Despite most of us being under lockdown or self-isolation, the Club managed to run our eighth annual Expat Finance Matters in the UK seminar in March, but this year using the Zoom video service rather than meeting in person.

Our speakers were once again Rory Dorman, Partner & Investment Advisor, Maseco (which provides financial advice to Americans in the UK); and Matthew Edwards, Senior Tax Manager, Satis Asset Management. Matt has been dealing with the tax affairs for Americans in the UK for more than 20 years.

Rory and Matt, who have both spoken at these events in the past, again provided very helpful insights and advice for Americans alums who are now in the UK tax system. Here are summaries of some of the points we discussed (alums should consult a tax advisor before acting on any of the information or advice below).

 

Tax Filing and Deadlines

We started the discussion with two basic questions: “Do I need to file tax returns in both the US and the UK?” and "Given all of the issues surrounding COVID-19, will there be an extension to filing deadlines?"

On the first question, Matt told us that subject to some very small de minimis exceptions Americans are required to file tax returns wherever they are.

However, he has found that it's a remarkably common occurrence to see people who have never filed a tax return. He has even worked with some who didn't realize they were American citizens — they were born in the U.S. but had left soon after.

On the second question, the general principle in the U.S. is that you are supposed to file your tax return and pay your taxes by 15 April. It has always been the case, though, that if you live outside the U.S. you have an extra two months to file, so the deadline is 15 June. And beyond those deadlines you can file paperwork to ask for additional time, typically to 15 October or if you're outside the U.S. to 15 December. Those deadlines apply in normal times.

However, these are not normal times. In March the IRS announced they would extend their payment deadline from 15 April to 15 July. If you think you'll owe taxes you will have a bit more time to sort out what you owe. And right before our meeting they confirmed that in addition to extending the payment deadline they'd extend the initial filing deadline to 15 July.

This gives everyone an additional three months. For those who make quarterly estimated payments towards next year's tax liability, the deadline is also extended to 15 July. It's not clear at this point what happens to the second quarterly payment, which is normally due in June. So you could find that the second quarterly payment is due before first.

On this side of the Atlantic, HMRC announced that they're going to defer the 31 July deadline for making tax payments on account. Details weren't available at the time of our event; as of this writing, the GOV.UK website says, “Because of coronavirus (COVID-19), you can delay (defer) making your second payment on account. If you choose to delay, you’ll have until 31 January 2021 to pay it.”

 

Question: We relocated to the UK last September from the US and will be filing both returns for the first time in 2020: Are there any recommendations to ensure we have everything we need to account for UK income on our US 2019 return?

Matt said the first cause of confusion for people have just relocated to the UK is first and foremost different tax years. In the US the tax year ends at the end of December. In the UK the tax year ends on the fifth of April. And that causes some confusion. It also means that a lot of the standard tax reporting paperwork that you get from UK companies, UK banks, and UK employers is not on a calendar year basis, which you will need for your US tax filings. And by the same token the 1099 forms that you're used to having in the US are not on the fiscal year calendar for the UK.

Matt's first piece of advice is if you're employees, keep your pay slips, because whether you do your US tax returns yourself or you have someone help you, you'll need those to work out what your income for the year was. And if you have money on deposit or if you have investments, you're going to need to try to work out what your interest income or your dividend income was for the years that are relevant for the filing.

Other things to think about — although it's too late for 2019 — is if you have income, remember that the US allows credit for foreign taxes paid. The default position for calculating that is to look at the foreign taxes actually paid during the year. So quite often Matt advises clients to pay their UK taxes in December, rather than waiting until the January deadline for paying and filing UK taxes. By paying a month early the foreign tax will appear a year earlier in your US tax filings.  And that can in the worst case scenario save you a double taxation problem. In a normal scenario it's a cash flow issue; you save having to pay two lots of tax and then waiting a year or so to get one lot back.

 

Question: Do we only pay US tax on money earned in the US?

Matt told us you have to report all earnings on your US tax return. by default you are subject to tax on all income. However, if you've paid tax on that income somewhere else in the world such as the UK, the US will give you a credit for the UK tax you paid. As a general principle UK taxes tend to work out higher than US taxes, so this normally means you're not paying US tax on non-US income, although there are a few wrinkles that can apply and a few things to be wary of.

 

Question: How many years can we carry forward foreign tax credits?

You can carry them backwards up to one year and you can carry them forward up to 10 years; after that you lose them.

There's a much bigger conversation around what is called the remittance basis of taxation here in the UK. Broadly speaking, it enables certain people who are not British-born to only pay UK tax on their UK income. However, there is a complication, because there are some costs involved.

For everyone, the cost is the loss of your personal allowance, which is the amount of money you can make tax-free every year in the UK. Once you've been here for more than seven years you have to pay a £30,000 tax charge to get this special tax treatment. Once you've been here more than 12 years that £30,000 goes up to £60,000 and once you've been here more than 15 years, you lose the right to pay a fee and only pay UK tax on UK income.

 

Question: Could you remind us If your tax domicile changes after 18 years, or 18 of 20?

It used to be after you've been here for more than 17 out of 20 years it changed; it's now 15 out of 20.

 

Question: And if you move, can you change it back to the US?

Yes, broadly speaking; to restart the clock you effectively have to have been out of the UK for more than three years. And your domicile hasn't changed, per se, under legal terms. The UK legislation introduced a concept of "deemed domicile," so for legal purposes, you may well still be domiciled in the US once you've passed that 15-year period, but just for tax purposes you would now be considered deemed domiciled. The other distinction is that the old 17-year rules only applied to inheritance tax. The new rule applies to inheritance tax, income tax and capital gains tax.

As somebody who's deemed domiciled in the UK, your worldwide estate will fall within the scope of UK inheritance tax. Whereas if you are not domiciled it would only cover your UK assets.

That might not seem like a major distinction. However, the current rules in the US give everyone roughly an $11.6 million exemption for estate taxes. In the UK, you get £325,000. That can be important.

 

Question: I'm currently freelancing for a US company while living in the UK. I also earn a UK income. Do I need to pay UK taxes on the US income?

The short answer is probably yes, unless your freelancing involves you going over to the States and doing the work there. If you're doing all of your work here in the UK, whether it's from your office or from your home, then the UK is going to be your primary taxing point and it doesn't really matter whether your client or freelancing work is in the US.

 

Question: I received a gift from my parents that would be tax free in the US as it will be deducted from their estate exemption. The money is not yet officially in my possession. If I deposited it in a US bank account, will I be liable to pay UK taxes on it? What if I move the money to the UK, either depositing it in the UK bank account or saving it to buy real estate (my primary residence)?

Matt explained that since the money is a gift it's not considered taxable income, in the UK or in the US. It can be deposited in the US or the UK; you won't pay any UK or US taxes on receipt.

 

Tax-Efficient Investing

It can be difficult to find investments that are tax-efficient in both the U.S. and the UK. Rory tackled this question.

First, holding cash is reasonably tax-efficient; there are no tax penalties for holding cash. Rory advised staying away from holding cash in a money market fund, though.

Real estate is reasonably tax efficient. You will pay income tax on any rental income you receive and will pay capital gains tax on any gains realized when you sell a property. Americans in the UK should be aware that although in the UK your principle residence is completely free of capital gains tax, in the US you have an allowance above which you're obliged to pay U.S. capital gains tax on the realized gain. This is $250,000 if you're married filing singly, and $500,000 if filing jointly. This may go a long way in certain parts of the U.S., but it won't get you very far when you sell a property in London. (See below for more on this.)

It's also important to be careful of exchange rate movements. Right now the dollar is at an all-time historic high against Sterling, which is helpful if you're realizing a big UK gain. (Matt added, though, that he's had a number of clients get stung by exchange rate changes in the last couple years: if you're selling US-dollar-denominated assets and reporting the gain on a UK tax return the current strength of the dollar against Sterling can significantly inflate your UK tax charge. If you're considering significant dollar-denominated sales or transactions, you do need to bear in mind the UK tax implications.)

Rory continued: you can also hold individual stocks and bonds; this can be reasonably tax efficient. You'll pay income tax on dividends and capital gains on gains.

Things become more complex when it comes to investing in funds. As an investment house MASECO firmly believes in investing in funds rather than in single equities; they are strong proponents of diversification and believe it's difficult to get sufficient diversification by holding individual stocks. They therefore prefer to use funds as the building blocks of the portfolios they manage.

But there are complications. On the U.S. side, if you invest in a U.S. fund, you're fine from a U.S. tax perspective. But if you invest in a non-U.S. fund, such as a UK fund, there could be issues. These investments are know as PFICs, or Passive Foreign Investment Companies. "PFIC" is a U.S. term for any non-U.S. fund, and the IRS taxes PFICS in a fairly aggressive way.

There are two different possible tax treatments: you can either mark to market the investment every year and pay tax on the unrealized gains. For example, if you invest £100,000 and on December 31st of the following year the fund is now worth £120,000, even if you haven't sold the investment you will pay capital gains tax on that £20,000 or the dollar equivalent of the gains. For most people that's quite difficult in terms of cash flow.

Therefore, most people elect to only pay taxes when they sell the fund. The IRS then may say that you should have been paying tax on an ongoing basis, and since you didn't, they will penalize you by charging income tax rates, rather than capital gains tax, and will charge at the highest rate of income tax. They will then work out the amount of tax you should have paid on an ongoing basis and will charge interest on the taxes you should have paid. (But at no point will they charge more than 100% of the gains.)

if you're a U.S. tax payer Rory's strong advice would be to avoid non-U.S. funds.

On the UK side, the legislation is similar but less draconian. if you invest in a non-UK fund then that non-UK fund, say a U.S. fund, needs to have something called UK reporting status. If it doesn’t have that, then you will end up paying income taxes instead of capital gains taxes on any gains that are realized. The trick is to invest in U.S. mutual funds that have UK reporting status to keep both HMRC and the IRS happy.

Rory warned that the list on the HMRC website can be confusing. A US fund should have the prefix “US” in front of it. You may find funds that appear to be the one you're looking for, but with an “LU” or “IE” prefix. That means they're Luxembourg or Ireland funds, which would be PFICs and terrible from the US tax point of view.

Unfortunately, most US mutual funds do not have UK reporting status, because it can be expensive to gain UK reporting status. And the demographic of potential American investors living in the UK is small, which gives the firms little incentive to gain the status.

 

This led to a question on unrealized gains/losses in pensions.

Broadly speaking from both the US and UK tax point of view, you don't need to worry about what's going on inside your pension scheme, whether it's a US or UK pension scheme. You only have to worry about tax when you're taking the money out. The exception in the UK is if you're close to your lifetime balance. If the money's in a pension wrapper it's fine.

This raises another important point: if you have a SIPP or UK pension, broadly speaking it's deemed a foreign pension from the US perspective. You could put into that pension wrapper a number of kinds of UK investments that you should otherwise avoid. You'll pay income tax when you draw the monies out of the pension.

Another related question came up: If I use a lifetime ISA [Individual Savings Account] as a retirement savings account would that be treated as a pension wrapper from a US perspective? If not, what are the tax implications?

Matt replied: in short, the answer is no. It wouldn't be treated as a pension wrapper, it would be treated from a US tax point of view as an investment account or a bank account. So the tax implications in the US will depend on what you are investing that money in.

You will either have interest income if it's in cash or you will have investment income to worry about if it's in investments and that means you need to think about passive foreign investment. It's important to try to avoid investing in those.

Rory agreed. He often sees Americans in the UK who have built up savings and investments in ISAs. Unfortunately, they don't work particularly well for American taxpayers because you end up having to file any gains on your US tax returns as income. The IRS effectively looks through the ISA. That being said, given the strength of the dollar, this might not be a terrible time to try to unwind investments like this. But generally speaking, it's not a good idea to invest in ISAs if you're an American taxpayer.

 

Question: Can you provide some advice on pensions and Roth IRAs?

Roth IRAs are a type of pension scheme introduced in the late '90s. With most pension schemes you pay tax when you take money out. With a Roth IRA there's no tax relief on way in but then no tax charged on the way out if you meet certain requirements. In 2008 when we had our last big market crash there was a big run on converting traditional IRA accounts into Roth IRA accounts because the conversion from one to the other triggered a tax charge, and when the markets were low the valuations that people were getting taxed on when they converted were also low. There may be a similar flurry of activity now.

You can effectively contribute $6,000 a year into a Roth IRA without that being a taxable event. Provided you're in the US you can then pull it out tax free. You're not obliged to take required minimum distributions from it, which means that it can under the right circumstances offer good estate tax planning because on your death you can pass it down to your heirs as part of your estate, which in the US has a $11.65 million lifetime gifting allowance.

But your heirs will inherit it and it will still be within the Roth IRA wrapper; they will be subject to required minimum distributions, but they won't pay tax on those distributions. So if you have excess liquidity, it can be a nice planning option under the right circumstances.

For people who are going to retire in the UK, though it's not clear that HMRC will view the pension as if it were tax-exempt in the same way that a Roth IRA distribution in the US would be.

 

Question: Could I transfer it to a UK pension provider?

The likelihood of you being able to find a UK pension provider that will accept a transfer from a US retirement plan is somewhere between slim and zero. So it's probably best to leave it where it is.

 

Question: What are the US tax implications of being a shareholder / director of a UK limited company used as an investment vehicle? For example, a company that holds a residential buy-to-let property. Are we taxed only on distributions from the company in the form of dividends / salary or are there wider implications?

Matt said the short answer is there are wider implications. Rory mentioned the concept to PFICs: aside from applying to investment funds they can also apply to private companies, where those companies are investment vehicles. If the PFIC rules don't apply in this case it can be because you own more than 50% of the company or you, combined with other US shareholders, own more than 50% of the company. Then you get out of one set of unpleasant rules and you land squarely into another set of unpleasant rules: the Control of Foreign Corporations. In short what will happen is that the US would tax you on the profits of the company, and the UK will tax you on the dividends or salary that you receive from the company. That mismatch can cause problems. There are ways of making it less burdensome and elections that can be made.

But they have implications that probably need to be discussed in a more detail. Broadly speaking, Matt would normally advise a client in that situation, who owns, for example, all of the investment company, to make an election from the US tax point of view to treat the company almost as if it didn't exist or if there are multiple owners to treat it as a partnership; that will make the tax implications a little less painful.

There's also a reporting issue for the bank account, and a reporting issue for ownership of the company.

Being a controlling shareholder of a foreign company means extra forms go into your US tax returns. Depending on the activities of the company they can be relatively straightforward, or they can be extremely complicated.

There's also foreign bank account reporting (FBAR): if you are the controlling owner of a foreign company then the bank accounts of the company are considered to be your bank accounts for FBAR purposes. Even if you don't control it you still have to report the bank accounts if you have signatory authority.

A bit more on the FBAR: the US Government wants all of its citizens to file a report on all bank accounts that they own or control on an annual basis. There is a de minimis exception, but that de minimis is that your sum total of all of your non US bank accounts and financial accounts ,pension schemes did not exceed $10,000 at any point during the year.

The FBAR is a relatively straightforward but tedious exercise: you're asked to list out all of your non-US bank accounts, and the highest balance in those bank accounts during the year.

 

Question: Do we need to include pension schemes in FBAR reporting?

Matt told us there isn't a clear rule on this and there's some disagreement amount accountants. However his perspective is that it is sensible and prudent to put pension schemes on the FBAR form, particularly private pension schemes. Employer pension schemes are less of an issue. Foreign account reporting has been a bit of a pet project within the US Treasury and the IRS for the last 10 years or so. While they've been reasonably lenient in terms of trying to apply penalties, Matt suspects that in time, they will get more aggressive on this. He therefore prefers to a bit more than necessary than a bit less.

 

Question: My husband and I own a flat here. When we come to sell it, is it only the appreciation that we pay capital gains tax on in the US?

Matt confirmed that the US will tax on the gain in value when the property is sold. But that gain can be affected by the exchange rate. Rory agreed and noted that it's likely the exchange rate movement would in a favorable way, since the dollar has probably strengthened since the property was purchased.

Also, any money spent on serious refurbishment of the flat be claimed against the uplift in value.

 

Question: I've lived here for 40 years. My house has gained quite a lot of appreciation. If I were to downsize, does that mean I have to pay capital gains in the US?

Yes. This is a situation many Americans encounter when they've lived in the UK for many years, own a house, and are looking to move to something smaller. They're worried that by the time they've paid tax to the Internal Revenue Service on the sale of the house they won't have enough left over to buy a smaller property. It's a genuine issue that needs some serious thought more detailed advice.

 

Question: I'm also looking to buy a property in the UK.  Is there any tax advice I should consider before I start that process? My husband is UK citizen. Does he need to think about US taxes?

There are several options in this situation, Matt told us. It could be possible to elect to treat him as if he were a US citizen for tax purposes. There are advantages to doing so. There are also disadvantages and it is an election that once made can be revoked, but cannot be made again. So it requires some thought.

You'll want to think about the extent to which the house is considered to be owned by you and the extent to which it is considered to be owned by your husband, because, as things stand, he is not subject to US tax unless he has income in the US.

Therefore his share of any gain will just be dealt with under the UK tax rules. As Rory pointed out earlier, the UK gives you a complete exemption from capital gains tax if the property has only ever been your home.

Therefore it could be possible to arrange for the non-US spouse to own a disproportionately large part of the property (assuming of course you're comfortable with that). In that situation, on sale it is the non-US spouse who is reporting a larger proportion of the gain, or rather not reporting. You as the US citizen would report a smaller amount.

That can be arranged with a conveyancing solicitor by purchasing the house as what's called Tenants in Common rather than a normal joint tenancy arrangement. As tenants in common, you can specify the ownership percentages. By default, they base it on the amount of money that each party's putting into the transaction. But you might decide to arrange it so it's a 70/30 split or 80/ 20 so that you're only exposed to US capital gains tax on 30% or 20% of the ultimate gain.

That would be one action that could be taken to protect yourself from some future US capital gains tax on sale.

 

Wills

Question: Do I need to have a will in both countries? Or two different wills?

It depends on the assets you have. You can get by with one will to cover both but that may not be the optimal position. Some people do have a US will to cover the US assets and a UK will to cover the UK assets. That can work quite well. The downside is you're paying two sets of lawyers.

You could just have a UK will to cover all of your assets or a US will to cover everything. That can result in increased probate costs. And probate is notoriously expensive in both countries, especially the US.

If your assets are sufficient enough to make it worthwhile, there are attorneys in London who specialize in dealing with Americans in the UK and they are very good at devising wills and estate plans that are supposed to deal with the intricacies of both jurisdictions. The only real problem with them is they don't come cheap; the starting point for many is around £5,000.

Depending on the complexity of your affairs that can be money very well spent. But if your affairs are relatively straightforward then you can probably get away with a UK will written by a UK lawyer with a nod to the US. Typical fees for UK will might be a £2,000; you could then ask someone who understands US law to look it over.

 

Retirement

Question: I know we pay National Insurance here in the UK in order to receive money when we retire. And that's the same as Social Security, I suppose. If I did want to spend some of my retirement back in the US should I be protecting my right to social security in some way?

Matt explained that we pay National Insurance here because we're living and working here. If we pay enough National Insurance contributions and broadly speaking, the minimum needed for a state pension in the UK is 10 years, then a state pension will be provided upon reaching retirement age.

That state pension, at least as rules currently stand, is available whether we're living here or in the US.

When it comes to Social Security in the US, we don't really have much of a mechanism to pay into it while we're living and working abroad.

The good news is that if someone isn't here long enough to get the 10 years minimum for a UK state pension and then moves back to the US and starts building up a US Social Security pension the US should give credit for the years spent in the UK. Theoretically there is an agreement in place that the two governments are to respect each other's social security.

 

Question: Are there any big changes to the US tax regime that we need to be aware of for this year?

Matt confirmed there were no substantial changes. Most of the big changes went through at the end of 2017 / beginning of 2018 when President Trump put his big tax reform bills through. It's worth pointing out that depending on what happens in November many of the tax reforms that were introduced at the end of 2017 will expire in 2025.

 

Investment Advice

Question: What would recommend in terms of getting financial advice? I'm mostly based in the UK. Should I get a UK financial advisor?  Or someone who knows both?

Rory took this question. In a perfect world, you would go with a specialist firm like ours that really understands both jurisdictions and advises accordingly. There are a few other firms like ours out there. The difficulty is that in order for a financial advisor to advise Americans over here the advisor needs to be regulated in both the US and the UK, which can be quite expensive. As a consequence, specialist wealth managers tend to have relatively high minimum investment sizes; as an example, MASECO's minimum investment size is around a million dollars.

If you're investing at lower levels than that it will be harder to find a good specialist. If you've been here for less than seven years, then you've got less to worry about on the UK side until that seven years hit. You could just invest in individual stocks and bonds, if you favor a do-it-yourself approach. Just make sure that if you're investing in funds, you're investing in US mutual funds with UK reporting status.

At previous year's tax events Rory has handed out Maseco’s flyer: 39 Steps to Smart Living in the UK. Some of you may have seen this already, but for those of you who haven't, it's worth a look for the practical advice it conveys in a humorous way: https://www.masecoprivatewealth.com/the39steps/

The Wellesley Club UK would like to extend our sincerest thanks to Rory and Matt for their insights.

As we were preparing this newsletter Congress passed the Coronavirus Aid Relief and Economic Security (CARES) Act and the president signed it into law. Democrats Abroad has written about its impact on Americans abroad. You can find that information here: https://www.democratsabroad.org/carmelan/coronavirus_aid_relief_economic_safety_cares_act_faqs

The American magazine also has a series of articles on US tax and COVID-19. You can find them here: https://www.theamerican.co.uk/pr/news-index

-Contributed by Audrey Mandela ’80