Tax considerations for US citizens working or residing in the UK
- Increasing internationalisation of clients means that advisers must be more aware.
- US crackdown on undeclared offshore accounts.
- The US tax implications of UK investments.
- The importance of accurate and prompt completion of FinCEN form 114.
- The Foreign Account Tax Compliance Act imposes new reporting obligations on foreign financial institutions.
As UK tax practices become more international, advisers require a good idea of the non-UK tax issues that apply to their clients. For most taxpayers, exposure to US tax rules is a distant “nightmare” scenario.
However, as taxpayers’ aﬀairs also become more international – or an adviser discovers that one of their taxpayers has a green card, passport, or other links to the US – they must grapple with aspects of US taxation.
The US Internal Revenue Service (IRS) has significantly stepped up its international compliance efforts in recent years. More of its taxpayers have been criminally charged since 2009 as a result of undeclared non-US accounts than have pled or been found guilty.
This indicates that more such pleas or verdicts are likely to be announced in the coming months; these will be not just from ongoing examinations, but from future ones as the US continues to receive information from non-US banks.
If recent events are evidence of a reinvigorated appetite in the IRS to increase international compliance, now is an ideal time for advisers to make a defensive move by increasing their knowledge of this area.
Since 2009, US officials have cracked down on undeclared offshore accounts, with the following results:
- US taxpayers criminally charged: 86.
- Firms or advisers criminally charged: 35.
- Guilty pleas: 64.
- Guilty verdicts: 10.
- Excluding some atypical cases, the average offshore account balance at its peak: $6.8m.
- Participants in the IRS offshore limited amnesty programme: more than 38,000.
- IRS collections from the limited amnesty programme: $5.5bn, with $5bn more to come.
Case study and the basics
As has been explained previously by David Treitel (Yank them into filing) US citizens and green card holders living outside the US must file a US tax return each year.
At the same time, they must comply with their UK tax requirements. Living or working in the UK can create US tax issues and pitfalls and this may best be illustrated by a case study.
Joanne has just moved back to London and has a US green card. Before delving into any UK tax issues, the accountant runs through the following list of US tax pitfalls that could apply because of her US status.
Perhaps we should start with a brief explanation of some fundamental aspects: tax years, exchange rates and deadlines.
- UK and US taxable years. Joanne should be told that the UK and US tax years are different. Most US taxpayers operate on a calendar year, while the UK tax year runs from 6 April to 5 April.
- Foreign exchange. When preparing US returns, Joanne will need to convert her income into US dollars and report it on a calendar year basis. She can use her monthly pay statements, bank interest statements, or year-end statements. When converting earnings Joanne can use the exchange rate on the dates she is paid or she can use a monthly average or an annual average, as long as the method used is consistent.
- Deadlines. Joanne can receive an automatic two-month extension from the IRS so that the tax return is due on 15 June rather than 15 April. Because the UK tax year does not end until 5 April she may not have her annual statements by June. In this case, she can file an extension, which would give her until 15 October to file federal income tax returns. However, if she owes tax to the IRS interest will accrue from 15 April. It is therefore worth trying to file her US tax returns as soon as possible. Joanne’s foreign bank account report (discussed below) remains due on 30 June, even if she obtains an extension to file taxes later. Her UK self-assessment tax return (if she is required to file one) is, of course, due by 31 January after the end of the tax year.
Treaties and pensions
Close attention will need to be paid to the US/UK tax treaty and totalisation agreement.
If Joanne is an employee in the UK, she is likely to be subject to tax under the PAYE system. Because of the treaty, she will generally not be double-taxed on her UK employment income and she can use the foreign tax credit and the foreign earned income exclusion to avoid paying any tax in the US.
If Joanne is self-employed, she would need to opt out of US social security taxes by claiming the benefits of the US/UK totalisation agreement in the US, even though she might be paying National Insurance.
This is not automatic but, to opt out, Joanne needs to obtain a certificate of coverage from HMRC’s National Insurance Contributions Office. A photocopy of this must be attached to her income tax return each year as proof of the US exemption.
On retirement savings, most employer-sponsored pension plans should not be problematic for US tax purposes. However, note that Joanne should not use a self-invested personal pension (SIPP) or individual savings account (ISA) without detailed US tax advice.
This is because these investments may be treated as foreign trusts for US federal tax purposes and she would need to report the earnings and capital gains each year. SIPPs and ISAs will also need to be reported each year on Joanne’s FinCEN form 114 (formerly known as an FBAR or foreign bank account report).
The foreign bank account report
It is worth taking a closer look at the FinCEN form 114.
Non-US bank account reporting can cause real trouble for Joanne. For example, if she were to acquire a home in the UK with an offset mortgage, the offset account should be reported on her FinCEN form 114.
So should all her accounts, including any SIPPs, ISAs, savings and current accounts and interests in other investment entities. If Joanne has more than $10,000 or its equivalent in the other currency in all her non-US accounts she must report them by filing FinCEN form 114 by 30 June after any calendar year in which the $10,000 threshold is met.
The filing deadline cannot be extended and the IRS can take up to six years from the original filing date to assess penalties for failure to file this form.
The penalties for failing to file the FinCEN form 114 are severe and can include criminal sanctions. Non-wilful violations would expose Joanne to fines as high as $10,000 for each year she fails to file this form.
The annual penalty for wilful failure to file is generally the greater of $100,000 or 50% of the maximum amount held in all of Joanne’s non-US accounts during the year.
For example, if Joanne has an equivalent of $200,000 in a non-US account for four years and does not file the FinCEN form 114 or report interest income earned by the account each year, the IRS could assess a $400,000 FBAR penalty if the failure was wilful.
Mitigation guidelines may reduce the penalty and Joanne may avoid the penalty altogether by showing that the failure to file was due to reasonable cause.
Although the IRS claims that finding wilfulness requires significant evidence of wrongdoing based on all the facts and circumstances, one court intimated that the simple failure to correctly answer a question about non-US accounts on a taxpayer’s return (by checking the wrong box) is sufficient to establish willfulness.
Criminal penalties are also possible and can include fines of up to $500,000 and/or 10 years in prison. Although rare, criminal prosecutions relating to FBAR violations do occur.
As a result of the implementation of the Foreign Account Tax Compliance Act (FATCA), more foreign financial institutions (FFIs), such as banks, stockbrokers, pension plans, hedge funds, insurance companies and trusts outside the US, will be disclosing the names of their US account holders to the IRS.
Beginning as early as mid-2014, FATCA forces FFIs to disclose the names of their US account holders and their account details directly to the IRS (or to their local tax authorities for further transmission to the IRS if the US has entered into an inter-governmental agreement with the country).
Failure to comply with these rules will result in a 30% withholding tax being imposed on the foreign entities’ income as well as on the gross proceeds from any sale‚ not just on the gain made.
FATCA classifies all foreign entities as either FFIs or non-financial foreign entities. The object of the legislation is to cause the disclosure of information relating to “US accounts” held by an FFI to the IRS.
The act’s methodology involves an FFI registering with the IRS unless it is exempt from such registration under the FATCA regulations or an applicable inter-governmental agreement. After registration, various FFIs will also be required to make a report to the IRS on any US accounts held or administered by it.
Countries that previously provided bank secrecy are now supporting the implementation of FATCA and generally encourage their banks to disclose US account holders. On 29 August 2013, the US Department of Justice announced a programme to encourage Swiss banks to provide detailed information about US account holders.
The Swiss Federal Department of Finance and the US Department of Justice released a joint statement stating that Switzerland would encourage its banks to participate in the program.
If Joanne has non-US accounts and has not told the IRS about them, even though she is required to do so, she must now deal with some hard truths:
- the requirement to disclose non-US accounts;
- severe penalties for failure to disclose; and
- the need to act quickly to evaluate participation in the disclosure programme.
In addition, under FATCA, Joanne must report her non-US financial assets to the IRS. This reporting will be made on form 8938, which Joanne should attach to her federal income tax return.
This will affect Joanne if she has:
- any form of investment held outside the US; or
- any investments in an FFI that are not FATCA-compliant.
With the implementation of FATCA and the other tools that the IRS has developed for finding non-compliant taxpayers, time is running out if Joanne is not up to date with her filings.
Furthermore, many banks and other foreign financial institutions will no longer be able to retain Joanne as a client. These are good reasons for Joanne to bring her US tax affairs up to date.
State tax returns
If Joanne has workdays in the US during the year, she may need to file a state tax return. Although double tax treaty provisions may treat US source income earned during her US workdays as non-US source, the treaty will not cover state taxes. If Joanne does work in a state like California for a week she may be subject to state income taxes.
Further points to note for New York and California are as follows.
- New York does not accept a copy of federal extension for delayed tax return filing, so if Joanne worked there during the calendar year she will need to file a separate state extension for delayed tax return filing.
- If Joanne needs more time to file her California return, she will be allowed a six-month extension without filing a request.
It is clear that the IRS is under a lot of pressure to increase its international compliance. We will not know for a while whether the recent crackdown on undeclared offshore accounts is the start of a new aggressive approach; however, advisers should take extra care when dealing with the department.
In recent years, many advisers have been blind to US tax issues. As FATCA implementation kicks into full gear and the IRS begins to receive a stream of international account holder information, it may only be a matter of time before US tax compliance becomes commonplace outside the US.
|US Treasury Department Circular 230: pursuant to US Treasury Department regulations, any federal tax advice contained in this article is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any tax-related matters addressed herein.|