UK Working Tax Credit, Bank Interest and the IRS

Hi,

I've filed several IRS tax returns in the past whilst living abroad, and it's all been easy as the only income has been earned income from work, lived the whole tax year abroad, etc. 

However, now that I live in the UK it seems to be more complicated.  For 2009, besides my wage (all UK) we (myself, UK un-married partner, and our dual baby daughter) have received UK working tax credits and earned a small amount of bank interest.  I think the bank interest should be reported to the IRS on a form 1116. Do I have to report the UK working tax credit income?  Am I right in my understanding of the UK-US tax treaty, that as I've already paid tax on the interest in UK for that I'm not liable to pay again to the IRS? 

I'd pay somebody to do this for me, but I simply can't afford to.   

I think the bank interest should be reported to the IRS on a form 1116.........  Am I right in my understanding of the UK-US tax treaty, that as I've already paid tax on the interest in UK for that I'm not liable to pay again to the IRS?

You've not given us quite enough information, so I will assume that you are offsetting all of your earned income on Form 2555.

Your bank interest should be declared on 1040, Schedule B. Don't forget to complete both parts 1 and 3. Part 1 is where you name your UK bank, and list the (gross) interest earned. Part 3 is where you acknowledge the existence of your UK bank account as a foreign bank account. If your accounts have a total of more than $10,000 in them at any time during the year, then you must also file an FBAR separately.

Form 1116 is where you take a credit for the UK taxes you have paid on the interest (in the passive basket). You are liable to the IRS for the interest paid in the UK, but take an allowable credit on 1116. If you are adventurous, by all means complete 1116. But it may not be necessary if you can reduce your tax liability to $0 through itemized or standard deductions, or exemptions.

I can not help you on your primary question on UK work credits. Hopefully someone with experience on this aspect will help us out.

Thanks for your reply.  You're correct, I'll be claiming all my earned income on a 2555, actually, I'll use the 2555-ez if possible.  I've been here since 2008 and all my income is UK based, so I think the 2555 EZ should do the trick, unless it won't.

I've looked at the 1116 and it does look like a mess.  Bank interest for 2009 might, possibly potentially be £20.  Next year, it should be higher, but for 2009, very low.  Will the $5,700 single filer deduction reduce my liability to zero?

Thanks again for your help.
Sam 

Will the $5,700 single filer deduction reduce my liability to zero?

Since every tax return is unique, there's no way for any of us to answer. You'll have to work through the figures yourself.

Your UK working tax credits may cause a problem. I could give you my guess but I don't think you'll like the answer. Be careful reading the treaty. All US treaties contain a 'saving clause'. It basically means many benefits of the treaty do not apply to US taxpayers. Article 17 of the treaty does allow some exceptions. We'd best wait for someone who can give us an accurate answer.

I see your point.  It seems that the $5700 deduction would more than cover any liability, seeing as how the £20 interest is the only other income I had.

I am worried about the tax credits though.  I'd be extremely annoyed if I was expected to pay tax to the US government for money that my family received because we were earning low wages to start with. 

I doubt the IRS would let me claim it as earned income given that it is only money we received because I was working, but possibly.  Like you say though, best wait until someone comes through that might have a clue. 

Why don't you try putting it in the 1040 as other income and do the calculations to see if you do end up paying any tax? Depending on the amount you may still not have any tax liability on it.

Good idea. I've plugged the additional income from tax credits in, and I still come up with no tax liability, if I've done everything correctly, which I may not have.  Anyway, thanks for the idea.  However, the idea that I should even have to mention this income to the IRS peeves me.  Now that I have a "proper" job, with a pension, it seems that next year's return will be an even bigger hassle.  Oh well.

Thanks Again,
Sam

I would expect someone in your circumstances to report working and/or childrens tax credit and/or health in pregnancy grants and/or child benefit as taxable income on the US return.  Any UK child trust fund would additionally require 3520 plus possibly 3520-A filing. 

The US tax system in turn would give refundable child tax credits and the making work pay credit.  These would be taxable income in the UK so you would report these as income on your UK tax returns and would also report these for the working and/or childrens tax credit returns as well in the years received.

Do you know for sure about this guya or are you just assuming?  Child tax credits are not part of taxable income for HMRC.  I called HMRC and asked if child tax credits from the US are taxable income and they said no, they aren't either (I somehow doubt if they had ever even thought about it before; however, the woman I spoke to seemed quite confident in her response). Similarly, I don't quite see how tax credits from the UK would be taxable income on 1040.  If you used 1116,  it seems to me that you would report tax credits by simply subtracting the tax credits you receive from the UK  from the total tax you paid in the UK. You wouldn't include it under "other income".   Indeed, the UK gives you a  tax credit for the tax you pay to the IRS.  You don't include that tax credit as part of your UK taxable income to the IRS.  You'd fall into an infinite loop every time you did your taxes (well, maybe the series would converge..). Can you can find an explicit statement in IRS documentation that says foreign tax credits are taxable income? 

Do you know for sure about this guya or are you just assuming?  Child tax credits are not part of taxable income for HMRC.  I called HMRC and asked if child tax credits from the US are taxable income and they said no, they aren't either (I somehow doubt if they had ever even thought about it before; however, the woman I spoke to seemed quite confident in her response). Similarly, I don't quite see how tax credits from the UK would be taxable income on 1040.  If you used 1116,  it seems to me that you would report tax credits by simply subtracting the tax credits you receive from the UK  from the total tax you paid in the UK. You wouldn't include it under "other income".   Indeed, the UK gives you a  tax credit for the tax you pay to the IRS.  You don't include that tax credit as part of your UK taxable income to the IRS.  You'd fall into an infinite loop every time you did your taxes (well, maybe the series would converge..). Can you can find an explicit statement in IRS documentation that says foreign tax credits are taxable income? 

Not sure what planet you inhabit my dear gldms?  Is it one where conjecture is the law?

I suggest you start with reading the 16th amendment to the Constitution and the Internal Revenue Code.  If you can find something in the Code that gives substantial authority for exempting foreign social security benefits from US tax then - and only then - can you omit such income from a US income tax return for a US person.

Deducting from foreign tax paid (if any) for a make-believe refund as you suggest would be unlawful in the US.  The penalties for failure to disclose a foreign tax redetermination are far too severe to contemplate.

From a UK perspective, the constitution is of course unwritten.  Nonetheless the UK does have a decent and ever-growing body of tax statute.  Generally speaking, income such as a foreign social security benefit (which is what the US refundable child credit actually is) is relevant foreign income taxable to a UK resident unless exempt because of a claim on a tax return such as to a treaty or the remittance basis.  I agree this has not yet been tested in Court but I have no desire to go there to check.  I can see no logic why this would not fall into charge.

I've double checked, and even with reporting the Working Tax Credit as other income, I still have credit leftover, so that's how I'll roll.  My UK partner received child tax credits, but it is in her name and paid to her so Uncle Sam can sod off, same with the Child Trust fund stuff. 

I think I'll write my Congressman though.  I know it won't make the slightest difference, but it really is offensive to me that the U.S. government taxes income wholly earned and spent in a foreign country.  Even worse, they think that it's prudent to tax pension contributions made into a foreign pension fund, for work performed in that foreign country (I know there is some gray area on this).  But, certainly the government/IRS should be encouraging Americans to save for their future, regardless of where they do it.  Again, it would be very far in the future before I would even have to worry about not having enough credit to cover my pension contributions (and my UK employers matching contributions), but it is a matter of principle.  Anyway, I digress....

Thanks again for everybody's help.

Sam
   

Sorry Guya, I don't think you quite understood what I said.. What I'm first saying is that if you get a tax refund  from the UK you should subtract that from the UK tax you are claiming tax credit for from the US.  Indeed, it says that in the 1116 instructions that you must do this.. However, I'm suggesting that a tax credit is equivalent to a tax refund and on this point I may indeed be wrong.  The way I read this is that, if I nominally pay £10,000 to the UK in tax but they gave me a child tax credit of £500, I should tell the IRS that I actually only paid £9500 tax to the UK and not try and claim a tax credit for the full £10000.  What could possibly be illegal about that? It's in the IRS's favor.  Now, you are saying that a tax credit is actually a form of social security payment and so should not be deducted from  your foreign tax on 1116  but should be included as taxable income.  On that point I have no idea. Do you have any source that equates tax credits with social security payments?  The tax treaty article 17 says that social security income is only taxable in the country of residence but, of course, we have the Saving Clause of Article 1 which overrides that for US citizens.  It's all an academic point since I suspect that even if you include the tax credits on 1040 line 21, you will still have an income below our standard deductions and exemptions and shouldn't owe any US tax anyway (your low income is why you got the UK tax credit in the first place).  I guess the safe way is what you propose and  include UK tax credits on line 21. They can't fault you for over-reporting income..  However, It would be nice  to see a definitive explanation  from the tax law.

I've seen a few references to the UK/US double tax treaty, heck, I referenced it myself.  It seems to my untrained eye that the treaty is designed to prevent double taxation, however, it seems from many things I've read that essentially, the IRS can double tax everything thanks to the Article 1, 'saving clause'.  So, is there actually anything that is truly exempted from the IRS trying to get their hands on (for US citizens).  If not, what exactly is the point of the convention.  I'm sure I'm missing something, no, I hope that I'm missing something.  My concern, now that I have a pension, is what will happen when I start drawing that money out?  It seems that it should only be taxed in the source country, in this case, the UK.  Is that true? Ahhh.  Probably doesn't really matter, everything will change in the minimum 40 years before I retire.  In the meantime, everything that can be, will be in my partner's name. 

-Sam 

The tax treaty article 17 says that social security income is only taxable in the country of residence but, of course, we have the Saving Clause of Article 1 which overrides that for US citizens.

I would suggest that you read the Treaty more carefully. US SSA retirement benifits, paid to a US citizen resident in the UK are exempt from US taxation as long as taxes on the benifits are paid in the UK. This is one area that voids the saving clause specifically. The confirmation (always subjective and open to interpretation) is from the IRS at the London Embassy.   

So, is there actually anything that is truly exempted from the IRS trying to get their hands on (for US citizens).  If not, what exactly is the point of the convention.

See post above for one example.

My concern, now that I have a pension, is what will happen when I start drawing that money out?  It seems that it should only be taxed in the source country, in this case, the UK.

First, the bad news. If it is a UK pension (UK company pension or UK State Pension for example) it will be taxed as foreign based income by the IRS. The US is the only major country that levies taxes based on citizenship. We share your exasperation. The good news, you've got 40 years before you have to worry about it. I applaud your awareness and determination, and would hope that in 40 years time, it will just be an annoyance and not a problem for you.