Some UK advisers wince at the prospect of taking on American expat clients, but with the right investment manager and specialist tax partner it is possible to deliver a valuable and cost-effective service.
There are two key challenges. The first is to deliver an investment service that does not create undue tax consequences from a US reporting perspective, which means the use of many investment funds we all take for granted may need to be avoided.
The second is to meet the demanding and distinct reporting requirements of two tax authorities – HM Revenue & Customs and the American Internal Revenue Service.
US tax law can extend even further to a group of people known as ‘accidental Americans’The root of the challenges lies in the fact that virtually all US citizens are legally obliged to file an annual tax return with the IRS, even if they have not earned a dime in the country.
Americans have Abraham Lincoln to thank – the 16th US president signed the antecedent laws during the Civil War as a way of disincentivising draft dodging.
Over 150 years later they are still in place, making America one of only two countries in the world to tax its expats. The other is Eritrea.
In the UK, there are estimated to be between 139,000 and 250,000 American citizens, many of whom will be obliged to comply.
But US tax law can extend even further to a group of people known as ‘accidental Americans’.
Key Points
- The US is one of only two countries in the world that taxes its expats, which means American clients will need a specialist tax adviser
- Advisers need to be aware the splitting of capital and income can be an issue for Americans in the UK
- The US and UK tax years are out of sync and capital gains are taxed differently
This connection can be as tenuous as simply having been born in the country, before moving elsewhere. Some have no memories of living in the country.
Often they are not even aware of their status or have only discovered it in adulthood.
Yet they could well be legally obliged to pay American taxes, and many of the issues present for an expat will be present for them too.
It is important that advisers understand the challenges American clients face – and how it might still be possible to help them, with the right support.
Investment pitfalls
Expat Americans have to tread particularly carefully when investing.
Loopholes have been closed, which means ownership of anything considered to be a passive foreign investment company is now taxed punishingly, and the work to untangle those investments can be complex and time-consuming for the individual and their accountant.
Unfortunately, the PFIC rules cover many popular unit trusts that British investors take for granted.
The US Foreign Account Tax Compliance Act was an extension to this.
The legalisation compels all US citizens to report ownership of all non-US assets to the IRS each year and requires all non-US financial institutions to provide information on US investors.
American expats might think the solution is to turn to US-registered funds, but these are not always a viable alternative either, as many often do not have UK reporting status and gains may therefore be subject to higher UK tax rates.
The splitting of capital and income can also be an issue where the individual is resident in the UK but US-domiciled and they want to remit assets to the UK.
The transfer into the UK of so-called ‘mixed funds’ or ‘dirty capital’ can have negative tax consequences and, again, can result in costly fees to tax advisers to unravel.
There can also be challenges with tax-efficient vehicles in the UK not being recognised in the US, such as Isas.
Pensions should also be looked at carefully.
We are not tax advisers and always work closely with a client’s tax adviser to plan in advance of making investments.
Reporting challenges
Reporting for US clients is more complicated and time-consuming as well.
Most UK residents have little problem getting information on their holdings, income and capital gains for HMRC.
But trying to provide reports that are compliant with both UK and US tax laws throws up multiple challenges.
For one, UK and US tax years are out of sync – the US goes by the calendar year, while the UK runs from April to April.
The IRS requires each transaction to be captured in the relative dollar equivalents at the point of completion.
Complicating matters further, the US authorities measure capital gains differently.
In the US, anything held for less than 12 months is a short-term gain and taxed as income. In the UK there is no distinction.
Capital gains are also calculated using different methods.
The UK uses average cost for the book cost in most cases. For the US, ‘first in, first out’ is usually the method used.
This can make capital gains calculations drastically more difficult, particularly if there has been a reasonably long period between buys and values have fluctuated.
Care must be taken on tax credits too.
What this means for advisers and their clients
If citizenship comes at such a premium, why not suggest clients renounce it?
Some do, but it is a long, drawn-out and costly process that can involve paying for legal advice in both countries, requires proof of five years of IRS tax compliance and can incur exit taxes.
It costs $2,350 (£1,883) just to hand in a passport.
Of course, there can be benefits to American citizenship, and renunciation is irrevocable.
As a consequence, many just accept that there is no way around the situation.
Adviser solution
There is no way to avoid the fact that advising an American can be a complex and time-consuming task.
But once advisers have a better understanding of how the regimes fit together and where the conflicts lie, there is an excellent opportunity for them in the pool of potential clients. It is best done with help.
The adviser should look for an investment manager that can build a portfolio that does not breach the PFIC rules.
In our case, this means one that invests in a well-balanced and globally diversified portfolio of direct equities and bonds – one that avoids funds altogether.
Make sure that the provider can also generate the reports your client will need to complete their tax return easily.
Investment reports that contain the right information to satisfy both tax authorities can save everyone time, money and stress.
Finding a specialist tax adviser will help too.
Your ability to bring this partnership together will make you a highly valuable commodity in the eyes of any client whose family falls into this tangle of rules.
Rosie Bullard is a partner at James Hambro & Partners
