04 Mar Challenges facing US expats in the UK when filing federal and state taxes
Any US expats living in the UK must understand the complex requirements ahead of filing their federal and state taxes. At Ingleton Partners, we have more than three decades of collective experience in ensuring full compliance with the always-changing regulations from the Inland Revenue Service (IRS). Here are some of the key points to keep in mind when approaching tax season.
Tax challenges ahead for US expats in the UK
On 20 March 2020, Treasury Secretary Steven Mnuchin announced via tweet that Tax Day has now officially moved from 15 April 2020 to 15 July 2020. And while, at the time of writing, there is no direct information available about the filing date for US expats, it’s expected that this will also be extended.
Either way, it’s never too early to ensure compliance. Filing a US tax return can be challenging for any US taxpayers living in the UK. The US has one of the most complex and convoluted tax systems in the world and is one of just countries choosing to tax its citizens regardless of where they live.
Added to these issues, the Internal Revenue Service (IRS) has introduced various new laws over recent years that impact US expats. American citizens or greencard holders living in the UK often have to file with both countries, but there is a tax agreement in place to stop double taxation. To ensure tax isn’t taken twice from their worldwide income, US expats in the UK can either use Foreign Tax Credit (FTC) on Form 1116, or Foreign Earned Income Exclusion (FEIE) on Form 2555.
The former allows them to claim tax credits on the payment they’ve already made in the UK, while the latter allows the first $100,800 of foreign earned income to be excluded. Note that this threshold changes every year in line with inflation, and that Form 2555 remains in effect until it’s revoked by the US expat.
So, what’s the difference between the two? The biggest difference is that FTC can be used for various types of income and not just on earned income. For example, income from property sales and pensions can come under Form 1116. FEIE can only be taken on earned income, such as from self-employment or PAYE wages.
Both forms can be used in the same tax return, but not relating to the same income. An extra form (Schedule A) can be used to claim any itemised deductions. Official advice from the IRS is that US expats should use one or the other.
Filing dates are different in the US and the UK
The duration of the tax year is different in the US and the UK, with the US following a calendar year. Documentation and reporting for US taxes mean expats might need to combine pay records with their P60s to fulfil the tax year requirements from the IRS. Earnings should be filed for federal taxes on earnings between 1 January and 31 December, rather than the UK tax year of 1 April to 30 March.
US expats, including partnerships and corporations, also have to file a Foreign Bank and Financial Accounts Report (FBAR) with the US Treasury Department. This is also due on 15 April, but anyone missing the deadline can get an extension until 15 October. US expats filing their own FBAR can file electronically using the BSA E-Filing System, but those using a tax expert must authorise them to do so using FinCEN Report 114a.
In addition, any US expat taxpayer with more than $50,000 held in foreign financial bank accounts must disclose this on the federal return under FATCA. Individuals must file both the FATCA and FBAR requirements, as they don’t cancel each other out.
What about pensions and other forms of income?
There are lengthy IRS guidelines regarding pension and annuity distributions for expats. However, generally US expats can deduct any contributions they’ve made to a UK pension scheme on their US tax return. It could also be subject to FATCA and FBAR reporting as well, and in some cases, pensions can be regarded as foreign grantor trusts and therefore need a separate filing.
If a US expat moved to the UK recently, then they may hold a 401(k) pension that was automatically closed down by their former employer when they left. Any US expat with a 401(k) must file Form 1099-R, which shows how much state and federal income tax was withheld (if any).
Each state of the US has its own tax rules, making state tax returns even more complex than federal tax returns. It’s not always immediately obvious whether a former resident of a state even needs to file them if they move to the UK. It all comes down to whether the expat is ‘domiciled’ in the state. However, states vary enormously on the definition of domiciliary, and have different criteria to considering people resident or non-resident. It’s not a legal requirement for US expats to hold a residency in any state. In most cases US expats won’t owe state taxes anyway, but we’d always advise checking with the specific state treasury to make sure.