In the UK, it’s not uncommon for citizens and expats to have money in an Individual Savings Account (ISA). The account is essentially a tax-efficient savings vehicle for UK residents. While they can be fundamental pieces of a UK financial strategy, US expats with ISAs need to be mindful of potential pitfalls in owning such an account. Here’s what you need to know about ISA reporting for your US expat tax return.
Reporting for Cash ISAs vs. Stocks and Shares ISAs
ISAs come in various flavors, but the most common schemes are cash ISAs or stocks and shares ISAs.
For US taxation purposes, the cash ISAs are treated as a normal foreign bank account with interest subject to tax at ordinary rates. However, when it comes to the stocks and shares ISAs, you’ll need to take care to determine the underlying investments. As the name implies, individual investors can put their money into a range of investments, including unit trusts, open-ended investment companies (OEICs), investment trusts, exchange-traded funds, individual shares, and bonds.
If the investment is in individual shares or bonds, the income from such investments is treated like interest from a cash ISA, where income from the investments flows to the applicable portion of the return (for instance schedule B, D, etc.) depending upon the nature and classification of the income earned.
You Could End Up With the Dreaded Form 3520 Requirement
In cases where the investment is in a foreign pooled investment, such as a mutual fund, ETF, unit trust, etc., the rules under IRC §6048 may apply. In these situations, these are actual trusts with a trustee where an individual holds several units, and the trust invests in shares of other companies.
If the ISAs are indeed trusts, these will generally be foreign for US purposes and the investors treated as beneficiaries. As a result of such treatment, in most cases, the US beneficiary of that trust is required to report distributions from foreign trusts on Form 3520, Annual Return to Report Transactions with Certain Trusts and Receipt of Certain Gifts. The distributions would be taxed as ordinary income.
Additional ISA Reporting Requirements for Expats
While reporting on Form 3520 can be cumbersome, it doesn’t always end there. If the investment is in OEICs, investment trusts, or exchange-traded funds, it is generally held that Passive Foreign Investment Company (PFIC) rules apply. PFICs are reported on Form 8621, Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund.
The Form 8621 filing requirement will depend on the tax treatment of the PFIC. Taxpayers owning PFICs treated under the MTM (Mark-to-Market) or QEF (Qualified Electing Fund) rules are required to file Form 8621 on an annual basis to report the annual income from the PFIC. Taxpayers owning a PFIC treated under the default method (excess distribution) must file Form 8621 to report an election, distribution from the PFIC, or disposition of an interest in the PFIC.
We Can Help Expats With ISA Reporting
The filing processes of Forms 3520 and 8621 are extraordinarily complex and will vary from taxpayer to taxpayer and situation to situation. Some are taxable and reportable, while others may not be. A close evaluation by an experienced Greenback accountant can help you rest assured that you’re in compliance. Schedule a consultation with us today!