Second Opinion on my Greenback Accountant's Advice

After a few years paying for an expensive firm that handled our US and UK tax returns, I gave Greenback a try based on some good feedback on this forum.  I feel like I need a second opinion on how to report a US source royalty payment my wife received in November 2020 (so not yet included on her UK tax return) to the IRS.  My Greenback accountant is advising the opposite of what our previous accountants did, and the opposite of my understanding of how the US-UK tax treaty works.

- We're UK residents, US citizens
- My wife is filing on the arising basis in the UK
- The royalty payment was based on work done in the US several years ago before our UK move, in case that's relevant

My understanding is that based on the US-UK tax treaty she will pay tax on the royalty payment to the UK and not pay tax on the royalty to the US.  My Greenback accountant is saying the opposite: "Royalty from the US are still subject to US taxes. Since this income will be reported on the UK tax return, you can claim a foreign tax credit on the UK tax return for the tax paid in the US".  My previous accountants paid the full amount to the UK and used IRS form 1116 marked "income resourced by treaty" to treat US bank account interest my wife received last year as UK source income. I think the new royalty payment should be handled in the same way as the US bank account interest, but my Greenback accountant doesn't want to handle it that way.

Is there an option to pay tax to the US and claim a credit in the UK or is my Greenback accountant giving me the wrong advice here?

If you're claiming  Treaty Based Position (Form 8833) then Article 12 applies to Royalties. Page 18 of the following.

https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/507431/usa-consolidated_-_in_force.pdf

My own advice is that you should feel comfortable and fully understand the basis of the advice you are given - any tax liability will be yours and not those of the 'experts' - who typically have very good insurance to cover them for bad advice!

Hope this helps.

I wasn't aware of Form 8833, my previous accountants didn't use it, and now I'm wondering why they didn't.

Thanks for the pointer to the treaty.  I sent my accountant these quotes and links to the treaties, and this was his response.  Again, the opposite of how I interpreted the treaties:

"Royalties arising in a Contracting State and beneficially owned by a resident of the other Contracting State shall be taxable only in that other State.": https://www.treasury.gov/resource-center/tax-policy/treaties/Documents/uktreaty.pdf [nofollow]
"Royalties derived and beneficially owned by a resident of the United Kingdom shall be exempt from tax by the United States.": https://www.gov.uk/hmrc-internal-manuals/double-taxation-relief/dt19911 [nofollow]

His response:

This means you will be entitled to claim a foreign tax credit in the UK for the tax paid in the US, so that the income isn’t double taxed. This doesn’t exempt you from reporting the royalty income on the US tax return

Seems like either I'm missing something or he is.  His draft return has us paying tax on the royalty to the US, but when it comes time for my wife to file the UK return, I don't see anything that would allow her to avoid paying tax on the royalty to the UK, so it would be doubly taxed. 

As you are resident in the UK but a USC, both HMRC & the IRS will require you to declare your worldwide income on each of their respective tax returns - it is taxable in both jurisdictions but you can also claim credit for the tax paid in the other jurisdiction.

The royalties will be taxable in both the UK & US - firstly in the UK (in accordance with the Treaty - see also https://www.gov.uk/hmrc-internal-manuals/double-taxation-relief/dt19911). The income is then also included and taxable in the US, but you will be able to claim a FTC for the tax paid on that income to HMRC. I personally think your accountant has it wrong - UK has first claim (based on your residency) and then the US accepts the UK tax as a credit (Form 1116) against the liability.

A further challenge for you may be timing of the FTC due to tax years being different (Tax paid in a different year to HMRC than the year the income relates to on the US tax return) - but it will all catch up in the end. (paid in different calendar years will always cause timing differences).

Because of the differing tax rates (UK being higher) you may find if you look at last years' tax return, that you have previously  unused FTC's brought forward that you can use. You will find these on Part III of Form 1116 on line 10. These credits brought forward can help alleviate any timing differences mention in the sentence above.

I hope this is of some help to you - it's a complex subject!

Very helpful info, thank you! 

Just an overnight thought:

Typically the use of  the Treaty and Form 8833 is to exclude declaring particular types of 'income' on your US tax return - I use a Treaty based position (and file Form 8833) to exclude UK employer pension contributions from my US declared earned income - which then equates to the UK tax treatment. The use of the Treaty I believe is mainly to avoid double taxation of the same income or to align the tax treatment.

In your particular case, the Royalty income is taxable and as stated above you'll most likely end up paying more tax here in the UK - but there's no way of avoiding or minimising that, unless it is covered by your personal allowance - therefore by using Form 1116 you'll claim the FTC and not have any tax to pay in the US.

If I follow you correctly, you're saying I probably just need to file form 1116 and not 8833?

> therefore by using Form 1116 you'll claim the FTC and not have any tax to pay in the US.

The correct way to do that is by using the Form 1116 "Certain Income Re-Sourced by Treaty" instructions and reporting the US-source royalty income as re-sourced to the UK, correct?

Thanks for your continued help!

Looking at your original post, as the royalties were US source income in the first place, shouldn't they have been subject to US tax withholding when they were paid? If US tax was withheld you will be able to use that tax to reduce your UK liability.

It would certainly appear that according to the Treaty you can re-source this income to the UK and then use Form 1116 to file - although it will have its' own form 1116 - you will only be able to claim FTC for tax paid in the UK on this income and as mentioned earlier, this may have a timing difference for you - although again prior year credits brought forward may apply.

If you don't mind me asking, what quantum of income are you talking about here?

It was reported on a 1099-MISC, no withholding.  It's close to $6000, enough that I want to make sure my accountant gets this right and we aren't doubly taxed.

We have enough credits from previous years to cover the tax on this income, so I'm not worried about that part.

Thanks for the update.

You won't be doubly taxed, although you will pay tax in the UK which is typically at a higher rate than the US.

It would be good to see the opinions of others on the forum but I am firmly of the opinion (but I can't give you advice, only opinion!)that this Royalty income is by definition of the Treaty income to be reported and taxed in the UK and is non-taxable in the US. Using the resultant UK tax as a credit being claimed as a FTC on Form 1116 - through the income resourced by Treaty means there is no US tax payable and fulfills any US reporting obligations - I presume this is the way your previous (expensive) accountants treated it?

I have no experience with Greenback and their website (to me at least) offers no indication of having UK tax knowledge - their focus is purely on satisfying US tax filing obligations. I don't want to knock them unnecessarily so will leave you to form your own opinion. I'm a UK Chartered Accountant as well as being a USC and when I initially sorted out my US tax affairs I used a UK based firm where the senior tax partner was also an IRS enrolled agent. They helped me with the Treaty side of things.

I don’t know about Royalties but US SS is not taxed by the US and the way that is reported is that it is reported as usual on the 1040 and an exactly matching negative amount put in the “Other” income line on the 1040 with a treaty position claimed.

“Resourced by treaty” is used where the UK is the primary taxing authority. For example my US private pensions are taxed by the IRS and HMRC and I use form 1116 with “Resourced by treaty” to claim foreign tax credits on that income. “Resourced by treaty” means that the US based income in question is being treated as if it was foreign income.

My understanding from the OP's first post is the wife is a US citizen and received a royalty.

In the treaty, royalties fall under Article 12.

If I'm reading the latest Treaty correctly, Article 12 is not an exception listed in Art.1(5) to Art.1(4), the "savings clause".  Therefore, as a USC, Article 12 of the Treaty plays no part in this discussion. Use of FTC would be the normal remedy to prevent double taxation, and, in my opinion, would not be "resourced by treaty" but (I'm guessing here) "general limitation".

Finally some progress!  After a few more requests, my accountant finally did fill out another Form 1116 for "Certain income re-sourced by treaty", but as he points out, there's no tax credit to apply to my return because I haven't paid any UK tax on this income (yet).  This isn't entirely true as my wife paid UK tax on her US bank account interest income in previous years, but I only really care about the new royalty income and not <$20 of interest income.  I didn't realize until now that the foreign taxes paid fall into different groupings matching the income.  My previous accountants re-sourced the small amounts of interest income to the UK, but didn't ever apply any foreign taxes paid as they probably should have, and I also overlooked this as it was a small amount.

So, now how do I apply FTC for UK taxes my wife will pay sometime in 2021 (or early 2022 as they're not due until then) to our 2020 1040 return?  I remember when we first moved to the UK my accountants advised us to pay an estimate of our UK taxes a year early to avoid this situation, and they mentioned that we could file an amended US return to fix the situation later, but that would cost us more in accounting fees.  I tried searching for details on this now and can't find anything, as I'm probably using the wrong search terms.

(Edit: I tried some more search terms and looks like "carryback" pulls up some relevant results.  I'm out of time to dig into the details right now, but it seems like after I make UK tax payments in 2021 for the Nov 2020 royalty payment and any 2021 royalty payment, and prepare/file our 2021 1040 return there will be excess FTC to apply to 2020 with a 1040X.  Not the ideal situation but at least I see a path now to avoid double taxation.)

I did say in an earlier post that timing differences between US & UK tax years can be a pain! However:

On Form 1116 Part II line 8, there is an option to select paid or accrued for Foreign Taxes - you can select accrued on the basis of your 2020/21 UK tax bill.

However, note the instructions as follows:

Generally, you can take a foreign tax
credit in the tax year you paid or
accrued the foreign taxes, depending
on your method of accounting. If you
report on the cash basis, you can
choose to take the credit for accrued
taxes by checking the “accrued” box in
Part II. But once you choose to do this,
you must credit foreign taxes in the year
they accrue on all future returns.

If you're going to go this route - I'd make it easier on yourself by paying the UK ASAP (even on account) before filing so you have some supporting information

I did say in an earlier post that timing differences between US & UK tax years can be a pain! However:

On Form 1116 Part II line 8, there is an option to select paid or accrued for Foreign Taxes - you can select accrued on the basis of your 2020/21 UK tax bill.

However, note the instructions as follows:

Generally, you can take a foreign tax
credit in the tax year you paid or
accrued the foreign taxes, depending
on your method of accounting. If you
report on the cash basis, you can
choose to take the credit for accrued
taxes by checking the “accrued” box in
Part II. But once you choose to do this,
you must credit foreign taxes in the year
they accrue on all future returns.

If you're going to go this route - I'd make it easier on yourself by paying the UK ASAP (even on account) before filing so you have some supporting information

+1

I always make estimated payments to HMRC through the portal, and I always make sure I complete  my  UK tax return before December 31st even though it is not due until January 31st the following year.  The accrued box is always checked on my 1116  forms.