Most US citizens in UK don't owe tax?

I'm a UK born US citizen (US parent) who has lived in the UK all my blissfully unaware of my US tax obligations - having recently discovered this I've been swiftly reading up on everything I can (thanks to all on this site for that!) and plan to enter into the streamlined process for non-resident non-filers.

I often read that most US citizens in the UK don't owe any US tax, but I'm struggling to see how this can be true, at least for anyone with a cash ISA (which must be a lot of people).

In my case my income is straightforward; $110k employment income, $1k cash ISA interest and $1k taxable interest (not exact numbers). I pay way more tax on employment income than I am due to pay to the US, so FTC covers that easily. No problem. The taxable interest is taxed at 40% in the UK  so gets HTKO'd to general income, where I already had more FTC than I knew what to do with, so again no tax due there. This leaves my ISA interest as the only thing on the passive 1116, where I have no FTC whatsoever, and thus owe tax on the entire of the ISA interest.

Am I missing something, or are there just much fewer people with ISAs than I imagine? Even if I had a much lower income and my interest was taxed at 20% in the UK so not HTKO'd (as is the case in earlier years I need to backfile), I would need to have have taxable interest way in excess of my ISA interest to rack up enough passive FTC to zero my tax bill.

I am single with no kids, so can't see any obvious credits I would claim for and am assuming standard deduction would be best for me. The tax amounts we are talking are not big ($200 a or so a year), it's just hard to imagine how it would be zero for most people.

Thanks in advance!

Based on those numbers and filing 6 years of US income tax returns I could actually forecast a modest refund overall.

If you are entering the streamlined process this would require just 3 income tax returns and you might find you are high risk already because you haven’t declared all your income in your country of residence (because it is in an ISA)

You'd be at even higher risk if you have a UK pension plan or insurance policy because you'd want to rely on the treaty to reduce US taxes.

If - as I believe - you may end up claiming a refund you really would have three high risk scores so would doubtless be high risk under the streamlined process. This could expose you to criminal prosecution; so it is unlikely that somone in your circumstances would choose the streamlined approach from the seven available choices.

Given that you are holding undeclared money outside America you can do only one of seven things at this stage.  Which of the seven routes will produce the best outcome always requires experienced counselling. I do not recommend going through any of the formal programmes wothout professional assistance, especially the new streamlined program as the stories we are hearing about IRS agents are not hugely comforting as yet.

Thanks for the helpful reply. I had optimistically interpreted that question as "have you declared all income you are required to declare in your country of residence", but you are right that taken literally the answer is no. Similarly if I have a FTSE 100 tracker in my pension, I indirectly hold financial interests in any foreign subsidiaries of FTSE 100 companies (of which there are many) so again taken literally I would fail this too. Both these interpretations sound entirely outside the 'spirit' of the process - I don't suppose there is any expectation of the IRS clarifying their position on these questions such that the new process might actually be useful to anyone?

Appreciate that I should seek professional advice before deciding next steps.

Although nearly 3 months old the article at this link is the best analysis I have seen of the program:
http://www.moodystax.com/moodystax-blog/21-us-taxation-services/202-do-you-qualify-for-irss-new-streamlined-procedure-to-bring-us-tax-returns-current.html

It is written from a Canadian perspective but much of the analysis holds true.  Out of my client base, I only have one family going through this new program; they have very low income and assets and are at close to zero risk. 

The more interesting question from what you have said so far is why you do not think you have reasonable cause - given that this is statutory versus the streamlined approach which is simply stuff on the IRS website without the benefit of the protection of law behind it?

The pension with the tracker in it sounds as if it could be trouble. PFIC, foreign trusts and deciding whether it qualifies as a pension under the treaty and then deciding how to treat it for US tax purposes spring to mind.

The IRS is a very "literal" organization so I would strongly advise you to employ a qualified professional to get you back into compliance to avoid/minimize fees and penalties.

On reasonable cause - I had generally assumed ignorance wouldn't constitute reasonable cause. Is this an avenue people in my kind of situation often use? To give more background, I have always been aware that I have been a US citizen and have held a passport which I use only to enter and leave the US when I visit family (every other year or so, for no more than 2 weeks). But having grown up in a world where taxation is based on residence (turns out that's the almost the entire world), I never considered the posibility that I needed to file tax returns to a country I'd never lived in. I've also never once had tax mentioned when renewing a passport.

On pensions - it's an employer provided DC pension into which I contribute much less than my employer, and the total contributions per year are well under $17k. So hopefully treaty admissible but I'd confirm with an adviser.

Unless you plan to live in the US, the best option would be to sit tight. You are not on the radar as you have never filed with the IRS. Your UK passport will show a UK place of birth so it won't give you away. Why pay thousands in professional fees to get current (with some risk) and voluntarily take on the ball and chain of US citizenship taxation? US citizenship is like a genetically/sexually transmitted disease that will have serious negative consequences for your financial life.

Unless you plan to live in the US, the best option would be to sit tight. You are not on the radar as you have never filed with the IRS. Your UK passport will show a UK place of birth so it won't give you away. Why pay thousands in professional fees to get current (with some risk) and voluntarily take on the ball and chain of US citizenship taxation? US citizenship is like a genetically/sexually transmitted disease that will have serious negative consequences for your financial life.

this is a great reply I have to say I agree with it and wish I'd heard it years ago!

The U.S. Passive Foreign Investment Company (PFIC) tax regime raises high hurdles for Americans in the United Kingdom to invest wisely and tax efficiently. This is because the United Kingdom has a parallel system of punitive taxation of non-UK funds. This investment "Catch-22" can be successfully navigated by investing in efficient U.S. exchange traded funds that are also so-called UK "reporting funds."

For the full article, http://thunfinancial.com/American-Expat-PFIC-UK-Non-Reporting-Fund-Investment-Trap.php [nofollow]

Check out the article on American Expat Investing and how Americans living in the UK must be careful about certain situations.

The U.S. Passive Foreign Investment Company (PFIC) tax regime raises high hurdles for Americans in the United Kingdom to invest wisely and tax efficiently. This is because the United Kingdom has a parallel system of punitive taxation of non-UK funds. This investment "Catch-22" can be successfully navigated by investing in efficient U.S. exchange traded funds that are also so-called UK "reporting funds."

For the full article, http://thunfinancial.com/American-Expat-PFIC-UK-Non-Reporting-Fund-Investment-Trap.php

Check out the article on American Expat Investing and how Americans living in the UK must be careful about certain situations.

This answer seems to be quite unrelated to the original question. The only investment discussed was in traditional UK pension plans.  It is unlikely in the extreme that most UK pension funds would choose to expose themselves to risk by investing in onshore US mutual funds that are denominated in US$ and not regulated by UK financial regulators.