Making use of an Investment Savings Account (ISA) to optimise your tax allowances should always be front of mind. For US citizens living in the UK, however, there are details worth considering when putting money into this tax-saving instrument.

US citizens living in the UK should be aware that their tax status has some additional complications, stemming from the need to abide by both UK and US requirements. These rules impact how US citizens should invest (if being mindful of how their tax bill is impacted) and so it is extremely important to consider the tax-efficiency of investments made and the account types used.

In this blog post, we will explore the relative benefits of an ISA for US nationals living in the UK.

What is an ISA and what is the UK tax benefit? 

An ISA is a UK tax-efficient savings account, available to UK residents. It has tax advantages, as the HMRC (UK tax authority) will not apply income tax or capital gains tax to investment profits made.

The account is very flexible and investors can withdraw funds tax free at any time. However, there is a £20,000 p.a. contribution allowance, which limits how much an individual can add to the account each year.

Alongside pension savings, an ISA is typically considered one of the first places to start saving.

Can US taxpayers use an ISA?

Most countries outside of the UK do not recognise the ISA structure and view the account as a regular, personally held investment account. The IRS does not recognise the status of an ISA and so, for US taxpayers, all the usual investment and tax reporting considerations that they have, still apply.

This includes:

• Consideration of avoiding Passive Foreign Investment Companies (PFICs)

• Ensuring you include all the income and gain realised in your US tax returns

• Including the ISA in your annual Foreign Bank Account Reporting (FBAR).

This does not mean that a US taxpayer cannot hold an ISA. It means however, that more consideration is required to determine the benefits of an ISA vs a regular investment account.

For US taxpayers, what are the advantages of holdings and ISA?

As above, the account remains fully reportable and taxable to the IRS. However, the UK tax savings could still provide a net benefit to some US taxpayers, based on the difference in US and UK taxation rates.

Individual Capital Gains and Dividend tax thresholds in 2023 (UK tax year 2023/24):

Tax rate:	0%	10%	15%	20%
US Long-Term Capital Gains	Up to $44,625	–	Up to $492,300	Thereafter
US Qualified Dividends	Up to $44,625	–	Up to $492,300	Thereafter
UK Capital Gains	Up to £6,000	Up to £50,270	–	Thereafter
Tax rate:	0%	8.75%	33.75%	39.35%
UK Dividend Tax Rates	Up to £1,000	Up to £50,270	Up to £125,140	Thereafter

Source: HMRC (gov.uk), IRS (irs.gov)

There are various points where an individual falling into higher tax rate thresholds in the UK might benefit from paying lower US tax rates, if the investment is held within an ISA. Additionally, for some individuals, shielding some investment from UK tax might also provide the opportunity to utilise foreign tax credits accrued outside the ISA, meaning that no further tax is payable on ISA profits.

What to watch out for

Most investments that are allowable within an ISA are UK funds or ETFs. These would be considered PFICS and therefore attract the usual disadvantages associated with these investments, including the potential for higher tax and penalties in the US. That would most likely offset any benefit of investing through an ISA and so should be avoided.

US funds or ETFs are not allowable investments within an ISA, and so the generally recommended investments within the ISA would be; cash, individual bonds or individual shares. The selection of individual shares is often considered high risk due to the reduced diversification compared with an index fund, for example. Investors therefore need to have the experience (and willingness) to invest in individual securities, or they might want to appoint a professional investment manager.

Due to the annual £20,000 contribution limit, building a diversified portfolio might not be possible immediately. Therefore, including an ISA in your investment strategy is best done as part of a long-term, multi-year financial plan.

We’re here to help

Whether to use an ISA as a US taxpayer is not a simple yes/no question, and needs specific consideration based on an individual’s circumstances. For some, the tax savings may be marginal, which might not be beneficial when the additional investment limitations and administration is considered.

Those moving into the higher-rate tax bands in the UK and those with excess foreign tax credits are potentially most able to take benefit of the structure. However, those wishing to assess this should seek personal advice.

If you would like to consider using an ISA as part of your investment strategy and holistic financial planning, please do reach out to one of our specialist financial planners.