans. ISAs create opportunities for British taxpayers to make limited annual contributions to tax-free investment accounts that can be withdrawn at any point, irrespective of age. ISA income remains fully taxable in the United States and retains its underlying character (ie., dividends, interest, capital gains, or PFIC income!).

Tax Incentives For Investment Income

In the United Kingdom, annual tax-free allowances on different sources of investment earnings have been steadily reduced over the past few years. For 2023/24, tax free allowances are offered for dividends (£1,000), capital gains (£6,000), interest (£1,000) and rental income (£1,000), in addition to the personal allowance. The allowance for interest is reduced to £500 for higher rate taxpayers and eliminated at the additional higher rate.

Rates on dividend income have also been increased. Basic rate taxpayers pay a tax rate of 8.75% on dividend income, which is increased to 33.75% for higher rate taxpayers, and 39.35% for taxpayers in the additional higher rate. For capital gains, basic rate taxpayers pay a 10% rate on the sale of assets other than residential property which is taxed at a rate of 18%. Higher and additional higher rate taxpayers will pay capital gains rates of 20%/28%.

On the US side, American taxpayers benefit from a 0% tax rate on long-term capital gains and certain dividends while in the 10% and 12% tax brackets and pay a rate of 15% thereafter. The rate then jumps to 20% once taxpayers reach $492,300 in income ($553,850 for MFJ) (2023). No corresponding allowances are available, meaning US tax could potentially be due on tax-protected UK income.

Further complicating matters, outside of the interest allowance in the United Kingdom, Americans will generally face UK tax on tax-free interest income from certain US government bonds and obligations. Health and education savings plans in the United States can also carry unintended UK tax consequences.

Mutual Funds And Unit Trusts

Despite the tax incentives for investment income in both countries, mutual fund investments are problematic for Americans on both sides of the pond. Mutual fund investments in the United Kingdom will be subject to taxation under the Passive Foreign Investment Company (PFIC) rules, whereby gains and certain irregular distributions are taxed at the highest marginal rate in the US with additional interest charges accruing over the holding period. The result is that the cost of compliance on the US side and underlying tax obligations have the potential to largely undermine investment objectives.

US mutual funds can also be inefficient for Americans who are tax resident in the United Kingdom and not using remittance basis. Like the PFIC rules in the United States, the United Kingdom taxes gains from certain non-UK mutual funds and unit trusts at income tax, rather than capital gains, rates. Fortunately, the same punitive rate and interest charges assessed in the United States under the PFIC guidelines do not apply.

Net Investment Income Tax (NIIT)

This 3.8% tax is assessed in the United States against the investment earnings of Americans with income over $200,000 ($250,000 if MFJ and $150,000 if MFS). Even when the investment income is UK sourced and more than sufficient foreign tax credits are available, as it is classified as a “Medicare” tax, the IRS maintains that is not part of the foreign tax credit calculations and cannot be reduced by UK income tax paid.

Retirement Savings

Opportunities to save for retirement start to form the silver lining of the landscape. Provisions in the Treaty provide protection from current taxation of plan-level earnings in qualifying retirement arrangements in both countries. Moreover, a unique provision protects same country rollovers and post-retirement Roth distributions from taxation in both countries. With retirement savings strategies being the main area where the stars align for American expats in the United Kingdom, coming up with a plan to optimise participation with your financial advisor may be a good idea.

Nevertheless, a couple of additional considerations will come into play when thinking about UK pension participation from a US tax perspective. First, in the United States, retirement funds can be accessed before age 59 ½ by paying an additional 10% tax on taxable portion of the distribution. In the UK, there is no similar mechanism to access your pension pot before age 55 without considerable cost and unfavourable tax ramifications.

Furthermore, UK pensions will be reportable as foreign assets for purposes of US, FinCEN and FATCA filings. The reporting is purely informational in nature, but Americans who leave behind retirement accounts in the United Kingdom will need to make sure they understand what ongoing reporting will be required of them even after a move back stateside.

4. Home Ownership

Keeping up with the momentum of the retirement savings alignment, ownership of a personal home is heavily incentivised in both countries with broader tax savings available in the United Kingdom. For US purposes, a taxpayer can exclude up to $250,000 of gain from the sale of a home that he or she has owned and used as a principal residence for two of the prior five years. This is doubled to $500,000 for married taxpayers filing jointly.

The tax exemption functions quite differently in the UK, where periods of usage as a main home can create a partial tax exclusion in the future, even when the property has not been used as a main home for an extended period. Furthermore, no cap is placed on the maximum amount that can be excluded from tax in the UK, meaning that gain from the sale of a property that has always been used as a main home in the UK will be fully tax protected irrespective of the amount of profit produced. Considerable capital gains could be generated from the sale of a main home that would be tax protected in the UK but taxed at capital gains rates with NIIT exposure in the United States, resulting in a sizeable check potentially being cut to Uncle Sam.

5. Child Tax Credits

Ending on a high note, filing US taxes can be a joyous occasion for Americans with children living in the United Kingdom. Since 2017, the income limitations for claiming the child tax credit have been increased to $200,000 for single taxpayers and $400,000 for married taxpayers filing jointly.

The way the tax credit ordering rules function on the US tax return allows for the foreign tax credit for UK tax to be applied first, fully offsetting the US liability and converting a portion of the child tax credit into an actual cash payment of up to $1,500 per child (2023). Americans with children who have been claiming the foreign earned income exclusion on their tax returns may want to ensure they have not left money on the table.

Conclusion

In summary, double taxation can generally be planned against despite the differences between the tax systems. Unfortunately, tax incentives in one country may be largely eliminated by limitations of the other. As a rule of thumb, the tax policy you will need to be concerned with is the more unfavourable between the two countries under the circumstances. American expats experience the best of both worlds in many ways, but do face the worst of both when it comes to taxes. Let us make it easier for you.

Roland A. Sabates, Expat Legal Services Group

Expat Legal Services Group offers unique legal services for American expatriates and foreign nationals with financial interests in the United States. Our firm serves the expat community in the areas of international tax, immigration law, and cross border business and estate planning leveraging a suite of modern technology solutions. Contact Expat Legal Services Group today at info@expatlegal.com or visit the website at www.expatlegal.com.

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