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Lifetime ISA & UK Pension

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Employer and private pensions for American expats in the UK.
Do I need to report my UK pension on my US tax return?

As a US citizen or Green Card Holder with an employer pension in the UK, you may have to report this as a foreign trust. US owners and beneficiaries of foreign trusts face complicated reporting requirements.

In order to qualify to receive a UK pension, you must live and work in the UK with a valid National Insurance Number.

When do you have to report your UK pension as a foreign trust?

For employer provided pension, the difference in whether you have to report your pension as a foreign trust or not lies in the amount of contributions into the account. If the employer contributions are more than your personal contributions into the account, there are no complicated US tax implications. All you have to do is report the balance of the employer provided pension on your FBAR or Form 8938 (Statement of Specified Foreign Financial Assets) if you have a Form 8938 filing requirement. This is considered a qualified retirement plan for US tax purposes, which means that your contributions and employer contributions into the pension along with growth are tax exempt.

There is another approach available because of the US-UK Tax Treaty, that is sometimes better for US taxpayers. Even though you report your contributions, employer contributions and growth in tax returns, there will most likely there will be no current year tax implication because your Foreign Tax Credit will be enough to cover tax. When you take out money from the pension you have already built a basis (portion taxed on previous tax return), so it will no longer be subject to US tax upon distribution.

When does a foreign trust become a foreign grantor trust?

As long as the contribution from the employer is higher or equal into the account than personal contributions then you are fine. The Problem occurs when you are putting in more money in than your employer is contributing, making it a Foreign Grantor Trust. In this situation, it would be similar to the treatment of a Self-Invested Pension Plan (SIPP), where you have to file Foreign Grantor Trust Form 3520 and Form 3520-A. Form 3520 reports the existence of the trust and the transactions, while Form 3520-A reports a statement of financial position with a profit and loss statement of the trust.

Assuming it is not a UK pension plan, whatever the income of the trust is, it flows through your tax return. As a UK pension plan, it is covered by the UK-US Tax Treaty and whatever income the trust generates will not flow through your tax return as it is tax exempt.

How and when do I file Form 3520-A?

Form 3520-A is due on March 15 of every year with the IRS. The trust can request a sixth-month extension by submitting Form 7004.

Foreign Grantor Trusts must now apply for an employer identification number (EIN), otherwise your Form 3520-A will be rejected. Call the IRS and get them to issue an EIN and make sure you file on time.

Although for many people, filing Form 3520 and 3520-A is a rare occurrence and is not the same has the annual reporting requirements of having a foreign bank account, it is very important to correctly and timely file these forms, otherwise you will face hefty fines. There is an automatic minimum penalty of $10,000 USD for sending this in late.

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When do ISAs become a problem for American expats?

 ISAs are very common in the UK, as no further UK tax is due on the income generated in an ISA and they are free of capital gains tax. However, they can be very problematic for US citizens or Green Card Holders.

When ISAs become problematic for US citizens or Green Card Holders depends on the type of ISA. If it is just a cash-based ISA, then there is no issue – you will just have to report the value of the ISA on your FBAR or Form 8938 (Statement of Specified Foreign Financial Assets). Whatever interest the cash-based ISA generates will be reported as interest income on your US tax return.

The more common type of investment ISA, a Stocks and Shares ISA, is more complicated for US citizens or Green Card Holders. The UK does not tax these ISAs, but the US does tax these and taxes them more harshly than a regular investments account.

A Stocks and Shares ISA is considered a Passive Foreign Investment Company (PFIC) and you will therefore have to file additional paperwork attached to your US tax return. In this additional paperwork you will need to compute the account earnings that are taxable in the US – which, if you don’t have any other regular investment account that you pay UK tax for, you will have US tax on. Income and gains will be taxable as under US PFICs.

If I’m an American living in the UK, is it worth having a stocks and shares ISA?

The benefit of having a stocks and shares ISA in the UK is outweighed by the costs on the US side

This is because the US does not want US persons to invest outside of the US, so they impose harsh taxes. If you do not do paperwork properly, you can be subject to the highest US tax rate of 39.6%.

The IRS will tax you on the profits of the PFIC even if you have not sold them. Effectively, you could make a profit on paper in your ISA that the IRS will want to tax you on before you have the funds in hand. Your unrealised gain is being taxed, so you may wonder if there are any exemptions or exclusions to tax on your PFIC. There are ways in which you can have the income taxed at a lower level, but it is dependent on each individual situation and respective income. You can elect either a mark-to-market or Qualified Electing Fund (QEF) treatment for your PFIC.

For the small returns of an ISA, it is outweighed by the reporting fees and harsh US taxes. We recommend that you make sure you only have a cash ISA.

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