US expat tax specialist Tom LR Griffiths, from Ingleton Partners explains why some US expats end up with a big tax bill.
Around 200,000 US expats live in the UK, according to recent estimates. Many have lived here for years, and others have taken up residence on a semi-permanent basis. And despite the fact that the US federal tax system is one of the most far-reaching and complex in the world, a high percentage of these expats don’t realise that they could end up with a large tax bill.
This is particularly the case for US citizens who have lived in the UK for the bulk of their lives. For example, ‘accidental Americans’ are defined as people who were born in the US but have lived for so long in the UK that they consider themselves British citizens.
Taxes for US expats have a long reach
The US tax regime is government by the Inland Revenue Service (IRS). It is so wide-ranging that it covers everything from income to property and investment assets. And if a US expat is thinking about renouncing their citizenship, the IRS will consider all of their belongings in its final tax calculation.
So, for all US expats and green card holders living and working in the UK, it’s advisable to plan ahead as soon as possible. The IRS is particularly concerned with citizens they consider to be evading tax on purpose and go to great lengths to track them down.
US citizens working in the UK can make all kinds of investment decisions that will harm them in terms of tax if they don’t understand their obligations to the IRS. This is exactly what they need to avoid.
US expats must file tax returns in US and UK
Anyone holding a green card or US passport is liable to pay tax to the US authorities. In fact, America is one of just two countries in the whole world that taxes its citizens regardless of where they physically live. The other is Eritrea.
And for those US citizens living in the UK, it’s possible they will also be subject to this country’s tax authorities too. In some ways US taxes are comparable to those in the UK, but if the IRS considers that the person in question is avoiding tax then penalties increase.
Some investment options in the UK are not recognised by the IRS as tax-free. For example, some ISAs (Individual Savings Accounts) and a significant number of investment funds aren’t considered tax-free by the US authorities. While ISAs work well in the UK, they are not advisable for US citizens as they will have t pay tax on their interest, gains and dividends.
Investment funds aimed at UK investors are considered to be passive foreign investment companies (PFICs) by the IRS and are taxed in different ways. It’s also possible for an investor to assume they have no tax to pay as the fund hasn’t made any distributions (dividends or interest) only to find out their gains when they cash the fund in. If this happens, the IRS will catch up with the investor and tax the fund for each separate year the client invested. The default tax rate is 39.6%, with the current year taxed at the current rate of about 20%.
And while it’s possible to look into a fund that is compatible with the US tax system, these are generally rare and not often suitable. There are a few that are set up for dual tax reporting, but the choice is very limited. It can work better for people to have three-year funds, rather than investments that stretch into the long term. For conventional funds, US citizens must file separate returns every year, clearly stating gains made. With compliance and adherence to the tax obligations, there will be lower rates of tax incurred – between 20 and 28%.
Property sales also affected by tax
Another area that can trip up US expats living in the UK covers selling properly. In the UK, selling a person’s main residence isn’t subject to capital gains tax (CGT). In the US, sale of the main residence usually is.
And while some US citizens in this position choose to renounce their citizenship entirely, this doesn’t actually cancel the IRS bill. People who decide to either give up their US passport or green card are looked on suspiciously by the IRS, as it can appear they are doing so solely to avoid tax. In some cases, they will still be liable for US taxes for up to a decade.
Currency gains is another issue that can be misunderstood. For example, if someone bought a property for £1.5 million and sold it for the same amount, there is no specific gain. However, if the currency valuation means there is, in fact, a gain in terms of dollars, this will still be taxed.
Key points for US expats in the UK are:
- Find out your obligations to the IRS.
- Remember that US tax authorities have a long reach.
- Plan your taxes in advance.
- Get expert advice.
Ingleton Partners has the experience and expertise on tax matters in the US and the UK and specialises in US expat taxes. For more information on US taxes in the UK click here.