The Foreign Account Tax Compliance Act (FATCA) has had a significant impact on the financial responsibilities of US citizens living abroad, particularly those with business interests in the UK.
Enacted to combat tax evasion, FATCA imposes extensive reporting requirements on both individuals and foreign financial institutions.
What is FATCA?
FATCA is a US federal law enacted in 2010 as part of the Hiring Incentives to Restore Employment (HIRE) Act. Its primary goal is to prevent tax evasion by US taxpayers using foreign accounts and investments.
Key objectives
- FATCA requires foreign financial institutions (FFIs) to disclose information about financial accounts held by US citizens.
- It requires US taxpayers with certain foreign financial assets to report them annually to the Internal Revenue Service (IRS).
- By increasing disclosure, FATCA aims to identify and deter tax avoidance strategies involving offshore accounts.
FATCA reporting requirements for US expats
For US expats with business interests in the UK, FATCA adds another layer of complexity to tax compliance.
Individual reporting requirements
Reporting Thresholds
Reporting thresholds vary by filing status and residency:
- Single filers living abroad:
Year-end balance: $200,000
Any time during the year: $300,000
- Married filing jointly living abroad:
Year-end balance: $400,000
Any time during the year: $600,000
Forms to file
To comply with FATCA, US expats must file certain forms, often after a tax consultation to ensure accuracy:
- Form 8938 (Statement of Specified Foreign Financial Assets):
Submitted with your annual tax return.
Reports details of foreign financial assets, such as bank accounts, investment accounts, and ownership of foreign entities.
FBAR (FinCEN Form 114):
Required if the total value of foreign financial accounts exceeds $10,000 at any time during the calendar year.
Submitted electronically through the Financial Crimes Enforcement Network (FinCEN).
Effects on US expats with UK business interests
Double taxation obligations
US taxation of worldwide income
- The United States taxes its citizens on their worldwide income, regardless of where they reside. This means that income from UK business interests must be reported to the IRS.
- Profits, dividends, and other income from UK businesses are subject to US taxation and must be reported on the expatriate’s US tax return.
UK tax obligations
- The UK taxes individuals based on their residency status. If you’re a UK resident, you’re liable for UK tax on your worldwide income.
- UK companies are subject to UK corporate tax laws, which may differ significantly from US rules.
Mitigating double taxation
- The US-UK treaty helps prevent double taxation by allowing tax credits and exemptions. It determines which country has the right to tax certain types of income.
- US expats can claim a credit for income taxes paid to the UK, reducing their US tax liability.
- The Foreign Earned Income Exclusion allows qualified individuals to exclude a certain amount of foreign earned income from US taxation.
Potential penalties
Failure to comply with FATCA can result in severe penalties.
- Failure to file Form 8938: Penalties start at $10,000, with an additional $10,000 for every 30 days of non-filing after notification by the IRS, up to a maximum of $50,000.
- Accuracy-based penalties: A 40% penalty may be assessed for underpayment of tax attributable to undisclosed foreign financial assets.
- Willful non-compliance: Willful failure to report can result in criminal charges, including fines of up to $250,000 and imprisonment.
- Tax evasion charges: Concealment of assets or income may result in prosecution for tax evasion.
- On foreign payments: A 30% withholding tax may be imposed on certain US source payments made to noncompliant individuals or entities.
- Increased scrutiny: Non-compliance can trigger audits and investigations, which can damage personal and professional reputations.
- Business disruption: Legal issues and fines can disrupt business operations and drain resources.
Mitigate the impact of FATCA
Strategies for tax planning
Proper tax planning is critical to minimizing the impact of FATCA and maximizing the benefits available under both US and UK tax laws.
Foreign Earned Income Exclusion (FEIE)
The FEIE allows qualified US expats to exclude up to $112,000 (for 2022) of foreign earned income from US taxation. This exclusion can be a powerful tool for those with significant income from UK sources.
To qualify, expats must meet the bona fide residence test or the physical presence test. Proper documentation is essential to prove eligibility.
Expatriate housing exclusion
US expats can exclude certain foreign housing expenses from their income, including rent, utilities, and insurance. The exclusion is in addition to the FEIE and can significantly reduce taxable income.
For expats living in high-cost cities such as London, the foreign housing exclusion can provide significant tax relief.
Foreign Tax Credit (FTC)
The FTC allows expats to claim a dollar-for-dollar credit for foreign taxes paid to the UK, thereby reducing their US tax liability. This credit is particularly useful if income is taxed at a higher rate in the UK than in the US.
The FTC is subject to limitations and may not fully offset US taxes in all cases. However, unused credits can often be carried forward to future tax years.
Planning for your retirement
Tax treatment of UK pensions
The tax treatment of UK pensions, such as self-invested personal pensions (SIPPs) and workplace pensions, can be complex under US tax law. Contributions, growth, and distributions can all have different tax implications.
The US-UK tax treaty has special provisions for the taxation of pensions, often allowing tax deferral similar to US qualified retirement accounts.
Roth IRAs and ISAs
While Roth IRAs offer tax-free growth under US law, their treatment under UK tax law may differ. Conversely, Individual Savings Accounts (ISAs) are tax-free in the UK but taxable in the US.
Social security agreements
The US-UK Totalization Agreement prevents double taxation of social security and helps determine eligibility for benefits.
Bottom line
FATCA poses significant challenges for US expats with business interests in the UK, but with strategic planning, it is possible to navigate these complexities effectively. By taking advantage of tax treaties, utilizing appropriate exclusions and credits, and engaging in proactive retirement and estate planning, expats can mitigate the impact of FATCA and optimize their financial outcomes.
Understanding the implications of FATCA is critical not only to ensure compliance but also to make informed decisions that comply with both US and UK tax laws.
Partnering with experienced tax and legal professionals, staying abreast of regulatory changes, and regularly reviewing financial strategies are key steps to successfully managing your global tax responsibilities.
