This article was published over 6 months ago & may contain inaccurate/out-of-date information,
please verify the latest status any quoted regulations.
The author of this article, David McKeegan, is Director and Founder of Greenback Expat Tax Services, a US Income Tax provider that specializes in tax preparation for Americans who live abroad. All information was correct at the time this article was written (February 2011).
You probably know that as an American living abroad you need to continue to file a US tax return even if you are filing in the UK as well (if you didn’t know that, now you do!) What you may not know are some of the specifics about how living in the UK will impact your US taxes and some of the pitfalls you may run into. The purpose of this article is to give you some of the basics you will need to stay compliant with the US tax authorities and avoid some very common tax traps.
UK and US tax years:
The first thing you will need to know is that the UK and US tax years are different. The US operates on a calendar year i.e. Jan 1st – Dec 31st, while the UK tax year runs from April 6th to April 5th each year. When preparing your US taxes you need to convert your earnings to USD and report according to the calendar year. You can use your monthly pay statements, bank interest statements, etc or you can use your year-end statements for the two years and reconcile the calendar year income that way. When converting your earnings to USD you can use a specific date method where you use the Foreign Exchange rate on the specific dates you get paid or you can use a monthly average or an annual average. You must use the method consistently, but if you receive large lump sum payments (say at bonus time) you can save quite a bit of money depending on the method you choose.
The next thing to know is the filing deadlines. If you are living abroad full-time then you receive an automatic 2 month extension from the IRS so your taxes are due June 15th rather than April 15th. As the UK tax year does not end until April 5th you may not have your annual statements by June. In this case you can file an extension, which would give you until October 15th to file your taxes. However, in any case, if you owe money, interest will accrue as of April 15th so it is worth trying to get your taxes completed as early as possible.
Your Foreign Bank Account Report (discussed below) is still due on June 30th, even if you get an extension to file your taxes later. You should also know that your UK Self-Assessment (if you are required to file one) is due by January 31st. As none of these deadlines are similar, you may forget about your US taxes so please make a note in your calendar or contact Greenback Expat Tax Services and we will happily send you reminders about these important dates.
Double Taxation Treaty between US and UK:
If you are living and working in the UK or considering moving over for work you are likely to be on the Pay As You Earn (PAYEPay As You Earn - UK Income Tax
) system i.e. your employer will deduct your UK Taxes due directly from your salary. The PAYEPay As You Earn - UK Income Tax
system is quite simple and you don’t need to do much to stay compliant with Her Majesties Revenue and Customs (HMRCHer Majesty's Revenue and Customs, now known as HMR
). Your taxes and National Insurance (NINorthern Ireland or National Insurance
) are automatically withdrawn from your salary. The US and UK have a double taxation treaty so you will not own tax on your income twice and you can use the Foreign Tax Credit and the Foreign Earned Income Exclusion to build up some credits in the US and/or avoid paying any tax in the US.
If you are self-employed, however, the situation becomes more complicated. The US / UK tax treaty says that you would need to opt out of US Social Security in the US, even if you are already paying NINorthern Ireland or National Insurance
– this is not automatic. To opt out you would need to visit the Social Security website at www.ssa.gov
and you can search for the UK tax treaty. If you fail to do this you could owe a significant amount of money to the IRS and this would not be offset by any of the credits or exclusions available i.e. you would need to write a check that would be about 15.3% of your 2010 earnings.
Retirement Savings- Important Considerations:
Pensions in the UK are another area where US citizens can get in trouble with the IRS and the Treasury. You may have a company pension where you and your employer put money into a retirement plan (“defined contribution”) or your employer may provide a final salary pension scheme (“defined benefit”). As employer- sponsored plans these are fine and nothing to worry about. You may also have a SIPP – (“Simplified Individual Pension Plan”) these are a bit of a grey area with the IRS. Some people consider these accounts to be foreign trusts and you would need to report the earnings and capital gains each year on your US taxes and pay tax on these earnings and capital gains. Other people have argued that they are qualified retirement vehicles and as such are exempt from tax. To date the IRS has not made a ruling on these so it continues to be a grey area. You should consult with your tax preparer before opening one of these accounts. The bigger tax trap is the ISA (“Individual Savings Account”). These are considered a foreign trust by the IRS and you do need to report your income and capital gains in these accounts each year on your US tax return (even though it is tax-free in the UK). You will need to pay tax on the income and gains from these accounts. SIPP’s and ISA’s will also need to be reported on your FBAR (“Foreign Bank Account Form”) each year.
Finally, the FBAR can cause real trouble for Americans in the UK. Here is an example of one common scenario: assume you own your own home and have an offset mortgage. The money you have offsetting your mortgage would need to be reported on your FBAR as would your SIPP’s, ISA’s, savings accounts, checking accounts etc. Failure to report these funds can result in very large penalties which start at $10,000 and go up from there. The rule is if you have over $10,000 or the foreign equivalent in overseas bank accounts you must report this money to the Treasury by June 30th. This is cumulative i.e. if you have $2,000 in 5 accounts you need to report all 5 accounts. At the moment the Treasury is not clear about how or who gets fined for not reporting these foreign bank accounts. One thing is clear, however: if you voluntarily report your accounts you are much less likely to be fined than if the Treasury catches you.