American expats in the UK face some unique challenges for managing their tax responsibilities. Here are eight tax tips to make the task a bit easier.
1. File Tax Returns in the UK and in the US
American expats in the UK likely need to file tax returns both in the UK and in the US. They’ll file tax returns with HM Revenue and Customs because they are living in the UK and that’s where they are earning their income. But, what can be surprising is that American expats in the UK also need to file tax returns with the IRS. That’s because the US taxes American citizens and green card holders on their worldwide income – we’re one of only two countries to do so.
2. American Expats in the UK Can Exclude UK Earned Income from US Tax
American expats in the UK can exclude some of their British earnings from US tax. To do this, you’ll use the Foreign Earned Income Exclusion. Under this exclusion, American expats can shield up to $105,900 (for 2019) of wages or self-employment income earned while residing in the UK from their US federal tax.
This exclusion works to shelter your income from US federal income tax. The exclusion does not shelter your income from Social Security or self-employment tax. But there is a special rule that does so: it’s called a totalization agreement.
3. Exclude UK Earned Income from US Social Security Tax
Here’s how the totalization agreement works: as long as American expats in the UK are paying into the UK’s national insurance program, then they will not have to pay US Social Security tax or self-employment tax on their UK earnings. To qualify, American expats in the UK will need to obtain a certificate of coverage from the UK government.
4. Taxes Paid to the UK Can Reduce Taxes American Expats in the UK Owe to the US
By using the Foreign Tax Credit Form 1116, American expats in the UK can reduce how much tax they pay to the IRS based on how much tax they pay to HMRC.
The foreign tax credit works a little differently than the Foreign Earned Income Exclusion. The two tax breaks are similar because both tax breaks can significantly reduce US taxes. But the foreign tax credit is not based on how long a person resides in the UK, nor is the foreign tax credit limited to earned income. Instead, the foreign tax credit applies to any type of income that could be taxed twice: once by the UK and then by the US. That means the foreign tax credit can be taken on wages, self-employment, interest, dividends, capital gains, and pensions – just to name a few.
5. Exclusion or Tax Credit? Use Whatever Is Most Beneficial
Which is better: the foreign tax credit or the FEIE? This is a common question that American expats in the UK often ask. The answer depends on the specific circumstances of the individual client.
Some clients can a combination of both. The FEIE can reduce the US tax on wages earned by American expats in the UK. And then the foreign tax credit could be put toward UK tax paid on investment income. For other clients, we might recommend claiming only the foreign tax credit, perhaps because the client doesn’t meet the time requirements for the exclusion, or because the foreign tax credit works out better mathematically.
The overall thought process is the same. Greenback’s accountants look at a person’s overall tax situation and then figure out which filing strategy will produce the best results financially.
6. Zero US Tax Is Possible for American Expats in the UK
A truly powerful effect occurs when combining the totalization agreement with the FEIE and the foreign tax credit. American expats in the UK may be able to achieve zero tax at the US federal level by using this combination. The foreign exclusion works to reduce federal income taxes on wages and self-employment. The foreign tax credit works to reduce US income tax on other types of income such as dividends or pensions. And the totalization agreement works to avoid self-employment and Social Security taxes in the US.
7. UK Individual Savings Accounts Are Tax-Deferred for US Tax Purposes
American expats in the UK may want to invest through Individual Savings Accounts (ISAs). ISAs are a type of financial account that are similar in nature to a US-based Roth IRA. For UK residents, ISAs provide a specific benefit: dividends and other investment income is not included in a person’s taxable income in the UK.
Normally, investment accounts that qualify for tax-exempt benefits in another country do not automatically qualify for tax-exempt status in the US. But under a special rule, American expats in the UK can enjoy the tax-free status of ISAs. This special rule is found in the tax treaty between the US and the UK. In a nutshell, this special rule says that pension schemes and similar arrangements that are tax-exempt in the UK are also tax-exempt in the US.
8. Disclose Any ISAs and Other Foreign Financial Accounts to the US
American expats in the UK may need to tell the Treasury Department and the IRS about financial accounts held in the UK. The requirement to disclose foreign accounts kicks in if a US expat has at least the equivalent of $10,000 sitting in one or more foreign accounts (in total) at any time during the year.
The types of foreign financial accounts that need to be disclosed include savings accounts at UK banks, investment and securities brokerage accounts, ISAs, retirement accounts, and whole life insurance policies with cash value.
Want to find out more? Download our guide to expat tax in the UK!
How Greenback Can Help
Greenback’s accountants specialize in international tax. Our accountants can prepare both your UK self-assessment tax return and your US tax return. Greenback is in the best position to provide a comprehensive approach to preparing and planning for your UK and US taxes. Get started with us today.