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us expat tax guide – united kingdom

Do I need to report my UK pension on my US tax return?

Yes, as a US citizen or Green Card holder with an employer pension in the UK, you may need to report it as a foreign trust.

When do you have to report your UK pension as a foreign trust?

You don’t have to file your UK pension as a Foreign Trust if your employer contributes more than you do. In these cases, if applicable, you only need to report the balance on your FBAR and Form 8938. 

Additionally, employer contributions and investment growth in qualified retirement plans are typically US tax-exempt.

What if the employee contributes more than the employer?

If your contributions exceed your employer’s, you might face a bit more complex US tax compliance, unless the pension is contract-based. 

A pension is considered “employer-funded” if most of the contributions come from the employer. If not, it is treated as a Foreign Grantor Trust and must be reported on Forms 3520 and 3520-A.

How are contributions compared over time?

When comparing contributions, you look at the total contributions over the life of the pension, not just a single year. If the employer’s contributions are the majority overall, the pension doesn’t need to be filed as a Foreign Grantor Trust.

How do contract-based and trust-based pensions differ?

Contract-based pensions are not considered Foreign Grantor Trusts, even if your contributions are higher than your employer’s. Therefore, Forms 3520 and 3520-A are not required for contract-based pensions.

What is another approach for US taxpayers under the US-UK Tax Treaty?

Under the US-UK Tax Treaty, reporting contributions and growth on your tax return may result in no current-year tax due to Foreign Tax Credits. The benefit comes when withdrawing money from the pension, as it will no longer be subject to US taxation, having been reported as income.

Will the IRS tax the 25% lump sum from my UK pension?

Yes, if you take a 25% lump sum tax-free from your UK pension, the IRS will tax it as income.

When does a foreign trust become a foreign grantor trust?

A foreign trust becomes a Foreign Grantor Trust when your contributions exceed your employer’s. In this case, it must be reported on Forms 3520 and 3520-A. If the pension is a UK plan covered by the UK-US Tax Treaty, its income is tax-exempt and does not flow through your tax return.

How and when do I file Form 3520-A?

Form 3520-A must be filed with the IRS by March 15 each year. The trust can request a six-month extension by submitting Form 7004 if needed. 

Foreign Grantor Trusts also need an Employer Identification Number (EIN) to file Form 3520-A. You can obtain an EIN by calling the IRS. Remember to file on time since late submissions incur an automatic minimum penalty of US$10,000.

When do ISAs become a problem for American expats?

ISAs (Individual Savings Accounts) are popular in the UK due to their tax benefits. However, depending on the type of ISA, they can be problematic for US citizens or Green Card holders. 

Cash-based ISAs are straightforward; you only need to report the value on your FBAR or Form 8938, and interest earned is reported as income on your US tax return.

What issues happen with Stocks and Shares ISAs for US expats?

Stocks and Shares ISAs pose more significant issues. Although the UK does not tax them, the US does, and often more harshly than regular investment accounts.

Is it worth having a Stocks and Shares ISA as a US expat?

The benefits of a Stocks and Shares ISA are often outweighed by the costs of US tax compliance. The US imposes high taxes on these investments to discourage saving outside the US. 

The IRS taxes PFIC profits even if they are unrealized, meaning you may owe taxes on paper gains. While there are methods to reduce the tax burden, such as electing Mark-To-Market or Qualified Electing Fund (QEF) treatment, the complexity and high taxes often make cash-based ISAs a better option.

What about a Lifetime ISA?

A Lifetime ISA (LISA) can be either cash-based or stocks and shares-based. If it’s cash-based, no PFIC filing is required. However, if it’s stocks and shares-based, some investments may be considered PFICs, which will require additional reporting and potentially higher taxes.

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