As a US Citizen or permanent resident living in the UK, you have to comply with the tax laws of both the UK and the US, and it can get complicated (and seem scary). In this article, we will walk through the most important components of both country’s tax systems, so that you know what you are up against and are aware of the key issues you will want to consider to ensure you are complying with the laws of both countries while optimizing your own tax situation
US Tax Implications
TL;DR
You’ll still have to pay taxes to the US whilst you are living in the UK. That said, a double-taxation treaty between the two countries means that you can most likely avoid double taxation of your income if you take advantage of certain mechanisms for reducing tax liability available to US citizens or permanent residents living abroad.
US Worldwide Tax
The US is one of two countries in the world that taxes its citizens and resident aliens on income earned anywhere in the world (what is known as ‘Worldwide Income’). Unfortunately, this means most types of income earned whilst you are living in the UK (including capital gains and property) are subject to US income tax, and that you will need to file an income tax return in the US every year. It is also worth noting that you automatically get a 2-month filing extension to June 15th as an American expat. (Source: IRS, KPMG)
Thanks to the 2001 UK/US Double Taxation Convention, you are unlikely to be taxed twice on the same income, but the U.S. Worldwide Tax adds additional layers of complexity and potentially more cost (particularly to investment income) (Source: UK Government site). For instance, it might mean that certain tax-free mechanisms (like the Individual Savings Account - ISA - in the UK) might not be recognised in the US, and therefore subject to US tax.
US Tax Relief
There are a few ways to avoid double taxation and to reduce or eliminate your US tax liability while you are living in the UK. Taking advantage of these US-based relief programs can often require complex calculations and multi-year planning. This section will give you an overview of the issues, but it may be worth speaking to a tax professional to determine how best to handle your specific situation.
Foreign Earned Income Exclusion (FEIE)
The FEIE allows US taxpayers to exclude up to $105,900 (2019) or $107,600 (2020) of their of foreign earned income from their taxes. To qualify: you must have foreign earned income, your tax domicile must be in the UK, and you must either pass the A) bona fide residence test or the B) physical presence test. Earned income does not include “passive income” such as interest and dividends, which will be taxed separately (see PFIC). (Source: KPMG).
For some taxpayers, it may not make sense to claim the FEIE, which offsets income taxed in the lowest brackets, rather than the highest (known as the FEIE ‘stacking’ rule). Given that the UK has higher tax rates than the US, it may be beneficial to explore other options, including Foreign Tax Credit and itemized deductions. Another consideration when deciding whether or not to participate in the FEIE (taxpayers must formally elect to participate in the FEIE “program”) is that taxpayers who revoke participation may not be eligible to participate in the program for seven years. (Source: KPMG).
Foreign Housing Cost exclusion (FHCE)
If you elect the FEIE, you can also qualify for the Foreign Housing Cost Exclusion (or the Foreign Housing Deduction, if you are self-employed), which allows you to exclude or deduct housing-related expenses over 16% of that year’s FEIE exclusion, effectively increasing the total sum you can exclude per tax year.
Qualified housing-related expenses include rent, utilities, personal property insurance, furniture rentals. The cost of household labor (cleaners, cooks), mortgage payments, furniture purchases, etc. cannot be included.
You’ll also need to make sure that your housing-related expenses do not exceed the maximum housing expenses limit, which is usually set at 30% of FEIE but can be higher for places the IRS recognises has a high cost of living (including the UK!). You can access a full list here (see page 11).
Example: Bob works for Company X in London. In 2019, Bob’s housing-related expenses were $35,000. Since $35,000 is greater than the base rate of 16% of 2019’s FEIE exclusion amount of $105,900 ($16,944), he qualifies for the housing allowance. To calculate Bob’s housing allowance, we subtract the base rate from the total housing-related expenses ($35,000 - $16,944 = $18,056. Bob can now add $18,056 to the 2019 FEIE exclusion amount of $105,900 to get his total exclusion amount for 2019. In other words, by taking advantage of both the FEIE and the Housing Exclusion, a total of $123,956 of Bob’s income is exempt from US taxation.
Foreign Tax Credit (FTC)
The FTC is essentially a dollar-for-dollar credit on the taxes you pay to a foreign country. Since the UK has higher tax rates than the US , then the FTC may help you offset or completely eliminate your US tax liability. For anyone whose income exceeds the limits laid out under the FEIE, the FTC can be the better option. To claim a tax as a FTC, it must be an income tax, war profits tax, or excess profits tax, or a tax paid in lieu of one of those.
Say for instance Bob earns £100k in the UK in 2019. The HMRC taxed Bob approx. £35k. If he had instead lived in the US, he would have only been taxed £31k, which gave him a £4k tax credit in the US through the FTC scheme. He can carry this over as a tax credit in the US for the next ten years to offset future tax liabilities.
Itemized Deductions
Using Itemized Deductions (as opposed to standard deductions) for your US tax return allows you to deduct certain expenses from your taxable income, including foreign tax paid. In some instances (ie if you have high medical expenses or mortgage interests), this can be a better option than claiming the FTC. However, this route can also require a significant amount of documentation. Again, we would recommend speaking with a professional to explore whether this is a good option for you. But you can first learn more by reading this page from the IRS for more details on FTC versus itemized deductions).
Income earned in the US
Any income earned in the US (referred to as ‘earned income’) is obviously not considered foreign by the IRS and therefore cannot be excluded from US taxes. However, if you are required to pay UK taxes on your US income, you may be able to use the Foreign Tax Credit as a dollar-for-dollar credit to offset the US taxes you owe.
FBAR AND FATCA
As stated above, all US citizens and resident aliens are required to file a US tax return every year. The US government may also require you to submit additional information about your financial holdings abroad through the FATCA and FBAR forms, which are filed separately from tax returns. Depending on your personal financial situation, you may be required to file FATCA, FBAR, both, or neither. Here is a brief overview to help you figure out what may be required of you.
FBAR
FBAR (Foreign Bank Account Report), is part of a US initiative to prevent American citizens from hiding money abroad. You must file an FBAR if the total aggregate balances of all your UK (and other foreign) bank accounts exceed $10,000 (which is a low base) . Even if your account(s) exceed $10,000 for only one day, you must file an FBAR. Pensions and investments may come into play here too. The FBAR is filed electronically through the BSA e-filing system, which is filed separately than your tax return and is due when you file your taxes.
FATCA
FATCA (Foreign Account Tax Compliance Act), is similar to FBAR in that it is intended to combat tax evasion. It takes a more comprehensive approach by targeting all foreign-owned assets (not just bank accounts). That said, the filing thresholds are much higher--generally only individuals without total assets above $200 - $300K are required to submit these forms. Assets covered may include foreign pensions, stockholdings, partnership interests, financial accounts, mutual funds, life insurance policies, etc. but do not include a personal residence in your foreign home. If the combined value of your assets exceeds the threshold, you will need to file Form 8938 with your taxes. You can learn more about the FATCA reporting thresholds from the IRS here.
Capital gains
While you are tax-domiciled in the UK, your UK investment income (including dividends and interest) is subject to tax under the same rules for residents of the U.S. Interest income is subject to tax unless it is from a “qualified obligation of a state, county, city, or municipality” in the United States (these are commonly referred to as “municipal bonds”).
In the U.S., capital gains are taxed at different rates, depending upon the holding period and the nature of the asset. Short-term capital gains (gains on assets that were held 12 months or less) are taxed at normal income tax rates. Long-term capital gains (+12 months) are generally taxed at 15 percent % (although this could be 8% if you have lower levels of taxable income or 20% if you have higher).
Passive Foreign Investment Companies (PFICs)
A PFIC is an investment company registered outside the US whose income is primarily “passive,” ie. generated from dividends, interest, rent, capital gains, etc. Many investment products, such as mutual funds and ETFs, are considered PFICs, so it’s important to watch out for these as you are deciding how to invest your money in the UK.
The IRS discourages investment in PFICs by levying punitive taxes on any gains, and in most instances similar US-registered funds will be more profitable (and less of a headache!).
State taxes
Depending on the state you lived in before moving to the UK, the length of your international assignment, and the connections you maintain with the state during your absence (e.g. whether you maintain a residence there), you may still be subject to state income tax whilst you are living abroad. Tax law varies greatly from state to state, and it is important to review your own of circumstances with your tax adviser. If you are subject to state income tax, be aware that many states do not allow the FEIE or the FTC that you might qualify for at the federal level (Source: KPMG).
UK Tax Implications
Your residency status in the UK will affect how you are taxed by HMRC on both UK and foreign income. It’s important to first clarify your residency status, which will depend on how many days you spend in the UK during the UK tax year (6th of April - 5th of April the following year) and where you are considered ‘domiciled’ from a tax perspective. Here are the main groups:
Resident
To be “domiciled” in the UK means that you consider the UK to be your permanent home. You are considered a UK resident if either A) you spend 183 or more days in the UK in the tax year and/or B) your only home is in the UK, where you have owned, rented or lived in this residence for at least 91 days, and you spent at least 30 days there in the tax year (Source: https://www.gov.uk/tax-foreign-income/residence).
Non-domiciled Resident
The UK government considers your domicile to normally be the country your father considered his permanent home when you were born. However, your domicile may have changed if you have moved to the UK and do not plan to return to the US (then you would become a domicile resident). These definitions are not necessarily straightforward - the HMRC has four different flow charts to help you determine whether you are domiciled and non-domiciled - and the charts don’t even provide you with conclusive answers (e.g. ‘you are probably domiciled outside of the UK..;). If you are confused about your domicile status, it is best to speak to an advisor.
Deemed Domicile
To make things even more complicated, if you are not a resident of the UK, you can still be ‘deemed domicile’ if either A) you were born in the UK, the UK is your domicile of origin, and you were resident in UK for 2017-2018 or later years or B) you have been UK resident for at least 15 of the past 20 tax years. You can find more guidance about Deemed Domicile status from the HMRC.
Non-resident
You are a non-resident if either: A) you spent fewer than 16 days in the UK (or 46 days if you have not been a UK resident for the last 3 years) and/or B) you work abroad full-time (averaging at least 35 hours a week) and spent fewer than 91 days in the UK, where no more than 30 days were spent working.
There ar other residency statuses too - secondment, student, temporary assignment, ‘deemed domicile’ etc. Again, best to do some research or get professional help. You can read more about it in HMRC's Statutory Residence Test guidance note or talk to an advisor.
Everyone who earns income in the UK - whether that is earned from work, capital gains, property - is subject to domestic UK income tax (and allowances). Like the US, many of the UK taxes are progressive, meaning that those with higher incomes pay taxes at a higher rate.
Filing Requirements
Tax is usually deducted automatically from UK wages and pensions - so you will not need to submit a tax return if your income only comes through these means.
You must file a tax return to the HMRC if:
- Your income exceeded £100,000
- You were self-employed as a sole trader and earned more than £1k
- You were a partner in a business partnership
- You earned income from renting out a property
- You earned income from UK-based investments, dividends, savings
- You have foreign income
The HMRC has this handy tool to find out if you need to send a tax return for the upcoming tax year.
UK Tax on Foreign Income
From a UK perspective, any income from outside the UK (England, Scotland, Wales, and Northern Ireland) is deemed ‘foreign income’. If you have assets and/or investments that you are keeping in the U.S., you need to pay close attention to how the UK treats foreign income. Here’s the lowdown:
Arising basis
If you are a domiciled or a “deemed domiciled” resident in the UK, you pay UK tax on all foreign income on an arising basis, meaning you pay tax on income for the tax year in which it “arose” (was earned). Your income will be taxed regardless of whether it is brought to the UK.
Example: Liz has an investment portfolio in the US, where her financial planner helps her manage her investments. Since Liz is a domiciled resident of the UK and has long term plans to stay in the country, her U.S. investments are liable to UK tax on an arising basis. Given that the US also taxes on worldwide income, Liz is worried she will be double taxed. All is not lost - the UK and US have a double taxation agreement and in both countries where Liz can claim tax credits. It can get complex, but Liz’s money is unlikely to be taxed twice.
Remittance basis
If you are a non-domicile resident, you still pay UK tax on UK income and gains within the tax year that they arise. However, for your foreign income - you get to choose whether you want to pay tax on an arising or “remittance” basis. Remittance basis means you only pay UK tax on foreign income and gains if you bring (hence the word ‘remitted’) them into the UK. The UK requires you to pay a ‘Remittance Basis Charge’ every year to access this form of taxation - and this charge is £30k! So this would only be worthwhile if you have significant assets and/or investments in the US and you are a non-domicile resident.
Offshore funds and UK Reporting Status
The UK will tax revenues from foreign investments differently depending on whether they are in specific companies versus mutual funds. For foreign mutual funds, you will either be taxed at income tax rates or capital gains rates depending on how these funds report to HMRC.
The UK defines an offshore fund as a mutual fund constituted by a company, often an open-ended investment company (OEIC) or trust resident outside the UK. If a foreign fund meets certain criteria set out by HMRC, it can apply to become a UK reporting fund and they send reports to HMRC to be transparent about the fund’s reportable income. There is a list of funds that have successfully applied for reporting fund status on HMRC’s website, and it’s updated monthly. list (PDF 21KB)
Unless an offshore fund has UK reporting status for the entire period that the investor holds it, any gain will be taxed as income instead of capital gains. This could subject you to significantly higher levels of taxation - the difference will depend on your situation, but this roughly means you will be taxed 20% more. There is therefore likely to be substantial benefit to investing in funds that have UK reporting status.
‘Disposing’ of a Property
If you're resident in the UK, you pay capital gains tax when you ‘dispose’ of your overseas property. 'Disposing of an asset includes: selling it, giving it away as gift/transferring ownership, swapping it for something else, and getting compensation (like insurance payout if it's been lost or destroyed).
If the property that you are disposing of is on US soil. It's likely you'll also have to pay tax in the US as well. If this is the case, you can claim relief from the HMRC. (source: HMRC).
If you are a non-domicile resident and have selected the ‘remittance’ form of taxation, the rules are different - you can read more about that here.
Rent from foreign property
You pay tax in the 'normal way' on overseas property income - meaning the same way UK property income is treated by the HMRC (you can read more about that here). If you rent out more than one, you can offset losses against income from other foreign properties (source: HMRC).
HMRC Relief for Foreign Tax Paid
How much tax credit relief you get depends on the UK’s Double Taxation Agreement (DTA) with the US. Where the DTA gives exclusive taxing rights to the UK, no foreign tax is payable and there is no relief from the UK. This will all be calculated in your self assessment.
Where the DTA does not prevent a source of income or capital gain being taxed in both countries or there is no DTA, then relief from the HMRC may be available using either of the two methods outlined below: FTCR or deductions.
Foreign Tax Credit Relief (FTCR)
Unlike American tax credits., if you pay more tax in foreign country on an asset, the UK will not give you credit to carry this over.
Deduction Relief
Instead of using a credit to reduce the tax liability, the foreign tax incurred can be used to reduce the foreign income or capital gains that are chargeable in the UK. You can choose between FTCR or deduction relief, depending on which is most beneficial. Generally, deduction relief will only be preferable where there is no UK tax liability in the year, for example due to losses or the deferral of a capital gain.