NHS Pension Contributions, Foreign Tax Credits (FTC), and Lifetime ISAs (LISA)

Hi all,

I'm a UKC married to a USC, living in the UK. She's been living here for over a year now on her first Spouse Visa, works as an NHS nurse, and we remain undecided on our location for the long term future (5+ years from now), i.e. a move to USA isn't completely off the cards. I have a few questions for us which I've separated for ease of answering. I've done my best to research this forum first, so please excuse me if I've repeated someone's question!

NHS Pension Scheme
As an NHS nurse, she pays into the NHS pension scheme a fixed rate and the NHS contribute 1/54th of her gross salary to her Defined Benefit pension.

Firstly my perception of this is that her "payment" into the pension scheme is not a pension contribution, in the sense that she never sees that money again, and therefore there is nothing to declare/include in a US tax return. Is this correct?

Secondly, is the contribution from the NHS into the Defined Benefit pension considered an employer contribution? If so, my understanding is that it can be useful to declare/include this in a US tax return so that it is (in the eyes of the IRS) tax-free upon drawdown. Is this correct?

I've seen mixed messages regarding the reporting of pension employee and employer contributions, where they are reported within tax reports, or ignoring them completely due to the UK-USA tax treaty.

FTC vs FEIE for a USC in the UK
I'm aware of the FTC (Foreign Tax Credit) vs FEIE (Foreign Earned Income Exclusion) option for USCs. My understanding is that generally, due to the UK having greater income taxation, it is beneficial for the USC to select the FTC route. One perk of the FTC over FEIE is that it can be used on other income beyond foreign earned income, e.g. employer pension contributions, interest, dividends, US-sourced income. Is this correct? Can the FTC tax reporting route be filed using TurboTax?

Cash Lifetime ISA (LISA) for a USC
I'm aware of the punitive measures by the IRS on taxing USCs who hold foreign investments (PFICs), to the point where it's best to avoid this route. However I've considered the option of setting up a Cash Lifetime ISA for my USC spouse, who would benefit from the 25% government bonus on her LISA contributions each year. Surely the bonus & interest would be worth it even after the passive income taxation by the IRS? Not to mention that FTCs could be used to offset some of the tax due. Can anyone confirm or comment on this?

I can have a stab at a couple of your questions only.

TurboTax does support FTCs (forms 1116) for folks like us living in the UK.

Myself and my wife, both USCs living the UK, do use cash-ISAs and they are not treated as PFICs, the interest paid is taxed as interest on our US tax returns on schedule B. I would expect a Lifetime Cash-ISA to be similarly treated. I don’t know how the UK government contributions would be treated.

This is not advice as such, but here's what i do - hopefully it helps.

I'm a dual UKC/USC.

In terms of pension contributions, I declare my employer contributions as part of my  income - my own contributions come out of my gross income so I declare my gross income. I never end up with a US tax liability on my UK earned income because of the more punitive rates of tax we suffer here in the UK.

Maybe a belt and braces approach but I also use form 8833 to declare a Treaty based position under article 18 & 19 (1) to defer dividends and capital gains with the pension. This was based on advice I received a few years ago from my UK based accountant who is also an IRS certified Tax Agent.

In terms of FEIE vs FTC, I use the FTC and file form F1116 - but beware - the form and calculations can become complex and need careful consideration - you have to break out dividend income, interest income and Capital Gains, which are all considered 'Passive' - and you may not have any UK tax credits to apply against this category of income - thereby creating a US tax liability - especially on income such as ISA interest (which is why I consider investing in an ISA to be not worth it - plus the awful interest rates anyway).

Like I say Forms 1116 becomes quite complex, especially if you have AMT to consider also, when you need to file an AMT version of the forms also.

Thank you both for your replies!

Myself and my wife, both USCs living the UK, do use cash-ISAs and they are not treated as PFICs, the interest paid is taxed as interest on our US tax returns on schedule B. I would expect a Lifetime Cash-ISA to be similarly treated. I don’t know how the UK government contributions would be treated.

I think I will err on the side of caution and report the UK government contribution as passive income/interest.
Can FTCs be used against the interest paid within the cash-ISA, so that the US is owed no tax?

I use the FTC and file form F1116 - but beware - the form and calculations can become complex and need careful consideration - you have to break out dividend income, interest income and Capital Gains, which are all considered 'Passive' - and you may not have any UK tax credits to apply against this category of income - thereby creating a US tax liability - especially on income such as ISA interest (which is why I consider investing in an ISA to be not worth it - plus the awful interest rates anyway).

In our situation, it would only be interest income from a bank account or cash-ISA to consider, which simplifies things a bit. Any investment in stocks will be in my name (UKC) only, and for now only my name is under the house mortgage. There's no danger of reaching AMT status either. With all that considered, I'm tempted to pursue the FTC route... deal with any pain of completing it the first time via TurboTax, and hopefully it should become routine thereafter (provided our circumstances don't change).

Thanks again 

Thank you both for your replies!

I think I will err on the side of caution and report the UK government contribution as passive income/interest.
Can FTCs be used against the interest paid within the cash-ISA, so that the US is owed no tax?

In our situation, it would only be interest income from a bank account or cash-ISA to consider, which simplifies things a bit. Any investment in stocks will be in my name (UKC) only, and for now only my name is under the house mortgage. There's no danger of reaching AMT status either. With all that considered, I'm tempted to pursue the FTC route... deal with any pain of completing it the first time via TurboTax, and hopefully it should become routine thereafter (provided our circumstances don't change).

Thanks again 

The government contribution cannot be passive basket. It would not meet the definition of passive income.

In terms of applying FTC's - I will defer to the experts

From the way I see Form 1116 working (based on my own filings), The FTC credit is applied per category of income so Income tax/PAYE is applied against General 1116 category income and any tax paid on UK interest income (or CGT) is applied against Passive income only. Standard Deductions are allocated in proportion  to your income in each category, so for example, if 95% of your income is general, then 95% of the standard deduction also goes against general and so on. Any unutilized FTC's can be carried forward up to 10 years and back one year against the same category of income  - just another complication!

Happy to be corrected by the experts!

The government contribution cannot be passive basket. It would not meet the definition of passive income.

What would it be defined as? Is the general consensus that it's too much of a grey area and so people tend to avoid it altogether?

Thank you both for your replies!

I think I will err on the side of caution and report the UK government contribution as passive income/interest.
Can FTCs be used against the interest paid within the cash-ISA, so that the US is owed no tax?

In our situation, it would only be interest income from a bank account or cash-ISA to consider, which simplifies things a bit. Any investment in stocks will be in my name (UKC) only, and for now only my name is under the house mortgage. There's no danger of reaching AMT status either. With all that considered, I'm tempted to pursue the FTC route... deal with any pain of completing it the first time via TurboTax, and hopefully it should become routine thereafter (provided our circumstances don't change).

Thanks again 

I don’t believe you can claim FTCs on interest, that you have not paid UK taxes on. Cash-ISA interest along  with the first £1,000 of other interest is free of tax in the UK.

Ah, I believe I had a fundamental misunderstanding of the FTCs. I had assumed that the FTCs accrued could be used for any basket rather than specifically for the basket from which you paid tax for.

I think I need to reconsider the net gain obtained from a cash-ISA versus the additional efforts of tax reporting.

This in itself has been very helpful, thank you.

Ah, I believe I had a fundamental misunderstanding of the FTCs. I had assumed that the FTCs accrued could be used for any basket rather than specifically for the basket from which you paid tax for.

I think I need to reconsider the net gain obtained from a cash-ISA versus the additional efforts of tax reporting.

This in itself has been very helpful, thank you.

You may be correct, I am far from being an expert in this.

This is exactly why I said earlier that I find no benefit in seeking out tax free interest accounts (such as ISA's) - I take my chances however with Premium Bonds - knowing however that if I hit the big one, Uncle Sam will want his share!

That said, Capital Gains fall in to the Passive category also, and so if you have paid any CGT to HMRC, you may have the ability to offset against taxable interest income - even utilising carry forward credits.

This is exactly why I said earlier that I find no benefit in seeking out tax free interest accounts (such as ISA's) - I take my chances however with Premium Bonds - knowing however that if I hit the big one, Uncle Sam will want his share!

That said, Capital Gains fall in to the Passive category also, and so if you have paid any CGT to HMRC, you may have the ability to offset against taxable interest income - even utilising carry forward credits.

Under domestic US law, capital gains are only passive basket if at least 10% in foreign tax is paid on the gain. (IRC Section 865(g)(2))

I have a follow-on question… related to using FTC now, to reduce US taxation on pension drawdown in the future (30 years+ from now!)

If I claim both employer & employee pension contributions under additional income on Schedule 1, should I then be entering my salary as Gross Salary minus the Employee Contributions, on Line 1 of form 1040?

The above is probably the only reason for me to consider choosing FTC over FEIE (currently).