TaxFeb 7 2019

US expats face a big tax bill

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US expats face a big tax bill

There are estimated to be 159,000 US expats living in the UK - that is, people born in the US - as of November last year.

Many have taken up residence in the UK on a semi-permanent basis and have been living here a long time.

But what many may not realise - especially those for whom the UK has been their main residence for much of their lives - is that the US tax authorities can catch up with them and land them with an unexpectedly large tax bill.

The tax regime, run by the Internal Revenue Service (IRS), can cover many aspects of a client's affairs, but is especially applicable to investments and property assets, and if one is planning on giving up one's citizenship, then it could be one's entire belongings.

Isas are quite good in the UK, but they're absolutely rubbish for US citizens, because they have to pay taxes on their gains and interest and dividends.Sigita Dromantaite

The most important point to remember is that if an adviser has someone with a US passport or green card on their books, then the earlier they can get some planning done, the better, as the IRS does not look kindly on anyone who appears to be trying to avoid tax.

Sigita Dromantaite, director at US and UK Eagle Taxation, says: "We're talking more than 50 per cent or 40 per cent of tax (including penalties and interest) - both US citizens and green card holders - and these are the areas where they usually stumble upon, and they don't have enough knowledge and get into investments that are not the best for them."

Pay up

The US tax authorities treat anyone with a US passport or green card as being liable for tax, regardless of where they are living in the world. Sometimes they will be subject to UK tax laws as well, and generally speaking, if the same asset is subject to a tax charge, the bill will revert to whichever regime has the higher rate of tax.

The tax charges in the US are to some extent comparable to the tax charges in the UK; it is when the IRS believes that the individual is trying to avoid paying tax is when the charges get higher.

And some investment wrappers are completely unrecognised by the US tax authorities as tax-free investments, such as Isas, as well as many investment funds. So it is not worthwhile leaving assets in an Isa as they will still be hit with a tax charge.

Ms Dromantaite says: "Isas are quite good in the UK, but they're absolutely rubbish for US citizens, because they have to pay taxes on their gains and interest and dividends, or if a timely election is made, on unrealised gains."

Similarly, many investment funds available to UK investors are unsuitable for American clients, because they are deemed to be 'PFICs', a passive foreign investment company, and will be taxed differently.

Furthermore, if the fund does not make any regular payments or 'distributions', as in paying interest or dividends, then the investor can fall into the trap of thinking they have not had any tax to pay until they cash in the fund and realise their gain.

This is actually not the case. Once the IRS catches up with the investor, it will look back over all the years when the fund made a gain and tax the fund, each year that the client has invested, at the default rate, which is currently 39.6 per cent. This year's gain will likely be taxed at the current rate of about 20 per cent.

The alternative to this is buying a US-compatible fund, but these may not be particularly available, or suitable on the investment side. A few are dual reporting, but again the choice is limited.

Ms Dromantaite explains: "You have to regularly report distributions to the IRS. If you don't regularly report distributions to the IRS you will be taxed at the higher rate."

The penalties for not planning ahead are severe, she adds.

"You have some people who give up 70 per cent or more to the IRS. They cash in now and they have to give it to the IRS," she notes.

"If it's a very rich person , I would say don't have long-term investments, have three-year funds."

Lessons learnt

The funds that are particularly affected are the less liquid ones, such as property and Indian infrastructure funds.

For more conventional funds, she says investors have to file returns each year, saying how much every fund gained each year. There will still be a tax charge but this is likely to be at the lower rate of 20 per cent to 28 per cent.

Another area that is problematic is the sale of property. In the UK, the sale of property that consists of one's main residence is not subject to capital gains tax; in the US it most likely is, as politician Boris Johnson found to his cost in 2014. 

His response was to ultimately give up his US citizenship - he had been born in the US when his parents lived out there. But the IRS would not have let him off the hook.

Similarly, this option may not be immediately available, or indeed desirable, and it does not do away with one's tax bill.

In addition, even if a client goes the whole hog and decides to give up their green card or passport, the US authorities are wise to it as being a way to escape future tax liabilities, and can refuse to allow someone to give up their status, making them potentially liable for paying tax to the IRS for another 10 years.

Another area that may escape people's attention is the issue of currency gains, especially on the sale of property.

If, for example, someone bought a property for £1m, and sold it for £1m, and made no obvious gain, nonetheless, if the currency translation meant that there was still a financial gain in dollar terms, then the property owner would be hit by a tax charge.

Andrew Grimes, executive director, head of Americas at Coutts, says: "The thing that people have to be most careful on is reductions of payments of mortgages are taxable events. 

"If you invest £1m in property, and you have a $1.5m mortgage, if you paid that in full, and the exchange rate today means it comes to $1.3m when you started, that's a currency gain of $200,000.

"A lot of tax advisers will say it's best not to have a floating mortgage."

Anyone with a US expat on their books is strongly recommended to involve an accountant with specialist knowledge of the tax authorities in the US and the UK.

The following articles go into more detail about some of the tax issues US expats are likely to face.

melanie.tringham@ft.com