US Returns: Form 2555 vs 1116

Hi all,

Just like other forum members, I have recently received a letter from my bank asking for my SSN because of the FACTA.

My situation is the following:

- Dual citizenship with US citizenship acquired from American parent.
- 30 years old, never really lived in the US
- Working in the UK since 2010, lived in other EU countries before, had several bank accounts in the countries where I lived, often above $10k threshold never reported FBAR (did not even know about that).
- Never filed a US Tax return

I would like to try and get my situation with the IRS regularised, even though I do not intend to move or visit the US any time soon.

I see that most expat guides for tax suggest using the FEIE via form 2555. I have looked into it as my earnings are bellow $98k. On the other hand, most UK banks accounts offer some sort of interest on current accounts and I surely have taken advantage of those in the last years which I guess would count as unearned income and would have to be declared. Would it be more accurate to use the tax credit route with form 1116 then? As I understand this could also bring advantages if I ever wanted to invest in the US via a Roth IRA etc (those are all things that I have learned in the last few days via this forum and others and that I would never had considered before getting this FACTA letter !).

Is there any reason why I should not go down this route?

Can anyone recommend any books or guides with more information on US Taxes for citizens living abroad? The guidance in the forms themselves do not seem very "user friendly" nor is publication 54.

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Additional question if you have read that far: anyone who invests in funds/stocks/ETFs in the UK? I have considered that but from a US Tax perspective it seems like a headache.. the UK offers a £10.6k allowance that I assume the US would not recognize. Would that mean investing here and paying tax to the US? Sounds crazy...

Many thanks for your help!

First of all, relax, there are several million people in exactly your situation.

Secondly read & research. Based on what you say you need to learn more about foreign tax credit baskets (the UK uses the jargon word "schedules", the Dutch use the word "box", but the Americans the word "basket" for dividing up kinds of income for tax purposes).

Finally, avoid PFICs. This is not crazy, it is normal sensible practice for US citizens in the UK.

If you feel you can't manage or are confused use a professional American Tax Return adviser in the UK for the tricky catch up exercise and go it alone afterwards perhaps.

Additional question if you have read that far: anyone who invests in funds/stocks/ETFs in the UK? I have considered that but from a US Tax perspective it seems like a headache.. the UK offers a £10.6k allowance that I assume the US would not recognize. Would that mean investing here and paying tax to the US? Sounds crazy...

Many thanks for your help!

A US tax payer should avoid all non-US mutual funds/ETFS....individual stocks don't have the same negative PFIC tax issues.

If you are a US citizen living in the UK and want to invest in funds the only way out of the PFIC/non-reporting fund "Catch 22" is to find investments that are not PFICs and are HMRC reporting. For the individual investor the simple solution is to use US Vanguard ETFs. As these are US funds they obviously don't have PFIC issues and they also appear on HMRCs list of reporting funds....job done. You get to declare capital gains and dividends rather than income and you keep your UK capital gains allowance.

You will have to use the appropriate tax rates from the treaty to pay the US tax due and resource the gains and dividends to the UK so you can calculate the tax due there.

Hi Guya,

I thought I had searched this forum for the relevant terms but obviously I did not do a good job. I have just noticed that my question has been asked before (in different ways) so thanks for taking the time to answer it!

I am trying to relax!  It is weird though that a couple of weeks ago I was ready to start investing some of my savings (hence the new bank account) and suddenly I find out that not only I should avoid that but also that that I might be behind with my "duties" as a US citizen.

You right, I still have some reading and research to do. I (now) understand that there are different baskets (general, passive, etc) and, if I understand correctly, I could even use form 2555 for my earned income and 1116 for savings interest.

I will keep reading and try to figure out everything myself, it is good to learn and understand it myself, I guess.

Nun: thanks for the advice! I was actually looking at vanguard products so the US ETFs might be a good option. I will try to learn more about it.

Thanks for your replies!

Nun: thanks for the advice! I was actually looking at vanguard products so the US ETFs might be a good option. I will try to learn more about it.

Thanks for your replies!

If you don't already have a Vanguard account they will not open one for you with a foreign address.

Another couple issues to consider...

If you exclude your foreign income you can't claim the alternative child tax credit (worth $1k a year) BUT then any US student loans may be  eligible to zero out on income based repayment.

Why does it all have to be so bleedin complicated!?!?

A US tax payer should avoid all non-US mutual funds/ETFS....individual stocks don't have the same negative PFIC tax issues.

If you are a US citizen living in the UK and want to invest in funds the only way out of the PFIC/non-reporting fund "Catch 22" is to find investments that are not PFICs and are HMRC reporting. For the individual investor the simple solution is to use US Vanguard ETFs. As these are US funds they obviously don't have PFIC issues and they also appear on HMRCs list of reporting funds....job done. You get to declare capital gains and dividends rather than income and you keep your UK capital gains allowance.

You will have to use the appropriate tax rates from the treaty to pay the US tax due and resource the gains and dividends to the UK so you can calculate the tax due there.

When you say "resource the gains and dividends to the UK" does that mean physically moving them to a UK bank and declaring the actual money in pounds or can you calculate the conversion to pounds on the day of the distributions and then transfer the funds at your leisure.  Or does that bring up forex issues?

When you say "resource the gains and dividends to the UK" does that mean physically moving them to a UK bank and declaring the actual money in pounds or can you calculate the conversion to pounds on the day of the distributions and then transfer the funds at your leisure.  Or does that bring up forex issues?

There's no actual movement of money in "Resourcing", it just describes the act of figuring out how much of your US capital gains and dividends etc are going to be treated as if they arose in the UK for tax purposes.

There are always forex issues as you will have to convert dollar gains to GBP so you can pay UK tax on them.

There's no actual movement of money in "Resourcing", it just describes the act of figuring out how much of your US capital gains and dividends etc are going to be treated as if they arose in the UK for tax purposes.

There are always forex issues as you will have to convert dollar gains to GBP so you can pay UK tax on them.

Thanks for the follow-up.  Are you suggesting that if you are a UK resident tax payer paying taxes on an arising basis you can exclude some capital gains and dividends from UK taxes?

Thanks for the follow-up.  Are you suggesting that if you are a UK resident tax payer paying taxes on an arising basis you can exclude some capital gains and dividends from UK taxes?

Yes, if you have capital gains from reporting funds you get to apply your UK capital gains allowance...so 10.5k GBP of capital gains is UK tax free. Also there is no UK tax on dividends if you are a basic rate tax payer....the tax rate is 10%, but you also get a 10% credit making the tax 0%.....under the treaty you have to pay 15% US tax on dividends.

How you deal with US capital gains distributions is the interesting question. You'd resource them to the UK, but how are they taxed in the UK....as capital gains or dividends? If you do end up paying any tax on them in the UK you'd take a foreign tax credit against any US tax due.

Yes, if you have capital gains from reporting funds you get to apply your UK capital gains allowance...so 10.5k GBP of capital gains is UK tax free. Also there is no UK tax on dividends if you are a basic rate tax payer....the tax rate is 10%, but you also get a 10% credit making the tax 0%.....under the treaty you have to pay 15% US tax on dividends.

How you deal with US capital gains distributions is the interesting question. You'd resource them to the UK, but how are they taxed in the UK....as capital gains or dividends? If you do end up paying any tax on them in the UK you'd take a foreign tax credit against any US tax due.

Thanks nun, that makes sense.

Since I have only held index etf's since January I was not sure if they ever distributed capital gains, and a little research shows that this can be something I will need to deal with on occasion.

https://investor.vanguard.com/etf/faqs

Will I get capital gains and dividend distributions with Vanguard ETFs? If so, can I reinvest them?

Yes, Vanguard ETFs are a share class of Vanguard index funds, so they'll declare dividends whenever the other share classes do. Capital gains, if any, will be distributed annually each December.

If you invest through a Vanguard Brokerage Account, you can reinvest dividends and capital gains. If you invest through another broker, ask whether it offers a reinvestment option.

https://www.fidelity.com/learning-center/investment-products/etf/etfs-tax-efficiency

For the most part, ETF managers are able to manage the secondary market transactions in a manner that minimizes the chances of an in-fund capital gains event. It is rare for an index-based ETF to pay out a capital gain; when it does occur it is usually due to some special unforeseen circumstance.

Some mutual funds and ETFs distribute capital gains, but some do not, or at least not very often. Vanguard Total Stock Market Index hasn't had a capital gains distribution since 2000 so that is a good one to hold in a taxable account for US tax purposes and will also simplify UK taxes. Any internal capital gains are reflected in the price of the stock and you'll have to pay capital gains tax when you sell, but at least that concept is well understood in both the UK and the US

http://www.bogleheads.org/wiki/Vanguard_Total_Stock_Market_Index_Fund_Tax_Distributions

https://personal.vanguard.com/us/insights/taxcenter/qdi/yearend-fund-distributions

If you would like a more user friendly overview of how to get caught up on your US taxes, I would strongly suggest this free guide. It goes over all of the most common ways to get caught up on your US taxes and how to make a plan for getting back on track.

http://www.greenbacktaxservices.com/tax-guides/expat-tax-guide-for-americans-living-abroad-filing-taxes-late/

I hope this helps and good luck with everything!