How are my UK investments taxed in the USA?
As a US citizen, your global income and gains are reportable and taxable in the USA. Therefore, you will need to report to the Internal Revenue Service (IRS), where you hold foreign assets, and complete tax filings for all income and gains.
Specific points to note:
- UK Funds – Passive Foreign Investment Companies (PFIC)
A fund that is not US registered will most likely be a PFIC. Therefore, in 99% of cases, the reporting requirements and increased tax suffered will make it an undesirable investment.
- ISAs – not recognised by the IRS
Whilst tax free in the UK, in the US the ISA wrapper provides no benefit and these accounts are taxed like any other. Note that the majority of investments eligible to be held in an ISA will be considered a PFIC, other than cash or individual securities.
- UK pensions – generally recognised under the US/UK tax treaty
Standard UK pensions are recognised under the tax treaty and so investments inside the pension will not be taxed in either the UK or the US. Tax may be payable on income distributions in retirement, and we suggest that you check this with your tax adviser.
- Property – capital gains and currency gains
Whilst the UK does not tax gains made on an individual’s primary residence, in the US, there is a $250,000 tax-free limit. Note that this is a US dollar limit and so an increase in the value of the pound versus dollar will increase the chance of a chargeable gain.
How are my US investments taxed?
As a UK resident, you are taxed in the UK on your global income and gains, unless you are claiming the remittance basis of taxation (please click here to see our ‘Introduction to Remittance Basis’ guide). For most US taxpayers, as you also pay tax in the USA, claiming the remittance basis may not be beneficial and should be considered carefully.
Specific points to note:
- US Mutual Funds and ETFs – offshore income gains
Unless the fund has received reporting status in the UK, all profits from non-UK funds will be taxed at an individual’s highest marginal rate (up to 45%). This can be a significant difference compared to when the individual could use their zero rate capital gains allowance or the regular capital gains tax rates of 10% or 20%.
- ‘Tax-free’ Municipal bonds – not tax-free in the UK
Whilst income from tax-free municipal bonds are not taxed in the USA, they are taxable in the UK. As the UK is likely to be the higher tax rate jurisdiction, these may not be the most beneficial investments.
- US pensions – such as 401k or IRA
These are also covered by the tax treaty; therefore, investments will accrue gains and income without being taxed in the UK and the USA. Tax may be payable on income distributions in retirement – we suggest checking with your tax adviser.
- Currency gains – it goes both ways
Just as your US gain will be higher if the pound has increased, your gain in pounds will be higher if the US dollar has increased.
What investment account types can I use?
You can, of course, use regular investment accounts that could be taxable in both the UK and the USA. Not all UK investment providers will accept US citizens and not all US providers will accept non-US residents. The companies that do accept both frequently change and you should conduct research to determine which provides the best option for you.
When investing in taxable accounts, be sure to understand the different UK and US tax considerations if investing in funds or ETFs, to avoid unnecessary excess tax or reporting. Note that whilst there are some US funds/ETFs that have UK reporting status and so are suitable in both jurisdictions from a tax perspective, most UK investment providers do not make these available direct to investors because they are not authorised to be sold in the UK.
Other common account types:
- ISA – remember these are taxable in the US but not the UK
There is a potential benefit where an individual’s UK tax rate is higher than in the USA, and also where the interest rate in a cash ISA is higher than available in a regular savings account. US funds and ETFs are not available in an ISA, so you will probably need to consider limiting your choices to cash and individual securities (shares and bonds).
- UK Pension – covered by tax treaty
As you do not need to pay UK or US tax on investments inside a UK pension, it is generally accepted that you can invest using standard UK funds without the usual PFIC concerns. Check this with your tax adviser though, as there may be circumstances where this is not the case for personal pensions. Indeed, depending on your personal circumstances, you may want your UK personal pension to be taxable in the US.
- US Pensions – covered by the tax treaty
As you do not need to pay UK or US tax on investments inside a US pension, it is generally accepted that you can invest using standard US funds without the usual offshore income gains concerns. This would include accounts such as your 401k and IRA.
How can I make savings for my minor children?
Gifting assets to your children does not necessarily mean that the parent is not responsible for the taxation of those assets. There are also gifting rules to be aware of, both in the UK and the USA, therefore, expert advice should be considered. If investing in your child’s name is suitable and there are advantages over holding the investment yourself, below are some of the common account types:
- Nominated Account/Bare Trust
This is essentially a taxable account owned by the minor child but under the control of the assigned adult (generally a parent). The source of funds held in this account type will determine the tax status and advice should be taken.
- Junior ISA
UK residents can contribute to a Junior ISA which, like a regular ISA, grows tax free in the UK, but like an adult’s ISA, it will be reportable in the US. Again, remember the need to avoid PFICs. Note that the child can only make withdrawals after the age of 18.
- 529 Savings
There are US tax benefits to using 529 plans, including tax free growth. However, the position in the UK is more complex as it would be seen as a trust. Therefore, the taxation in the UK would differ depending on who is making the contribution and advice should be taken.
At what stage is it effective to use a professional adviser/investment manager?
For many, there is a benefit to taking professional financial planning and investment management advice, and there are various options available. There is, however, a cost for this service and so that needs to be weighed against the potential benefits.
- Ad-hoc or one-off financial advice
There is no fixed minimum investment amount or earnings level for taking advice, but there will often be a minimum cost. Generally, the adviser will provide an hour of complimentary consultation to ascertain what advice is required (such as mortgages, insurances, pensions, savings or investments) and they will be able to provide a quote for the advice needed.
- Delegating investment management
If you wish to appoint an adviser to oversee your investments on an ongoing basis, these services typically start for a minimum investment of £100,000.
- Bespoke investment management
If you want to appoint a discretionary investment manager to oversee a personalised investment portfolio, these services typically start for £1m of investment assets. There are intermediate points in between £100,000 to £1m where the level of service can be tailored based on your needs.
What should I do first?
Whether you choose to take professional advice or not, there are some “first steps” that we would suggest are considered. These are not in order of priority, as everyone’s circumstances are different, but these should be amongst your initial considerations:
- Cash savings
An initial priority should be to secure your annual expenses and consider building a cash buffer or savings deposit for short-term expenditure or unexpected needs. The amount of cash savings required will vary with personal circumstances.
- Pension savings
For many individuals, the most logical place to start investing will be in your company’s pension scheme. Each scheme is different, and you will need to familiarise yourself with the terms and options available you. A pension should be considered as long-term savings as you are generally unable to access it until retirement. In the UK, you can contribute up to £60,000 per annum into your pension and can use up to three years of your previous years unused allowance. Note that the allowable amount does vary depending on your income, so you should check your personal allowance before contributing.
- Repayment of debt
Consideration should be made to reducing debt (mortgages, credits cards, personal loans) where possible, especially now interest rates are higher than they have been. Generally, it is best to start by repaying those with the highest interest rate, but consideration needs to be given to flexibility and any tax efficiency impacts. Note that for US tax payers there may be currency considerations. For example, repaying a GBP loan after the value of the pound has fallen could mean you have a taxable gain in the USA.
Remember that all types of investment carry the risk of loss, therefore, investing might not be suitable for everyone. Be sure you understand the risks of any investment before you invest and that you are willing and able to accept the risk of loss.
As provisions within this area are so complex, we believe it is essential to seek expert advice in order to maximise tax efficiency and reduce the risk of making mistakes. We have both the experience and knowledge required to help our clients with a range of international and multi-jurisdictional needs, and we are only a phone call or email away.
Nathan Prior
Partner, Head of PWM International
nprior@partnerswealthmanagement.co.uk
020 7444 4053
The contents of the article have been prepared solely for information purposes. The article contains information on financial products and services and such information is designed for and addressed solely to individuals seeking generic industry information.
Partners Wealth Management does not provide tax, legal or accounting advice. It is important to take professional advice before making any decision relating to your personal finances. Information within this document is based on our current understanding and can be subject to change without notice and the accuracy and completeness of the information cannot be guaranteed. It does not provide individual tailored investment advice and is for guidance only. Some rules may vary in different parts of the UK. We cannot assume legal liability for any errors or omissions it might contain. Levels and bases of, and reliefs from, taxation are those currently applying or proposed and are subject to change; their value depends on the individual circumstances of the investor. No part of this document may be reproduced in any manner without prior permission. Taxation is based on your individual circumstances and may be subject to change.
