According to more recent population studies, the number of US citizens living in the UK has increased to well over 200,000 individuals. Importantly, each and every one of these citizens has potential US tax obligations to consider.
For those US citizens working in the UK, US taxes are clearly an important implication of income generation, even if such income is UK sourced.
In this blog, we offer 5 basic tips for US citizens working in the UK, which elaborate on the obligation to file annually with the IRS, as well as other key insights.
TIP #1 – THE TAX OBLIGATIONS OF US CITIZENS WORKING IN THE UK ENDURE
Often, expats mistakenly believe that moving abroad means that their US tax obligations end. This is a fundamental error in understanding the US tax system.
US citizens, even those residing outside the United States, are considered to be US residents for tax purposes and are therefore subject to US tax reporting on their worldwide income. As such, US citizens working in the UK must annually report all of their income to the IRS, whether the income is US sourced or UK sourced, or sourced to any other country.
TIP #2 – INFORMATION REPORTING TO THE IRS
US citizens working in the UK who hold accounts or other assets overseas are subject to a number of specific filing requirements in the form of informational forms. Some of these forms are submitted to the IRS as attachments to the personal income tax return (Form 1040), while others are submitted to other governmental departments, including the US Treasury Department. The failure to file any of these forms can result in large penalties, such as a $10,000 penalty per form per year, or even have criminal consequences, if fraud is involved.
Some of the more common forms include:
- Foreign Bank and Financial Account Report (FBAR)
- Form 8938, Statement of Specified Foreign Financial Assets (FATCA Reporting)
- Form 3520, Foreign Trust/Pension and Gifts
- Form 5471, Foreign Corporation Ownership Reporting
TIP #3 – ACTIVITIES IN THE UK WITH US TAX IMPLICATIONS
With each item of income that an expat earns and with each foreign asset that is owned or acquired, special considerations need to be addressed. This is especially true for US citizens working in the UK. Other examples include:
UK Limited Companies, a popular business vehicle, raise potential issues from a US tax perspective. For instance, these entities may be considered controlled foreign corporations (“CFCs”) for US federal income tax purposes, a classification that can potentially have significant US tax implications. For instance, a 10% or more US shareholder of a CFC must include currently in his or her gross income the CFC’s so-called “subpart F income,” which generally includes passive-type income, such as interest, dividends and rental income (meaning, for tax purposes, a CFC’s subpart F income is considered to be earned directly by the shareholder prior to an actual distribution to the shareholder). Under the CFC regime, company loans to an expat owner can trigger a so-called “Section 956 inclusion,” i.e., current inclusion of the loan amount in a 10% or more US shareholder’s gross income. Starting with the 2018 tax year, certain non-subpart F income will also be required to be included currently at the shareholder level under the new so-called “GILTI” rules.
Also, a number of UK investment products may be classified as passive foreign investment companies (“PFICs”) for US federal tax purposes. PFIC status can result in very onerous tax implications if not dealt with sufficiently.
Examples of common UK investment products that may trigger adverse PFIC implications include UK corporate bond funds as well as certain insurance products with significant investment components (e.g., Scottish Widows). Additionally, most foreign mutual funds fall within the definition of a PFIC. This can be the case even if such funds are held through a tax-deferred savings account, such as a UK individual savings account (“ISA”).
Another common activity in the UK with important US tax implications is participation in a UK pension plan. In general, non-US pension plans do not qualify for the beneficial tax-deferral treatment afforded to certain US pension plans under Section 401 of the US Internal Revenue Code (e.g., a 401(k) plan). Fortunately, the US-UK income tax treaty may exempt certain UK pension plan contributions and earnings, assuming that the plan qualifies for beneficial treatment under the treaty.
Aside from the substantive tax consequences associated with UK pension plans, plan participation can also have important tax reporting implications. In some instances, a self-funded plan, such as a self-invested personal pension (“SIPP”), may be viewed as a “foreign grantor trust” for US tax purposes, which may trigger additional reporting obligations, such as the requirement to file a foreign trust form (IRS Form 3520).
Because of the US tax complexities associated with foreign pension plans, it is essential that US expats participating in a UK pension plan understand the full US tax and reporting implications associated with plan participation.
TIP #4 – US TAX BENEFITS ARE AVAILABLE TO US CITIZENS WORKING IN THE UK
The good news for expats living in the UK is that both US domestic tax law and US-UK bilateral agreements contain a number of provisions that are designed to prevent “double taxation,” or taxation on the same income in both countries. These include the foreign earned income exclusion (“FEIE”), foreign housing exclusion (“FHE”), and foreign tax credit (“FTC”).
These provisions, in many cases, can reduce or even eliminate the US federal income tax that would otherwise be due by the expat taxpayer. Keep in mind, however, that even if no US tax is owed, a US tax return still generally must be filed and the failure to do so can result in severe penalties.
TIP #5 – FATCA HAS EXPANDED THE REACH OF THE IRS
FATCA stands for the “Foreign Account Tax Compliance Act.” FATCA is a relatively new designed to combat offshore tax evasion by requiring US citizens to report their holdings in foreign financial accounts and their foreign assets on an annual basis to the IRS. As part of the implementation of FATCA, starting with the 2011 tax season, the IRS requires certain US citizens to report (on Form 8938) the total value of their “foreign financial assets.”
In order to further enforce FATCA reporting, starting on January 1, 2014, foreign financial institutions (“FFIs”) (which include just about every foreign bank, investment house and even some foreign insurance companies) became required to report the balances in the accounts held by customers who are US citizens. To date, we have seen several large foreign banks require that all US citizens who maintain accounts with them provide a Form W-9 (declaring their status as US citizens) and sign a waiver of confidentiality agreement whereby they allow the bank to provide information about their account to the IRS. In some cases, foreign banks have closed the accounts of US expats who refuse to cooperate with these requests.
If you are a US citizen working in the UK, it is essential that you remain compliant with your continuing US tax obligations. Our experts at Expat Tax Professionals are available to help you understand your US tax filing requirements and to assist you with all of your US tax compliance needs.