Americans in the UK Need to Avoid this Catch-22 Investment Trap

The U.S. Passive Foreign Investment Company (PFIC) tax regime raises high hurdles for Americans in the United Kingdom to invest wisely and tax efficiently. This is because the United Kingdom has a parallel system of punitive taxation of non-UK funds. This investment "Catch-22" can be successfully navigated by investing in efficient U.S. exchange traded funds that are also so-called UK "reporting funds." Most importantly, the new U.S. FATCA legislation makes this once easily ignored tax issue critical for all American investors living in the United Kingdom.

Please see Americans in the UK Need to Avoid this Catch-22 Investment Trap [nofollow] for the full article

Good point. Here is the spreadsheet with the current HMRC reporting funds.

http://www.hmrc.gov.uk/collective/rep-funds.xls

I'd stick to funds that have a CUSIP number as they will definitely be "kosher" for US tax purposes as well as UK. IMHO the Vanguard EFTs are a good way to go.

Remember this "Catch-22" only applies for funds that are in taxable accounts, retirement accounts like 401ks, IRAs etc are tax sheltered under the treaty until you take income. No PFIC or Reporting Funds issues for those, unless you don't invoke the treaty and pay tax on contributions and gains to build up a tax free basis.

Remember this "Catch-22" only applies for funds that are in taxable accounts, retirement accounts like 401ks, IRAs etc are tax sheltered under the treaty until you take income. No PFIC or Reporting Funds issues for those, unless you don't invoke the treaty and pay tax on contributions and gains to build up a tax free basis.

If we move to the UK most of our US funds will be in Roth IRA, 403b, and 457 accounts.  We'll be drawing on the 403b and 457 for our income, if needed to supplement Social Security and NY State Pension etc.  However, we do have some actual stocks and shares (not mutual funds.)  Do equities get complicated for a US person living in the UK?  (We've a year or two to go yet, just starting on the mental pre-planning..)

If we move to the UK most of our US funds will be in Roth IRA, 403b, and 457 accounts.  We'll be drawing on the 403b and 457 for our income, if needed to supplement Social Security and NY State Pension etc.  However, we do have some actual stocks and shares (not mutual funds.)  Do equities get complicated for a US person living in the UK?  (We've a year or two to go yet, just starting on the mental pre-planning..)

Individual stocks and shares are fine. You will have to keep good documentation so you can declare dividends and capital gains and comply with US and UK taxation, but they do not come under the UK reporting funds regulations.

One issue you might have is with the 457. I also have one of those and they don't seem to be covered in the UK/US treaty along with other retirement funds. They are different from things like 401ks and IRAs because they are deferred compensation so mutual funds you have inside a 457 plan might well be subject to the UKs reporting funds regulations. I'm not certain of that and I haven't received any definitive answers from HMRC or anyone else. So if you can give up the no penalty early withdrawal before 59.5 aspect of the 457 it might be worth while just rolling it over into an IRA before you come to the UK. I'll probably do that just to avoid any potential complications.

Individual stocks and shares are fine. You will have to keep good documentation so you can declare dividends and capital gains and comply with US and UK taxation, but they do not come under the UK reporting funds regulations.

One issue you might have is with the 457. I also have one of those and they don't seem to be covered in the UK/US treaty along with other retirement funds. They are different from things like 401ks and IRAs because they are deferred compensation so mutual funds you have inside a 457 plan might well be subject to the UKs reporting funds regulations. I'm not certain of that and I haven't received any definitive answers from HMRC or anyone else. So if you can give up the no penalty early withdrawal before 59.5 aspect of the 457 it might be worth while just rolling it over into an IRA before you come to the UK. I'll probably do that just to avoid any potential complications.

nun, thanks for that tip.  I'll keep a watch on the 457 situation before we think of moving. 

I'm watching this thread with interest (ha!) I'm moving this weekend and just called my state teacher retirement system. My account stays "active" for 4 years and continues to earn interest. After that it goes inactive, but gets no fees or penalties, etc. I could just let it sit there and would get my retirement payout at age 60. I'm probably going to roll it over to another interest-earning retirement account. Will it ever or is it now tax reportable? Or can it just continue to exist and I don't have to worry about all this tax nonsense?

I am soooo clueless when it comes to more complicated financial situations!

I'm watching this thread with interest (ha!) I'm moving this weekend and just called my state teacher retirement system. My account stays "active" for 4 years and continues to earn interest. After that it goes inactive, but gets no fees or penalties, etc. I could just let it sit there and would get my retirement payout at age 60. I'm probably going to roll it over to another interest-earning retirement account. Will it ever or is it now tax reportable? Or can it just continue to exist and I don't have to worry about all this tax nonsense?

I am soooo clueless when it comes to more complicated financial situations!

You definitely have to consider taxation.....but I wouldn't worry too much.

It sounds as if your state teacher retirement pension would be covered under the "Government Pensions" article in the UK/US tax treaty. Pensions are definitely subject to tax in the UK and the US, but the tax treaty allows many of them to remain tax deferred in both the US and the UK. When you take money out you have to pay income tax and have to work out which country gets what.

When you get to the UK you can tell HMRC about your US pension account including something to the effect "gains and income in US qualified scheme not taxable under US/UK DTT". So no UK or US tax until you retire and take income.

As nun says, you'll have to file a UK tax return each year to elect into the treaty.

When money comes out it will either be exempt from US tax under the treaty or resourced as foreign income under the treaty depending on whether or not you are a UK citizen by then.

As nun says, you'll have to file a UK tax return each year to elect into the treaty.

When money comes out it will either be exempt from US tax under the treaty or resourced as foreign income under the treaty depending on whether or not you are a UK citizen by then.

Thanks for the response. I will very likely be a UK citizen by then (I'm only 38 now.) Will I actually pay tax on the income in the UK? And/or to the US?

Thanks for the response. I will very likely be a UK citizen by then (I'm only 38 now.) Will I actually pay tax on the income in the UK? And/or to the US?

If you are a US/UK dual citizen, resident in the UK you will be liable to both US and UK tax on the income you take from your Government service pension. As a non-resident US citizen your US pension administrator must withhold tax at a level depending on the type of account, 10% for an IRA, 20% for a 403b, I'm not sure what it is for a defined benefit plan, but there will be mandatory withholding. You will then use this US tax as a foreign tax credit on your UK taxes.

Most folks would do this the other way round and claim credit in the US for the UK tax; but this is quite academic today as you are a young 38 - so by the time you get to take benefits the two countries will probably have renegotiated the current treaty.

Most folks would do this the other way round and claim credit in the US for the UK tax; but this is quite academic today as you are a young 38 - so by the time you get to take benefits the two countries will probably have renegotiated the current treaty.

I still don't quite get it; why is there a choice?  and this doesn't work the same for the 457 as the 403b?  (I'm 62 so not so academic for me!)  And will the IRS refund the 20% withheld if no US tax is due?

I still don't quite get it; why is there a choice?  and this doesn't work the same for the 457 as the 403b?  (I'm 62 so not so academic for me!)  And will the IRS refund the 20% withheld if no US tax is due?

The 457 is a non-qualified retirement plan whereas the 403b is a qualified plan. The main difference is that a 457 plan can be accessed without penalty any time after you leave service, you don't have to wait until 59.5 like you do with a 403b, 401k etc. The US/UK tax treaty does not specifically mention 457 plans when it defines US pension accounts, so I'm not certain about their treatment. Worst case income and gains would not be UK tax deferred and you'd have to deal with UK reporting funds issues, best case they are treated just like a 403b......I don't know, but the uncertainty can be avoided by rolling a 457 over to an IRA.

As a US citizen living abroad you get no choice in the amount of tax withheld from pension payments made to you abroad. So for a 403b payment you'll have 20% withheld by your pension provider. Then if you pay your full amount of UK tax you'd include that and the 20% US withholding when calculating your US taxes and you'll probably get a big refund.....doing it this way does seem to leave you almost paying tax twice for part of the year while you wait for your refund though. But the different US and UK tax years and the time lags until you actually have to pay the tax for the previous year might get around that.

I still don't quite get it; why is there a choice?  and this doesn't work the same for the 457 as the 403b?  (I'm 62 so not so academic for me!)  And will the IRS refund the 20% withheld if no US tax is due?

Depends if you claim the remittance basis or not. Depends on how you interpret the Treaty (thee are various interpretations). Depends if you use Article 24 or not. I use Article 24. nun does not mention it. Interpretation again.

Get a dually US/UK qualified tax adviser if you are uncertain.

Depends if you claim the remittance basis or not. Depends on how you interpret the Treaty (thee are various interpretations). Depends if you use Article 24 or not. I use Article 24. nun does not mention it. Interpretation again.

Get a dually US/UK qualified tax adviser if you are uncertain.

I didn't explicitly mention article 24, just the idea of foreign tax credits. But as Article 24 isn't subject to the savings clause maybe the UK foreign tax credit could be used to reduce the mandatory withholding tax and maybe eliminate it if the UK tax was large enough. It's one of those chick and egg scenarios that freaks me out. maybe resourcing comes in here. So I agree about getting a tax adviser. That's what I will do when presented with these issues, at least for the first couple of filings. In the meantime here is some reading

http://www.nysscpa.org/taxstringer/2011/nov/shore.htm