What is an ISA to the IRS?

There was a recent discussion about the US taxation of the UK Individual Savings Account (ISA). So I thought I'd start a thread to ask for people's opinion's on this.

Here is some info about the ISA

http://www.hmrc.gov.uk/isa/faqs.htm#1

I think it is important to note that no where in the above link is the ISA described as a pension plan or retirement savings account. It is a savings or investment account to which a UK tax resident can contribute on an after tax basis and any interest and gains are free of UK tax. Money can be taken from the account at anytime, unless there is some time constraint on the underlying savings account or investment. I have many friends in the UK who have ISAs and they do not think of them as retirement savings accounts, and the UK government websites include them in the savings sections; they are never included in the pension sections.

Why doesn't the IRS just tell us? Would that be so hard?

Is the whole ISA thing itself just a "red herring" and basically irrelevant to the IRS? The critical thing being the underlying structure of the accounts or investments held in the ISA.

I believe that the general rule of thumb for U.S.C’s residing in the U.K is to keep things as simple as possible. Clearly ISA’s are not discussed under the DTA as retirement accounts, as they don’t generally correspond to anything on offer State Side. I believe that if its cash ISA, then you just report the income on schedule B and your 1040, if you happen to have any previous year’s tax credits, then you could soak up some of these and file an 1116 too. Stocks and share type ISA’s give rise to all sorts of interpretations, mine would be that that PFIC filing would be in order, definitely an area to stay well clear of. From what I see normal high street/on-line banks can often offer better net rates then a cash ISA’s. People tend to see the “tax free” label and think they’re getting a good deal, where in reality, especially with “teaser rates”, they’re not.

For the US Person with a non-US residence, the topic greatly depends on each individuals own financial and personal circumstances. For the US, ISA's are just various types of taxable accounts with different names, and depending on the type of account they require various methods of reporting. Greater ISA profits generates more income taxed by the US.

Thanks to effective lobbying, Congress has favoured the funds going into a US account for US Persons. Taxation is well defined. Simple, but for the fact that the country of residence may declare the gains made in the US to be taxable income in that country of residence.

As long as they stay in an ISA, the gains are tax free in the UK. Are there any 'forever' tax free accounts in the US?

In the end, it comes down to whether or not you'll actually pay tax on the income (in the US, or the foreign country, or because of your personal situation or the type of investment/reporting, neither), and if so, which tax rate is the more favourable.

We're back to the issue of the US taxing on a citizenship basis. That's a separate thread. For this thread, the name 'ISA' has no bearing, and it's up to each individual to review their own circumstances regarding taxation of the accounts. Regardless of circumstances, the annoyance remains the currency fluctuations. As long as we're taxed on citizenship, that won't go away. 

I believe that the general rule of thumb for U.S.C’s residing in the U.K is to keep things as simple as possible. Clearly ISA’s are not discussed under the DTA as retirement accounts, as they don’t generally correspond to anything on offer State Side.

+1
I've been disturbed to read on the web phrases like "the ISA is just like a IRA" which I think is wrong as there is no retirement aspect of the ISA, it's just a UK tax advantaged saving or investing product. Obviously that does not avoid the complexities of the taxation of the underlying investments.

The consensus view does seem to be that the IRS ignores the ISA wrapper and looks at the underlying product. If this is an interest bearing account or individual stocks and shares, then report as normal.

But then you'll find other people, some apparently with professional credentials, who say no, this is a foreign trust and all sorts of complex forms are necessary (which they will complete for a fee!)

Who to believe? Without a definitive public statement from the IRS, one cannot be 100% sure. The consensus view may even be their current practice but they may decide to change this at any time without warning.

For the US, ISA's are just various types of taxable accounts with different names, and depending on the type of account they require various methods of reporting.

Do you know the origin of the opinion that the ISA is a foreign trust? or a link to the IRS ruling? I've searched on the web and can't find anything.

The consensus view does seem to be that the IRS ignores the ISA wrapper and looks at the underlying product. If this is an interest bearing account or individual stocks and shares, then report as normal.

But then you'll find other people, some apparently with professional credentials, who say no, this is a foreign trust and all sorts of complex forms are necessary (which they will complete for a fee!)

Who to believe? Without a definitive public statement from the IRS, one cannot be 100% sure. The consensus view may even be their current practice but they may decide to change this at any time without warning.

I'm wondering this myself.

Do you know the origin of the opinion that the ISA is a foreign trust? or a link to the IRS ruling? I've searched on the web and can't find anything.

No to both questions.

I've always looked to the type of underlying account and reported as required for that type of account. Since I only have a cash ISA, I've always reported it as a termed, fixed rate foreign bank account that had no UK tax with held. It would be the same as if my income was below the UK personal allowance, and no tax was with held on the gains from a normal bank account. I can't see it being a trust in any way, but hey, I could be wrong.

I've always looked to the type of underlying account and reported as required for that type of account.

This is what firms were doing when I was still in public practice.  It has been three years but I haven't heard of any major shift in opinion from my peers that are still practicing.

I was going to make this point before the other thread burned out.  Just because Aviva calls something a "Cash Fund" doesn't mean that the underlying account is what we talk about generically as a cash ISA (meaning interest income only).  If there are still pooled investments, well then you need to be thinking PFIC.  In any situation, you need to know exactly how your money is being "invested".  In short, the discussion on what is an ISA (specifically) is a red herring.

Someone mentioned upstream that it would be great if the IRS would comment.  No one should hold their breath.  The IRS cannot investigate and comment on every type of foreign investment to translate to US terms.

I've seen many professional sites that state an "ISA is a foreign trust". I did some googling and Canada has a similar product called a Tax Free Savings Account and there is a great deal more info in that.

http://www.taxspecialistgroup.ca/public/taxtips.asp?n=11-08&site=tsg

It seems that professional advisors are taking the safest possible position, which I understand, but I am unable to find anything from the IRS that says anything about the ISA or TFSA being a foreign trust.

I've seen many professional sites that state an "ISA is a foreign trust". I did some googling and Canada has a similar product called a Tax Free Savings Account and there is a great deal more info in that.

http://www.taxspecialistgroup.ca/public/taxtips.asp?n=11-08&site=tsg

It seems that professional advisors are taking the safest possible position, which I understand, but I am unable to find anything from the IRS that says anything about the ISA or TFSA being a foreign trust.

I think we first need to determine if we are talking apples to apples.  When I think of a cash ISA, I am thinking of more or less of a high interest rate savings account.  You invest money to a financial institution and they provide a particular interest rate.  No discussion of investing your money, pooling, etc.  Just the bank is taking your funds and giving you interest for the length of time you keep the money there.  I am not sure how this can be argued to be a trust from any angle.

While I don't disagree elements of th TFSA could be similar, elements are also very similar to the stocks/shares ISA and there is also an element that is indirectly linked to the Canadian equivalent of an IRA, which if anything is more complicated than the UK ISA options.  I have very limited experience with the particulars so I am just not even going to comment on this vehicle, other than to say your own link states that the IRS *may* consider this a foreign trust.  

And this probably gets to the heart of your post, to point out that you have seen professional sites reference a foreign trust.  I don't doubt that and have seen it myself.  However I don't consider spitballing on forums or vague references to *may* be a trust as reputable.  I would need to see technical resources to be convinced.  And honestly, if this has legs you should be able to see specific written technical commentary on these types of things at least at the large firm level.  I have many peers that do this full time and used to be involved in this myself.  It should exist.

And as I mentioned before, I will eat my hat if you ever see the IRS provide specific comment on an ISA.  Not having to do anything with an ISA but because where does it end?  Do you think the IRS is keen to provide comment on every investment vehicles in every foreign country?  Why do you think ISA would float to the top of the pile?

ETA: Tons of typos. Oh my!

That's interesting, it may be impolitic, but what do you mean by "not in a reputable context" (I completely understand if you don't answer that).

I see the ISA and it's Canadian counterpart the Tax Free Savings Account (TFSA) described as foreign trusts on several US tax professionals's websites and indeed here

http://www.uk-yankee.com/articles/us-tax-guide-americans-living-uk
http://hodgen.com/form-3520-a-filing-deadline-is-march-15-2011/
http://forums.serbinski.com/viewtopic.php?t=3972&sid=6d4c18e6dde91dc80c7e16e2b2d1b597

they mention IRS rulings, but I can't find them online.

I pasted this from the other thread.

I mention above what I mean about lack of reputable source.  Basically forums or vague internet articles from no-name firms that seem to have a limited grasp of the fundamentals.  Being a tax geek, I need references or white papers darnit!!!

I am not saying that I would never consider an ISA a trust.  I cannot personally fathom calling a high interest cash ISA a trust for sure.  I am open to some situations where stocks/shares ISA could be considered - possibly when you have limited means to direct your funds.  However, the only stocks/shares ISAs I have personally seen (with direct knowledge) are directed investments and are no different from a UK mutual fund really - considered PFICs (and yes, I have seen many, many white papers on this point).

I suppose I will start to be convinced if the bigger firms starting stating the trust position and, even then, I will want to read the opinions.  I definitely have seen a shift more broadly to calling tons of things trusts, perhaps starting around 2009.  It might just be a bit of hysteria and overreaction to tax laws or it might be a genuine refinement in how certain vehicles are viewed.  Only time will tell, at the expense of all of us I am sure.

Thank you Sara, that's a very informative response and confirms the way I was thinking. The cash ISA (and I mean a fixed interest savings account NOT a money market fund in an brokerage account or other pooled investments) may not be the most exciting investment for US citizens living in the UK, but it could be a useful part of a portfolio for some US expats. It would be a shame if people did not take advantage because of worrying that it "maybe" a foreign trust.

I just wonder where the "foreign trust" idea came from. Is it from the comparison of the ISA with an IRA, which is a "trust or custodial account", without reference to the underlying investments? or from looking at ISAs held with brokerage companies and invested in UK investment trusts?