Americans who live and work in the United Kingdom need to know a little about how the tax system works in the US and in the UK. This article provides 12 tax tips for American expats, plus a brief comparison of the US and UK tax system, plus common questions that expats ask Visor.
1. What you need to know about the US tax system
As Americans, we pay US taxes on our worldwide income.
So any income you earn while living and working in the UK needs to be reported on your US tax return.
You might not owe any tax in the US. That’s because we might be able to exclude some or all of your UK income from US tax, and/or you might be able to offset your US tax liability with any tax paid to the UK.
2. The foreign earned income exclusion
For the year 2018, Americans who work in the U.K. can exclude up to US$104,100 of their British wages or self-employment income from U.S. federal taxes.
This exclusion helps Americans mitigate against the risk that their income could be taxed by both HMRC and the IRS.
To qualify, Americans need to meet one of two tests.
Either they must live in the U.K. (and/or other foreign countries) for at least 330 full days during any consecutive 12-month period;
Or they must be a bona fide resident of the U.K. (and/or other foreign countries) for an uninterrupted period that includes a full calendar year.
3. The foreign tax credit
Americans can reduce how much tax they pay to the United States by taking a credit for taxes paid to the U.K. National insurance contributions don’t count towards this credit. Only income taxes count towards this credit.
4. Independent contractors can avoid U.S. self-employment taxes
Americans who are self-employed, sole traders, or running their own business are typically responsible for paying the self-employment tax in the United States, even if they are utilizing the foreign earned income exclusion to shelter their British earnings from US tax. But there’s a workaround available for American expats. Americans, who are paying into and covered by the National Insurance, can be exempt from paying the self-employment tax. This little-known tax strategy is made possible by the Social Security Totalization Agreement between the U.S. and the U.K.
5. Charitable Donations
Unfortunately, Americans cannot take a deduction for gifts donated to registered charities in the United Kingdom. Under U.S. tax laws, we can only deduct donations to charities registered in the U.S., Canada, Mexico, and Israel.
6. Earnings inside an I.S.A. is tax-deferred until the funds are distributed.
Americans are permitted to save and invest through employment-based pensions and personal pensions set up in the United Kingdom, including Individual Savings Account (ISA). Under a tax treaty between the U.S. and the U.K., earnings that accumulate inside of U.K. pension plans does not become taxable in the United States until the funds are distributed.
7. You Might Need to Tell the US Government that You Have an I.S.A. (and other Foreign Financial Accounts)
The U.S. government is keen on having its citizens and resident aliens declare the existence of any bank accounts and other types of financial accounts located outside the U.S. Americans need to file a special “foreign bank account report” (FinCen Form 114) if their highest balance in each foreign financial account, when added up across all foreign accounts, reaches at least US$10,000 at any time during the year.
An ISA is such a foreign financial account.
In other words, Americans may need to disclose to the U.S. government the details of their checking, savings, ISA, brokerage, whole life insurance policies, and other types of bank, securities and financial accounts. While there is no tax associated with Form 114, the US government can impose severe penalties (starting at $12,459) for not filing this report.
8. The US tax year is different than the UK tax year.
In the United States, our tax year runs from January 1st through December 31st.
The tax year in the United Kingdom runs from April 6th to April 5th.
This difference in tax years means that you and your US tax accountant will need to do a little more work to make sure that your UK income is reported properly on your US tax return. For example, wage income reported on the P60 form may need to be split up into the income earned during each calendar year. This is pretty straightforward mathematically speaking. The key is having a conversation with your accountant regarding when this income was earned.
9. How to convert pounds sterling into US dollars
On your US tax return, we will need to convert amounts stated in pounds sterling into their US dollar equivalents. A common question clients ask us is which exchange rates to use? There are two parts to this answer.
First, let your US tax accountant handle these currency conversions. That’s because we want to see the amounts both in foreign currency and in US dollars, as sometimes the tax forms ask us for the amount in foreign currency and to show our currency conversion math.
Second, typically accountants will use either the Yearly Average Exchange Rates as published on the IRS.gov website, or use one of the quarterly exchange rates as published on the Treasury website. We can also use any published exchange rate, as long as the exchange rate properly reflects your income and deductions.
10. Rent can be Deducted (Sometimes)
In certain circumstances, US expats may be able to deduct rent and other housing costs. This is known as the foreign housing exclusion (for wage-earners) or as the foreign housing deduction (for self-employed persons). This is an additional exclusion on top of the foreign earned income exclusion. As such, we start to look at this exclusion if a person is earning more than $104,100 per year.
11. All the Other Normal Deductions Still Apply to Expats
American expats can take advantage of all other tax deductions. This is especially important to remember for expats who have incomes over the $104,100 limit on the foreign earned income exclusion. In addition to claiming the foreign earned income exclusion, we can also deduct the standard deduction or itemized deductions. Itemized deductions include expenses such as interest on a home loan, property taxes, and donations to charities.
12. US and UK tax stuff side-by-side
|Tax thing||United States||United Kingdom|
|Tax Year||January 1 – December 31||April 6 – April 5|
|National Tax Agency||Internal Revenue Service (IRS.gov)||HM Revenue and Customs (hmrc.gov.uk)|
|Tax Filing Deadline||April 15 (or October 15 with an extension)||October 31 (for returns filed on paper) or January 31 (for returns filed online)|
|Wage and tax statement||Form W-2||Form P60|
|How to set your tax withholding for wages||Give Form W-4 to your employer||If this is your first job in the UK, use the Starter Checklist for PAYE.
If you left one job and started another, give Form P45 to your new employer.
|Personal pension plans||Individual Retirement Accounts (IRA)||Individual Savings Accounts (ISA)|
|Tax-free allowances||Standard Deduction ($12,000 for singles; $18,000 for head of household; $24,000 for married couples)||Personal allowance (£11,500)|
Common questions that American expats living in the UK ask Visor
- Why do I have to file a US tax return?
Americans have to file a tax return in the United States because the US taxes its citizens on their worldwide income. As long as your gross income is at least $10,400 for the year (for a single person under age 65), then you are required to file a tax return.
- Does Visor file the UK tax return?
No. Visor only prepares and files US tax returns.
- What documents do you need to prepare a US tax return?
We need documents that show your income. This could be your P60 forms for your wage and salary income. Or it could be a tally of your income and expenses related to your self-employed business. Your UK tax returns would also be useful. Send us documents relating to any other types of income — such as bank interest, dividends, stock trades, rental income, social security benefits, unemployment benefits, distributions from retirement plans, gambling winnings, and any other income you might have for the year. We would also need to know how much tax you paid to the UK, as that will help us calculate your foreign tax credit.
- Do I need to have my documents translated into English for Visor?
Not necessarily. We will ask you to clarify what the numbers on your documents mean.
- What is the FBAR, and do I need to file one?
FBAR refers to the Foreign Bank Account Report. This is a special report filed with the Financial Crimes Enforcement Network (FinCEN), which is a division within the US Treasury Department and a sister agency to the Internal Revenue Service. The FBAR is required if an United States citizen, national, resident alien, or green card holder has a financial interest in or signature authority over foreign financial accounts must file an FBAR and the aggregate value of the foreign financial accounts exceeds US$10,000 at any time during the calendar year.
FBARs are due each April 15th for the previous calendar year. This deadline is automatically extended to October 15th.
FBARs are filed separately from the income tax return. There is no tax or government fee associated with the FBAR. But there are significant penalties if someone doesn’t file an FBAR.
- I have not filed US tax returns for several years. What do I do?
The best thing to do is to start filing your US tax returns. The IRS currently has a special program for resolving this specific problem. It’s called the Streamlined Filing Compliance Procedures. Under this program, the IRS wants us to file your current tax return plus three past-due tax returns, plus six years of past-due FBARs. The IRS typically waives all penalties as long as any tax due is paid, plus interest.
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