In this blog, we will discuss the UK NT tax code and US reporting compliance. An NT tax code relates to UK tax withholding. US reporting compliance deals with correctly filing your tax returns in the US.
Please note: we are not tax advisers and we do not give tax advice. That being said, due to our relationship with our clients and the vantage point we have over their affairs, we are often the first ones to spot possible issues, including the ones we are discussing here.
US Reporting Requirements
Many US taxpayers who grew up in foreign tax systems, like in the UK, are unaware of some unique features to the US tax code. Furthermore, there are some additional requirements for US taxpayers with “foreign” (I.e. non-US) assets and/or income that even many CPAs/EA*s are unaware of.
Here are the issues you should be aware of:
US residents are usually subject to US income tax on their worldwide income. Any non-US income must be reported and may be subject US tax. State pension benefits paid into a UK bank account are reportable and taxable in the US. UK rental property income paid into a UK bank account is reportable and taxable in the US. The same goes for UK pensions and all other sources of UK (indeed, any and all non-US) income.
If you assume that just because your pension/income/asset is in the UK then you don’t have to report it or pay tax on it in the US, then you are making a huge mistake and setting yourself up for much bigger problems down the line. If you suffer UK tax on it as well, you may get relief for this in the US under the treaty. But if you assume that since you’ve paid tax in the UK, then you don’t have to pay it (or at least report it) in the US, you are likely incorrect.
In our experience, this is one of the most common areas where expats make errors. Unlike many other countries, the US requires taxpayers (citizens and residents) to report their foreign accounts (not just bank accounts – ANY financial account) subject to certain relatively low thresholds, even when no immediate tax is due. Many countries subject resident taxpayers to tax on worldwide income, but few require assets to be reported every year. Furthermore, there are multiple forms required that have different thresholds and different requirements. These are known as “informational returns” and not submitting them can lead to stiff penalties and the statute of limitations on entire tax returns may remain open indefinitely.
Most commonly, expats with foreign assets should be filing FBAR (aka FinCEN Report 114) and 8938, although they have different thresholds at which they are required, so it is not always a given that both will be needed. Other common requirements include form 3520 and 3520A, which deal with gifts, inheritances, and foreign trusts (which, arguably, includes many foreign pensions and retirement accounts), and form 8621, which reports information related to PFICS, passive foreign investment companies. There are also requirements for owners/shareholders of foreign businesses and partnerships, and many more not addressed in this blog.
Gift and Inheritance Reporting
The IRS requires that US taxpayers report foreign gifts and or inheritances that total $100k or more in a tax year. The threshold is much lower if the gift is from a foreign company. The receipt of such gifts/inheritances is not necessarily taxable in the US, but not filing the form could lead to stiff penalties (see below).
US Citizens Abroad
The US tax system is based on citizenship, as opposed to residency. There are only two countries in the world that do this – the US and Eritrea. This means that if you are a US citizen you are likely required to submit a US tax return every year and report all your foreign assets, even if you do not live in the US. This can make life challenging for US expats. You will almost certainly be subject to double tax at some point. Hopefully, there is a robust tax treaty in place with your new country of residence (see earlier blog), which can mitigate most, but not all, double tax.
Given how common mistakes are with US asset reporting, the associated costs associated are the most shocking. If you are caught by the IRS, or self-report your non-reporting mistake, you may face up to 3 different financial implications: tax, interest, and penalties.
The tax is what the taxpayer should have paid. Interest accrues from when that tax was due, and it cannot be waived (even if the IRS wanted to which I am sure they wouldn’t). Penalties are usually punitive fines, even for innocent (i.e. non-wilful) non-compliance.
What shocks and frightens people the most are the potential penalties for not submitting the aforementioned informational returns when no tax was due. Taxpayers can unwittingly rack up tens of thousands (or more) of dollars in penalties by simply not reporting their foreign assets, even though no income or gains were unreported and no tax was unpaid. The same asset may be required to be reported on three or more separate informational returns and by not reporting it you can start racking up potential exposure to several [MK1] separately assessed penalties each year. It’s brutal.
The IRS probably knows about your non-US accounts (even if you haven’t told them): In 2010 the US introduced legislation known as FATCA, which stands for the Foreign Account Tax Compliance Act. It created, among other things, the requirement for foreign financial institutions to report details of all US account holders. Foreign institutions either comply or suffer penalties to their US businesses. This is one reason why it can be so difficult to open foreign accounts as a US person (anyone who has tried to open a UK bank account knows what we’re talking about).
This means that if the institution you hold accounts/investments knows you are a US person (say, for example, they have a US address for you), they are likely reporting details of your accounts to the IRS. Even if you haven’t told the IRS about your foreign accounts, they probably have details, and you would be wise to correct this voluntarily before they catch up with you.
PFICS (Passive Foreign Investment Companies)
In most cases, the US views non-US collective investment funds unfavourably. Although they may seem mainstream and benign, those collective investments are usually categorised by the US as Passive Foreign Investment Companies (PFICs).
Are you a US Citizen who has moved back to the UK and discovered what a burden US citizenship as an ex-pat can be, or perhaps you are still on a Green Card and plan on giving it up when you leave? Don’t just assume you can leave repercussion free.
The biggest issues we encounter are no or underreporting of foreign accounts (e.g. submitting some but not all informational returns) and of British expats returning to the UK as US citizens and underestimating the true impact of this on their financial lives.
The single best piece of advice we can give British expats living in America is to employ a US/UK-specific cross-border tax adviser to prepare your tax returns and advise you. Doing it yourself as an expat is an act of madness in our opinion and employing a local CPA/EA is often insufficient. Even employing a CPA/EA who says they have expatriate experience may not be enough.
We strongly believe that British expats should work with cross-border tax advisers who have specific UK/US knowledge and expertise, who understand the intricacies of UK products and, crucially, how they interact with the US and who are familiar with the US/UK tax treaty.
In a perfect world, every expat would consult such a professional before moving to the US and get their finances in order before emigrating here. Second best is to start working with one now and voluntarily clear up any issues that they diagnose. It will be stressful, and it may be costly, but probably far less stressful and costly than having the IRS identify the same issues.
* Everyone knows what a CPA is, but not an EA. EA stands for “Enrolled Agent”, as in enrolled with the IRS to represent taxpayers (most obviously by submitting tax returns). An EA is a tax advisor who is a federally authorised tax practitioner by the US Dept of Treasury. Enrolled Agent status is the highest credential awarded by the IRS.
Plan First Wealth is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.