The struggle for US expatriates investing abroad is an ever-evolving challenge. In the complex web of US investment tax rules, one can find themselves with a daunting task ahead. With the stakes high, it is imperative to seek guidance from qualified financial advisers to navigate these potentially overwhelming complexities.
Quickly, US persons realise the various hurdles that come with investing outside the United States. The investment landscape for US citizens abroad is fraught with restrictions and requirements, leaving few options for those seeking financial guidance.
The following are just some of the factors US persons living abroad must consider before investing:
- Tax reporting requirements can be onerous for US persons abroad. Tax charges and penalties apply even in cases where no taxes are payable in the country of residence.
- Strict regulations apply to the types of investments US persons can hold. Popular investments in the UK and other countries may be heavily taxed by US authorities, leading to potentially costly mistakes.
- The implementation of FATCA (Foreign Account Tax Compliance Act). This placed significant obligations on non-US banks and financial companies to report details of their US-linked customers to the Internal Revenue Service. Many companies chose to avoid the burden by simply refusing to accept Americans as clients, such as the likes of AJ Bell.
While there are more investment and banking options available to US citizens abroad than there were several years ago, the choices are still relatively limited and often result in higher costs for basic services.
By seeking out knowledgeable and experienced financial advisers who understand the unique requirements of US citizens living abroad, individuals can make informed investment decisions and protect themselves from unnecessary tax burdens.
In this article, we explore some of the intricacies of US investment tax rules abroad, including in the UK, and shed light on the key role played by financial advisers in ensuring a smooth and successful investment journey for American expats.
Investing in the UK for US Persons
For US persons living in the UK, investing can be a complicated and challenging process. The options are limited, and there are significant tax implications that must be considered. Here are some of the options available.
Pensions and Junior Pensions
The most realistic investment option for US persons in the UK is a pension, as it is held through a pension trust. This means that the funds are not held directly by the person, but in the benefit of the person, also being protected from most taxes, being efficient with income tax and IHT.
Pensions can be passed on to beneficiaries in the event of the investor’s death with no liabilities, and offer tax relief on contributions, which can help to reduce the investor’s US tax liability. However, it’s important to note that withdrawals from a UK pension can be subject to US tax, depending on the circumstances at the time.
ISAs
Although ISAs can seem extremely attractive due to its usual tax-free advertising, US persons cannot really benefit from this structure due to the reporting requirements. In fact, most ISA providers in the UK do not allow US connected persons to open an ISA, as there can be severe penalties if not reported correctly to the IRS. Additionally, income and growth from ISAs are typically subject to US tax.
General Investment Account (GIA)
US persons can invest in the UK stock market through general investment accounts, but they must be extremely careful with the rules on Passive Foreign Investment Companies (PFICs). Penalties for non-compliance with PFIC rules can be higher than normal, so it’s essential to seek professional advice before investing. Additionally, it’s important to be aware of the potential tax implications of buying and selling UK stocks, as this can trigger US tax liabilities.
It is important for US persons to consult with a qualified financial advisor and tax specialist to ensure that their wealth and finances are structured in a way that minimises their tax liability and complies with US and UK tax laws.
UK Real Estate
Investing in UK real estate can be a viable option for US persons, but it’s important to note that income from these investments does not form part of any exemptions and can be heavily taxed. It’s essential to seek professional advice to ensure that the investment is structured in a tax-efficient manner, but it is still not a typically recommended structure for US connected persons
Understanding US Tax Rules
American citizens living abroad face an abstruse tax regime which has been designed to ensure that every US Person is taxed as if they were still living in the US. Furthermore, this does not just apply to US Citizens, but “US Connected Persons”.
In other words, the US tax system applies to any person connected to the US regardless of where they are living and earning their income. This unique and somewhat burdensome tax system can be a significant challenge for American expats who are trying to invest their money while living overseas.
What is a US Connected Person?
US connected persons are individuals who have a certain type of connection with the United States that requires them to comply with US tax rules, even if they live outside the country. These connections can include:
- US citizens living abroad
- Green Card holders
- Other visa holders living in the US. However, this can get complicated, as H1B visa holders are only sometimes considered US-connected persons, so analysis would be required
- US taxpayers
- Individuals born outside the US but have a US parent
- Individuals born in the US, even if they left as a child
- And in most cases, if you have been a lawful resident in the US for eight out of the fifteen years preceding your expatriation year, whether as a green card holder or a US citizen, it is likely that you will be subject to exit taxes.
All of these individuals are considered US-connected persons and must comply with US tax laws and regulations, regardless of their location.
This makes tax planning and compliance more complicated and may require the assistance of a qualified financial advisor or tax specialist to navigate. Non-compliance with these rules can result in significant financial penalties and legal issues, making it crucial for US-connected persons to stay informed and up-to-date with the latest tax requirements.
Double-Taxation Agreements
Double Taxation Agreements (DTAs) are critical in mitigating the effects of double taxation for US expats in the UK, and for UK residents who earn income in the US, such as Digital Nomads (those working for US firms remotely).
DTAs are treaties between two countries that are intended to ensure that citizens of one country do not have to pay taxes on the same income twice. The UK and the US have a comprehensive double tax treaty that aims to reduce the burden of double taxation.
As such, DTAs are vital since if you are a US expat living in the UK, you are still subject to US tax laws on your worldwide income, including any income earned in the UK. However, as a resident of the UK, you are also liable to UK tax laws. Without a DTA in place, you could end up paying taxes on the same income twice.
The UK-US DTA helps to alleviate the financial burden of double taxation by establishing a set of rules to determine which country has the primary right to tax specific types of income. It also provides relief from the US tax requirements for many UK pensions, which would otherwise be subject to double taxation.
It is crucial to understand the DTA between the UK and the US, as it can have a significant impact on your tax liability as a US expat living in the UK or a UK resident earning income in the US. Together with a qualified financial adviser and tax specialist, both professionals can help you navigate the complexities of the DTA and ensure that you are taking advantage of all the available tax benefits.
Foreign Bank Account Report (FBAR)
Introduced in 1970 as part of the Bank Secrecy Act, the Foreign Bank Account Report (FBAR) is a critical requirement for US citizens residing abroad who hold financial accounts outside of the United States. Any foreign financial accounts exceeding $10,000 in value at any point during the year must be disclosed, regardless of whether the accounts generate income or not. For example, even if you hold three accounts, one with $3,000, another with $7,000, and a third with £0, merely open for the sake of it, you are still required to report all three accounts to the IRS.
For over 50 years, the FBAR has been in place as the first significant effort by the US government to monitor offshore accounts. It is intended to prevent tax evasion by ensuring that US taxpayers with foreign accounts disclose their financial holdings to the US government. In recent years, there has been a considerable increase in the enforcement of FBAR reporting requirements. As a result, FBAR has become a crucial component of the US government’s efforts to combat tax evasion.
To comply with FBAR, US taxpayers must submit FinCEN Form 114 online. It is worth noting that the penalty for failure to comply with FBAR can be significant, including up to $10,000 per form per year missed. As such, it is imperative that US citizens residing abroad understand their obligations under FBAR and take the necessary steps to ensure compliance.
Foreign Account Tax Compliance Act (FATCA)
Introduced in 2010, the Foreign Account Tax Compliance Act (FATCA) has been at the forefront of the US government’s efforts to clamp down on tax evasion. The act seeks to ensure that US citizens holding foreign financial assets disclose their assets to the US IRS by requiring foreign financial institutions (FFIs) to report financial accounts held by US citizens and residents.
However, FATCA has had a significant impact on US citizens living abroad. With the additional reporting requirements and potential penalties for non-compliance, the law has become a source of concern for many US citizens living overseas. What’s more, it has caused many foreign banks to close accounts held by US citizens due to the burdensome reporting requirements.
To comply with FATCA, US-connected persons must submit Form 8938, also known as the Statement of Specified Foreign Financial Assets. Failure to do so can result in severe penalties, adding to the already complex requirements for US citizens living abroad.
While supporters of the law argue that it is necessary to ensure compliance with US tax laws, critics contend that it places an unnecessary burden on FFIs and violates privacy rights. Despite the controversy, FATCA remains an essential part of the US government’s efforts to combat tax evasion.
Other Tax Reporting Rules and Responsibilities
Another responsibility for US connected persons living abroad is the rules on Passive Foreign Investment Companies (PFICs).
Passive Foreign Investment Companies (PFICs)
PFICs are a hot topic for US taxpayers living abroad, particularly those wishing to invest in non-US companies, stocks or shares. These rules were introduced to prevent US persons from investing in foreign financial instruments to avoid taxes.
Investing in PFICs can be an easy mistake to make, but the IRS will apply harsher tax penalties for non-compliance. It is essential to understand the complex regulations surrounding PFICs and how they can impact your taxes.
Therefore, the IRS has implemented a set of guidelines designed to differentiate between investments in operating businesses and those that pursue passive income streams. To meet the requirements, an investment must pass two tests: the “income test” and the “asset test“.
However, the definition of passive income is quite intricate and vast. It depends on who is producing the dividends and interest from companies, as they may or may not qualify as passive income. Additionally, the classification of shares quoted on a major stock market, such as the London Stock Exchange, may be subject to different rules, depending on the nature of the business that issued said shares.
That said, it is generally understood that shares in businesses whose profits and revenue are primarily derived from the sale of goods or services, such as Shell or HSBC, would likely pass the tests. It is only when these shares are wrapped within a different vehicle that they become a PFIC, and therefore are subject to harsher tax rules.
How Can a US Person Invest in the UK?
The UK’s sophisticated financial services industry has tended to favour two types of collective fund structures: unit trusts and open-ended investment companies (OEICS). However, these vehicles need to be established in a specific way if they are not to be treated as PFICs, and most are unfortunately not.
This is because, when non-US shares or instruments are grouped together in a portfolio, such as a unit trust managed by a UK asset manager, the vehicle itself is likely to fail the tests mentioned beforehand. As a result, it will be considered a PFIC and be potentially subject to higher taxation.
Fortunately, there are some ways to mitigate the tax burden of PFICs, including electing to treat the investment as a Qualified Electing Fund (QEF). However, this method is not always easy to navigate, and it is essential to consult with a qualified tax specialist alongside an IFA to ensure that no costly mistakes are made.
Ultimately, it is essential for US citizens living in the UK to be aware of these regulations and seek professional advice to avoid unwanted tax implications. And lastly, although the rules surrounding PFICs can be onerous, with proper planning and expert advice, it is possible to invest in non-US companies and remain compliant with US tax laws.
Do I Need to Report My UK Investments to the IRS?
As the UK Financial System is renowned for its strength and stability, this robustness also extends to the way it treats US tax reporting rules. If you are a US person living in the UK, you’ll find that these rules are taken extremely seriously.
As such, it’s normally a requirement that you file a tax return with the IRS, even if you don’t owe them any taxes.This means that if you’re a US expat living in the UK, you need to ensure that you’re fully compliant with US tax laws to avoid any potential penalties or legal issues down the line.
Can I Do Anything to Avoid It?
The short answer is Yes, as it is not all doom and gloom, but there is (unfortunately) a longer answer. Although you can “avoid” US taxes (also known as mitigating them), you cannot evade them. There are several ways to reduce your US tax liability, such as by using two main exemptions: Foreign Earned Income Exclusion (FEIE) and the Foreign Tax Credit. We will touch on these shortly.
Moreover, you will still be able to invest your money and grow your wealth, especially in the UK. The problem is, only a select few platform providers and Independent Financial Advisers (IFAs) permit this.
IFAs can provide expert advice on investments, as well as help navigate the complexities of the US Tax Reporting Rules. While it’s true that restrictions to investing may still apply, it’s worth considering the potential benefits of investing in the UK. Despite the probable requirement to file a tax return, with the help of an IFA, US citizens living abroad can still make the most of their financial opportunities.
Utilising Tax Advantageous Schemes to Reduce Your Liability
Although we are not Tax Advisers, and this is not Tax Advice, there are several tax advantageous schemes available to reduce your US Tax Liability, such as the Foreign Earned Income Exclusion (FEIE) and the Foreign Tax Credit.
Foreign Tax Credit
Foreign Tax Credit is a useful tool for American taxpayers to reduce their US tax liabilities. However, not all foreign taxes are created equal. To qualify for the credit, the tax must:
- be imposed on you
- paid or accrued by you
- a legal and actual foreign tax liability
- and an income tax or a tax in lieu of an income tax.
Taxes that don’t qualify for the credit include foreign real estate, social security, and property taxes because they are not taxes imposed on income or profit.
So, how does the Foreign Tax Credit work? Let’s say you’re a US citizen working in the UK and have to pay income tax in both the UK and the US. To avoid double taxation, you can claim a Foreign Tax Credit on your US tax return for the income tax paid to the UK. The credit reduces your US tax liability dollar-for-dollar for the amount of qualifying foreign taxes paid, which can help reduce your overall tax burden.
Foreign Earned Income Exclusion
The Foreign Earned Income Exclusion (FEIE) is a valuable tool for US citizens and Green Card holders who live and work abroad. This exclusion allows eligible taxpayers to exclude up to $120,000 (2023 tax-year) of foreign earned income from their taxable income in 2021. To qualify for this exclusion, the taxpayer must meet one of two tests: either the bona fide residence test or the physical presence test.
- The bona fide residence test requires that the taxpayer is a resident in a foreign country for an uninterrupted period that includes a full calendar year.
- The physical presence test requires the taxpayer to be physically present in a foreign country for 330 days out of any consecutive 12-month period.
It is important to note that not all types of income are eligible for the FEIE. The exclusion applies only to earned income, such as wages, salaries, and self-employment income. Additionally, if you earn more than the exclusion amount, you will still need to file a tax return and report all your income. However, using the FEIE can significantly reduce your tax liability and save you money.
In Summary
Both of these exemptions are complex, but with the help of an IFA and experienced Tax Specialist, you can get help navigating the intricacies of the tax code and make sure you’re taking advantage of all the available tax benefits.
Is It Even Worth Investing in the UK as a US Connected Person?
Investing as a US connected person in the UK can be a complex and challenging task. With stringent tax reporting requirements, restrictions on the types of investments available and the potential for severe penalties for non-compliance, it is natural to ask whether it is even worth investing in the first place.
The answer to this question depends on several factors, such as your financial goals, investment time horizon, risk tolerance and tax situation. For many US expats, investing in the UK can be an excellent way to build wealth and achieve financial independence.
However, it is crucial to work with a qualified financial adviser and tax specialist who can guide you through the complexities of the UK investment landscape and ensure that you are making informed investment decisions that align with your financial goals.
Overall, despite the complexities involved, investing in the UK as a US person can still be a worthwhile endeavour. While there are certainly risks involved, with the right guidance and advice, US expats and residents can take advantage of a range of investment opportunities in the UK to grow their wealth.
The Importance of Financial Advice – and Why It’s So Difficult to Get it In the UK!
Navigating the intricacies of tax law, investment regulations, and the ever-changing global financial landscape can be a daunting task. For US persons living in the UK, it can be even more challenging, as they must contend with the complex tax laws of both countries. This is where seeking professional financial advice from qualified experts can be invaluable.
However, obtaining sound financial advice as a US person living in the UK can be difficult due to the stringent regulations and licensing requirements of UK financial advisers. UK IFAs are usually only regulated with the Financial Conduct Authority (FCA) in the UK, but not with the Securities and Exchange Commission (SEC) in the States, which can often cause troubles in the long-run.
Many financial advisers are unwilling to provide services to US persons due to the extra regulations and reporting requirements involved.
Furthermore, there are additional challenges when it comes to finding an adviser who is knowledgeable about both UK and US financial regulations, as well as the specific challenges facing US persons living in the UK. It is important to find a financial adviser who is not only qualified but also experienced in dealing with the unique needs and requirements of US persons.
The importance of seeking professional financial advice cannot be overstated, as it can help ensure compliance with complex tax laws and regulations, as well as help individuals make informed investment decisions. A knowledgeable financial adviser can help US persons navigate the complexities of the UK and US tax systems, determine the most advantageous investment options, and avoid costly mistakes. As such, one can confidently say that working with the right adviser can make all the difference in achieving financial stability and success.
How Can Cameron James Help US Citizens Invest in the UK?
At Cameron James, we understand the unique challenges faced by our clients and provide bespoke solutions to help navigate the complexities of US and UK tax laws. With clients in 23 US States at present, and many in the UK and internationally, we are able to provide regulated, suitable advice to individuals seeking help with their finances.
Our advisers are experienced and highly qualified, holding both SEC and FCA regulatory licences, including the Securities 65 Exam and Level 4 Diploma; and, our company is regulated by both the FCA and SEC, ensuring that our clients receive the highest standards of service.
Furthermore, we have established several partnerships with US and UK Tax Specialists, including Cross-Border and International Tax Advisers, to ensure that our clients receive synergistic advice on their investments and tax planning.
Our goal is to help our clients achieve financial peace of mind and optimise their financial situation. If you are a US person living in the UK, we invite you to book a free initial consultation with one of our IFAs below, to discuss your unique needs and develop a personalised solution. Let Cameron James be your trusted partner in navigating the complex world of US and UK taxes.
