In 2016, the US State Department estimated that there are nine million US citizens living abroad and as many as 200,000 ‘US persons’ resident in the UK. All of them are subject to US income tax – and some of them don’t even know they are Americans. It’s a situation frequently encountered by Janette Saxer, Portfolio Director for Schroders Wealth Management US Ltd, who has more than 30 years’ experience advising clients and working alongside their other professional advisers.
Find out more about the services we offer to US citizens living in the US, UK and elsewhere
“If you have a US passport, then you are American,” she explains. “But it’s more complex than that. For tax purposes, a US person is anyone who was born in the US, or has a parent (even an adoptive parent) who is an American citizen. The parent could have left the US years ago and no longer uses their US passport, and the child could be none the wiser. Or if you have worked in the US and hold a green card, even after you return to the UK, you still have to file US taxes.”
Many people who are subject to such liabilities are completely unaware of their obligations, but for those whose non-compliance is intentional, it’s becoming harder and harder to hide from America’s IRS. The Foreign Account Tax Compliance Act (FATCA) is a 2010 US federal law requiring all non-US financial institutions to search their records for customers with US person status and report on the foreign assets they hold.
“Even if you’re paying tax in the UK, you should still have filed all your US tax returns annually,” Janette says. “If you have failed to do so, you could be liable for a penalty and back taxes as well as expensive professional charges. We often find ourselves helping people to solve a problem they didn’t know they had.”
An essential step towards finding a solution is obtaining the right advice. This usually means engaging not only an accountant who will help navigate the details of the US tax system, but also a lawyer who can advise on the best route towards compliance. “Don’t skimp on advice,” Janette says. “You don’t want to make mistakes with the IRS, or appear flaky. At the same time, you need an adviser who’s right for you. It’s an emotional time and you’ve got to feel trust.”
Kristin Konschnik, a US tax attorney at Butler Snow in London, says: “Our first step is to talk to the client and understand what the background is and how they acquired whatever US connection they have. Once we know that, our role is to advise the client on the most appropriate way to become compliant by bringing your US filings up to date. If the client has been paying UK tax and they have a relatively straightforward situation, for example they earn wage income that is PAYE, the residual US tax typically is not that significant. If they have a more complex situation, if they have owned and run a business in the UK, or they have made investments in assets that are not US tax-friendly, then the residual US tax can be higher.”
A crucial role played by lawyers such as Kristin is establishing that their client’s non-compliance with US tax laws was not wilful – and putting this case to the IRS, which has significant discretion in whether to impose penalties. However, under a current IRS sanctioned ‘streamlined filing’ approach, accidental Americans have a good opportunity to bring their US tax affairs up to date without paying the penalties that typically apply in these situations.
To preserve legal privilege, accidental Americans (and anyone else who is not up to date with their US tax affairs) should consult first with a lawyer to determine the most appropriate approach to their compliance. “Ideally, we’re involved right at the start of the process because the discussions that we have with clients and potential clients are covered by the attorney-client privilege, another significant advantage of talking this through with a lawyer in the first instance,” says Kristin.
As part of the process, Kristin says it is necessary to prepare a detailed statement explaining the client’s situation and why their failure to file was non-wilful. “As lawyers, our involvement in the process is critical, to ensure the client’s statement meets the necessary legal standard and accurately and sympathetically sets out the client’s case,” she says.
Assets or liabilities
While the process of becoming tax compliant is often quite straightforward, some people’s financial situations may make it far more complex. Family trusts, owning a business and even certain types of investment can cause tax headaches for US persons. “In the case of a deceased estate, the IRS can pursue tax liability through several generations,” Janette says. “And investments such as shares in passive foreign investment company vehicles, including mutual funds, hedge funds, and even some insurance products and non-US pension plans, are a tax accounting nightmare for a US person. You have to be savvy with how you invest.”
And then there’s another common investment: property. In 2014, the then London Mayor, Boris Johnson, who was born in the US and held both US and UK passports, entered into a public spat with the IRS over capital gains tax owed from the sale of his London home. While a capital gain from the sale of a main residence is not liable for tax in the UK, it is in the US. “I think it’s absolutely outrageous,” he said at the time. “Why should I [pay]? I haven’t lived in the US [since] I was five years old… I pay my taxes to the full in the UK where I live and work.”
Unfortunately, Boris’s objections fell on deaf ears, and he has since renounced his US citizenship after reportedly settling his tax obligations with the IRS. It’s a choice many – but by no means all – of Kristin’s clients elect to make. “It’s about evenly split between people who retain their US citizenship and those who relinquish it,” she says. “People who knew they were American, but had not understood the tax implications that come with that, are generally not interested in giving up their citizenship. But those who had no idea they were US citizens are more likely to give it up. It is a very personal decision.”
Whatever route accidental Americans take to bring their affairs in order, one thing is certain: burying your head in the sand is not an option. “You’ve got to grasp the nettle,” Janette says. “If not for yourself, then for your children"