Dividends and foreign earned income exclusion

I am an American owner of a UK limited company, resident in the UK, and seeking to understand my tax liability if I were to pay myself dividends. Is there any advantage to paying dividends rather than PAYE salary since it appears that dividend earnings are taxable in the US? And can anyone recommend a professional to advise on US/UK business and personal tax structuring?

Thanks in advance.

db

This is just based on what I've seen on the IRS publications.

- Dividends count as "unearned income" for the foreign earned income exclusion, so are ineligible there.
- Taxes for the "foreign tax credit" must be "imposed on you", which leads me to believe that you can't count any corporate tax (paid on dividends) to alleviate that.

I've already paid myself some dividends this year, but I think I'll have to stop doing that, in order to avoid having to pay US taxes on the dividend amount.

I'd also be interested to find a qualified US/UK tax professional for advice on this.

Thanks for the reply. So, I suppose we need a more definitive response on the FTC. Can anyone one add to our understanding of whether FTC can apply to dividends paid in the UK?

So I've been e-mailing back and forth with my accountant for my limited company. She's not an expert in international tax law, but did say that corporate taxes on dividends would count as being imposed on you personally with regards to the foreign tax credit.

I plan to verify this with someone who is an international tax expert, but her example was:

Dividend tax is definitely imposed tax.  The way they are taxed here is
that if you receive £1,000 then HMRC see it as £1,111 with tax paid of
£111.

The same would be true in the US - they see UK income of £1,111 and they
calculate the tax due under US rules, but then deduct the tax you've paid
here of £111.  If their tax is lower, nothing further is due.  If their
tax is higher, you just pay the difference.  For example:

£1,111 x 15% = £167.  Tax credit of £111 = tax due to US of £56.

Given US/UK tax rates, you'll still likely owe the US taxes on dividend income (since federal income tax brackets start at 10% and jump to 15% pretty quickly), but at least it'll be lower.

I'll let you know if I find any more info out!

Just a quick follow-up. The IRS website says:

Tax Must Be an Income Tax (or Tax in Lieu of Income Tax)

Generally, only income, war profits, and excess profits taxes (income taxes) qualify for the foreign tax credit. Foreign taxes on wages, dividends, interest, and royalties generally qualify for the credit.

Many thanks for the reply. Any further info or advice is welcome.

db

Dividends count as "unearned income"

Agree.

Taxes for the "foreign tax credit" must be "imposed on you", which leads me to believe that you can't count any corporate tax (paid on dividends) to alleviate that.

 Agree.

The same would be true in the US - they see UK income of £1,111 and they calculate the tax due under US rules, but then deduct the tax you've paid here of £111.  If their tax is lower, nothing further is due.

 Disagree.  For U.S. tax purposes, the taxable amount is the amount of the cash dividend received (in the example, £1,000).  The corporate tax paid is not creditable in the U.S.  If the UK imposed a withholding tax on the dividends paid, then that tax would be creditable because it would be treated as imposed on the shareholder.  However, taxes imposed on the corporation are generally not creditable in the U.S.

Do not automatically assume that you do not pay tax personally on UK dividends!

The company pays corporation tax at 21%, for which you personally get a 10% "tax credit" on your dividend but you have to pay income tax on any amount that pushes your total income into the higher rate tax band.

In fact, the only real reason to take a dividend from a limited company is to avoid paying NIC, but the higher Corp Tax rate virtually covers that anyway.

IR35 put paid to dividends being better than PAYE, certainly for contractors.

If it's a sole proprietor operation, could you not elect to have it treated as a self employment, declare your earnings on your 1040 and waive the self employment tax with the certificate? Thus it's transparent, not separate from you as an entity, and the "corporation tax" is just in lieu of income tax as the above IRS blurb indicates?

I'm looking into doing something similar but am, quite frankly, completely put off by the complexity of US/UK tax law. I'd rather stack shelves for a living, to be honest.

The question I am still left with is whether I should pay myself through a salary/dividend split, or entirely through salary. I understand that doing all salary through PAYE will make our US tax situation simpler, especially since we will be below the Foreign Earned Income Exclusion limit for my wife and me. But, it seems that the combined US and UK tax liability still might be lower if we pay a basic salary and the rest in dividends. For instance, to pay a full directors salary on £40k, the total UK tax rate is about 33%, considering employers NIC contributions and the like. To take a basic salary and the rest in dividends, the UK taxes are 18%..but then there is a US liability on the 'unearned income.' If I go the dividend route, then I will incur late penalties from the IRS. Any advice on how to decide on the better approach?

Does anyone know about the "check the box" option that appears to allow owners of a limited company to be taxes in a 'flow-through' manner, thus treating the dividends as earned income? In other words, if an individual owns 100% of a foreign company, can they elect to "check the box" and be treated as self-employed by the IRS and thus claim a Foreign Tax Credit on all or part of the tax paid on dividends? If so, would you claim credit for the 10% notional tax credit on dividends?

Recently got to the bottom of this issue and wanted to share. I am a dual national and own a UK business and have been paying myself dividends for some time for UK tax efficiency and then got really worried about my US returns as passive income such as dividends is not eligible for foreign earned income exclusion.  Well, there's mostly good news and a little bad.

1st the bad: If you own more than 10% of a UK business (or are an officer of a UK business) you are supposed to file form 5471 and you may have to adjust your personal return with a horror called sub-part F income -do take advice on this. I paid my accountant $600 for doing 5471 for 1 year - it's a horribly complex form and expensive to get help with.

Now the good news: If the company's revenue is UK-based and you only take dividends out of profits then there is no sub-part F income and 5471 has no impact on your personal return. You do have to declare your UK dividends and cannot claim the UK dividend tax credit but UK dividends do count as 'qualified dividends' on your US return. As a result they are therefore eligible for a 15% tax rate and the UK taxes you will have paid on your UK dividends should be sufficient as a credit to eliminate any US liability. Note: many websites say the foreign dividends have to be from foreign companies traded in the US to be 'qualified dividends' - this is a sufficient condition but not a necessary one.  Closer reading of the US tax laws says simply that the company must be incorporated in a jurisdiction with a comprehensive tax treaty with the US and the UK qualifies in this regard. See newcomer link: http://www.tax-news.com/asp/res/treasury_notice_oct_03.html [nonactive]

Really been through the wringer on this one and for a while thought I had a massive incremental US tax liability but end result was simply an unpleasantly complex filing requirement with no additional liability - I can live with this.
Good luck!

This is a great analysis.  A few extra things:
1. You'd have to pay the higher rate UK tax by 31 December each year.
2. Ideally you'd have your UK accountant prepare the 5471 if you could so the planning is done with US tax in mind as well (don't forget the 5471 is prepared though under US GAAP, not UK GAAP)
3. You'll have to be very careful to avoid subpart F
4. You'll need to value the company for Form 8938 purposes
5. There is often a Form 926 filing obligation at the start as well...
6. The IRS could recharacterize the dividends as compensation if audited

Now the good news: If the company's revenue is UK-based and you only take dividends out of profits then there is no sub-part F income and 5471 has no impact on your personal return.

I was wondering if anyone could point me to a reference in the tax code that can support this?

Thanks

This thread is over a year old. You should probably start a new one.