UK Income Tax
Do I need to report UK Government Support on my US tax return?
If you’re living in the UK, you may be receiving support funds from the UK government, such as carers allowance or unemployment benefits. So, you may be wondering whether these funds count in taking you over the threshold to have to file a US tax return. To put it simply, yes – these funds are considered as taxable income for US tax purposes. However, whether you have to file a US return depends on your filing status.
For example, if you are receiving £6,000 from UK national insurance and are a single filer, this would be below the $12,200 filing threshold. In this case, the single person is not required to file a US tax return. However, if you are married to a non-American, the only filing status available to you without having a dependent is ‘married filing separately’, for which the filing threshold is only $5. So, you would have to file a US tax return for any government support over $5. Despite receiving the same amount of income from the government, if you were single you would not have to file, but if you were married to a non-American, you would have to file.
For married joint filers the threshold is $24,400, and for Head of household it is $18,300. Any worldwide income of any currency counts towards what you earn and will mean you have to file a US tax return if it exceeds the threshold amounts.
Do I actually have to pay US tax on my UK income?
After realising that they need to file a US tax return, a big question for many Americans, Green Card Holders and dual nationals living in the UK, is whether they need to pay US tax on UK income. The US-UK Tax Treaty is one of the most comprehensive and beneficial treaties (or ‘totalisation agreements’) out there for Americans. Its main purpose is to avoid double taxation. The Treaty prevents US expats living in the UK from paying social security/Medicare taxes to two countries at the same time, as contributions can be made to either country, depending on how long you will stay in the UK.
There are 2 types of benefits for expats living and working in the UK:
– The Foreign Earned Income Exclusion (FEIE), and
– Foreign Tax Credit
Under the FEIE / ‘Form 2555’, you report all of your current income on your US tax return and claim a corresponding exclusion / deduction to arrive at your taxable income. So, the amount excluded will be taken off of your net tax liability and you will just pay tax on what is left above the FEIE limit (around $100,000 / £80,000 a year) if there is any left over. However, form 2555 is not the most beneficial way for filing US taxes from the UK. The best way is to claim the Foreign Tax Credit.
The UK is a high tax jurisdiction, with tax rates higher than the US – meaning that whatever is paid in the UK, is still higher than US tax. If you are paying taxes in the UK where it is higher, you effectively never end up paying taxes to the IRS. So, once your US tax liability is calculated on your US tax return and you claim Foreign Tax Credit for the UK tax payments you’ve made, the bottom line will be 0 or negative. To put it simply, taxes paid to HRMC are offset on the US side, which will mean that you will end up paying no taxes in the US.
Why is filing FTC better than FEIE when you’re residing in the UK??
The Foreign Tax Credit method is much better for those residing in the UK than the Foreign Earned Income Exclusion/ Form 2555, for the following 3 reasons:
- If you are earning more than the FEIE limit (around $100,000 a year), you will still have some taxes to pay. However, if you use Foreign Tax Credit earning the same amount, you will have 0 tax liability.
- You can carry the credit forward for 10 years. If you have worked in the UK for 5 years and built $100,000 tax credit and decide to move and work in a low tax jurisdiction (such as a country in the Middle East), you can still use the FTC carried forward to offset the tax on that income in the low tax country. If you were to live in Dubai with no taxes, you would essentially be able to eat into the pool of tax you had accumulated in the UK for credit.
- When claiming FTC, if you have dependent children and do not earn a lot, you can take refundable child tax credits, which is not available for individuals claiming FEIE.
How do I file for the Foreign Tax Credit?
When claiming as an individual, you need to file Form 1116 with your US tax return (if filing as a corporation, file Form 1118). Before completing Form 1116, all of your foreign taxes paid will need to be converted into US dollars.