19 Jul What is the US/UK tax treaty and how does it affect US expats?
Tom LR Griffiths is a US and UK tax specialist at Ingleton Partners.
While there are around 173,470 US expats living in the UK, at Ingleton Partners we often find people who aren’t aware of their tax obligations to the US Federal Government.
One of the most crucial parts of US legislation affecting US expats living in the UK is the US/UK tax treaty, which was signed in 2001. Its full title is “[the] Convention between the Government of Great Britain and Northern Ireland for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income and Capital Gains”.
Why was the US/UK tax treaty introduced?
The treaty was introduced to ensure that the Federal Government of the US successfully levies taxes on all of its citizens, regardless of where they live. Of course, US expats also have to pay tax in the country where they’re living and working. US expats living in the UK must comply with HMRC, which is the department of the UK Government that deals with income tax. The convention is to protect these expats from paying ‘double tax’, as well as to make sure they’re legally complying with their country of birth.
It is worth noting that the tax system in the US is extremely complex, and far-reaching. Just two countries in the world tax their citizens if they are living overseas (the other is Eritrea), which gives rise to complicated and often intimidating amounts of compliance for the people concerned.
All US citizens must file tax returns
All US citizens and greencard holders are legally obliged to file a US tax return on their worldwide income. This is true for US expats in the UK, regardless of whether they have any income from the US itself.
The UK statutory residence test is very complex, but three general cases might be taken as:
- They spend a minimum of 183 days in the UK during one UK tax year (6 April to the following 5 April).
- Their only home is in the UK for a minimum of 91 days in a UK tax year.
- Their main home base is the UK.
The combination of the two country’s tax laws means many US expats living and working in the UK must file two separate tax returns. Filing both returns is generally unavoidable, so there is already a need for twice the admin to ensure full compliance. However, it could also leave them at risk of paying double the amount of tax, one sum to the UK Government and one to the US Government. Luckily, this is generally avoidable through the correct use of various separate filings.
All US citizens have to file their tax returns every year by 15 April. US expats are granted an automatic extension until 15 June, with the idea that they can get the UK’s taxes filed first and therefore know how to offset any US tax they owe. Should they need a further extension, it can be applied for and granted until 15 October. This is never automatic and requires separate paperwork to be filed.
US expats who live in the UK might also be required to file a Foreign Bank Account Report (FBAR). This applies to expats who have more than $10,000 in foreign bank accounts, which refers to any accounts not situated on the mainland of the US.
Preventing the possibility of double taxation
The Treaty creates provisos to protect US expats from paying double taxation through a series of US tax credits that can offset the tax paid to the UK. If they have income from the US, then they can claim British tax credits against taxes paid to the IRS when they file their UK return.
US expats who want to claim US tax credits against tax they’ve paid the British Government must file Form 1116 along with Form 1040, which is the federal tax return.
Some US expats claim through a different exemption – the Foreign Earned Income Exclusion (FEIE) using Form 2555. This exemption allows the person to exclude the first $105,900 of their income from being taxed by the IRS. This threshold changes every year along with inflation, and this figure is for 2019.
When deciding which exemption to use, US expats must consider their personal circumstances, including the type of income they have, their immigration status, their family status and how much they earn.
Corporation tax and social security
Corporation tax is also covered by the US/UK Tax Treat. A company is taxed in the country of its registration, unless it has an office, branch or factory (a ‘permanent establishment’) in the other country. If this is the case, its profits are taxed in its country of location.
There is also a clause that allows the UK and US Governments to swap and share tax information. This means that HMRC can see the tax US expats are paying to the IRS, and vice versa.
A separate and distinct agreement between the two countries called the ‘Totalisation Agreement’, allows US expats living in the UK to not have to pay tax on social security to both Governments. Any contributions they make in the UK can be credited to either country’s system, or which country they pay depends on how long they intend to live in the UK.