How is my income taxed as an American expat living in the UK?

As a U.S. citizen living abroad, you are generally still required to file a U.S. federal income tax return, even if you are paying taxes in your country of residence. Whether you must file depends on your filing status, age, and gross income from all worldwide sources. Here’s an overview of how your income is taxed and the implications for U.S. and UK taxes:

US Taxes for Expats

Filing a U.S. Tax Return:

  • Standard Filing Thresholds: The IRS sets specific income thresholds each year that determine if you must file a tax return. These thresholds vary based on your filing status (single, married filing jointly, etc.). You can find the current year's thresholds on the IRS website or in IRS Publication 54, Tax Guide for U.S. Citizens and Resident Aliens Abroad.

  • Worldwide Income: Your gross income includes earnings from all sources, including wages, salary, self-employment income, investment income, and any other taxable income you receive, regardless of where it was earned.

  • Foreign Tax Credit and Foreign Earned Income Exclusion: Even though you must file a U.S. tax return, you may be able to reduce or eliminate your U.S. tax liability through foreign tax credits or the foreign earned income exclusion.

  • Foreign Earned Income Exclusion (FEIE): You may qualify to exclude a portion of your foreign earnings from U.S. taxation using the FEIE if you meet either the bona fide residence test or the physical presence test. For tax year 2024, the maximum exclusion is $130,000 per person. If two individuals are married, and both work abroad and meet either the bona fide residence test or the physical presence test, each one can choose the foreign earned income exclusion. Together, they can exclude as much as $260,000 for the 2025 tax year (this amount is adjusted annually for inflation).

  • Foreign Tax Credit (FTC): If you pay taxes to the UK, you can often claim these as a credit against your U.S. tax liability to avoid double taxation on the same income. A credit reduces your actual U.S. income tax on a dollar-for-dollar basis, while a deduction reduces only your income subject to tax. The amount of credit claimed cannot exceed the portion of U.S. tax liability attributable to the taxpayer's foreign earned income. Taxpayers may carry back unused foreign taxes to the previous tax year and carry forward to the next ten tax years, allowing them to utilize the credit in years when it's most beneficial.

  • Comparing the FEIE with the FTC:

    FEIE Pros:

    • Simplicity: Easier to claim compared to the FTC.

    • Tax-Free Income: Can potentially eliminate US tax liability if income falls under the limit.

    FEIE Cons:

    • Limited to Earned Income: Excludes passive income from investments.

    • Income Cap: Less beneficial for those with high incomes exceeding the exclusion limit.

    • Limited Deductions: Cannot be combined with certain deductions like the Child Tax Credit.

    • Residency Requirements: Taxpayer must meet either the bona fide residence test or the physical presence test

    • Contribution to IRA: If you exclude all of your earned income with the FEIE, you are not eligible to contribute to an IRA.

    • Switching from claiming the FEIE to the FTC in a given year constitutes a revocation of the exclusion election. Once revoked, claiming the exclusion again within the following five years requires IRS consent.

    FTC Pros:

    • Includes All Foreign Income types: Covers both earned and passive income.

    • No Income Limit: Beneficial for those with high foreign incomes.

    • Carryover Option: Excess FTCs can be carried back one year or forward ten years. This accumulated credit can be valuable in scenarios where your future U.S. tax liability increases, such as if you move to a country with lower tax rates where you might not generate enough new foreign tax credits to offset your U.S. taxes, or if you expect to receive a UK pension or other foreign income that would increase your U.S. tax liability. However, the usefulness of FTCs for offsetting UK pension income may be limited due to provisions in the U.S.-UK tax treaty.

    • Potential for Full US Tax Elimination: In many cases, the FTC can offset the entire US tax liability.

    FTC Cons:

    • Complexity: Requires meticulous documentation of foreign taxes paid or accrued.

  • Claiming the FEIE and the FTC: High earners can strategically claim both the Foreign Earned Income Exclusion (FEIE) and the Foreign Tax Credit (FTC) in certain situations to optimize their tax benefits. This strategy combines the benefits of both tax breaks, ensuring the maximum amount of foreign earned income is either excluded or offset by tax credits. You must still need to meet all the eligibility criteria for both the FEIE and the FTC. The suitability of this approach depends on individual factors like your income level, the foreign tax rate, and the types of income earned.

  • Reporting Foreign Bank Accounts (FBAR):

    In addition to filing a tax return, you may also be required to report foreign bank accounts if the aggregate value of all your foreign financial accounts exceeds $10,000 at any time during the calendar year. This reporting is done through the FinCEN Report 114, also known as the FBAR.

    • Financial Accounts: This includes bank accounts, brokerage accounts, mutual funds, trusts, and other types of foreign financial accounts.

    • Filing Deadline: The FBAR is typically due on April 15th of the following year, but filers often receive an automatic extension to October 15th.

    • Penalties: Failure to file an FBAR can result in significant penalties, so it's important to understand your reporting obligations. See FBAR penalties here.

  • FATCA Reporting for U.S. Citizens in the UK: Understanding Your Obligations

    The Foreign Account Tax Compliance Act (FATCA) is a U.S. law that aims to combat tax evasion by U.S. citizens holding assets in foreign accounts. If you're a U.S. citizen living in the UK, FATCA has significant implications for your financial reporting obligations.

    What is FATCA?

    FATCA requires foreign financial institutions (FFIs), including banks, investment firms, and insurance companies, to report information about their U.S. account holders to the IRS. This helps the IRS ensure that U.S. taxpayers are reporting their worldwide income accurately.

    FATCA Reporting Requirements:

    • U.S. Citizens: As a U.S. citizen, you may be required to report your foreign financial assets, including UK bank accounts, on Form 8938 if they exceed certain thresholds. These thresholds vary based on your filing status and residency. See Form 8938 thresholds, deadlines and penalties here.

    • Foreign Financial Institutions: Your UK bank, may also be required to report information about your accounts directly to the IRS. This reporting helps the IRS verify the information you provide on your tax return.

UK Taxes for Expats

  • Residency and Taxation: Your tax liability in the UK largely depends on your residency status. If you are considered a UK resident, you will generally be taxed on your worldwide income by the UK. Non-residents are usually taxed only on their UK-sourced income.

  • Income Tax: The UK has a progressive income tax system with rates that range from 0% to 45%, depending on your income level. You’ll start paying income tax on earnings above your Personal Allowance, which is £12,570 for the 2024/25 tax year.

  • Personal Allowance: You're generally entitled to a personal allowance, which is a portion of your income that is tax-free. Most UK residents are entitled to the full Personal Allowance. However, your Personal Allowance may be reduced if your income exceeds £100,000. You can claim your Personal Allowance through your employer's payroll or by filing a self-assessment tax return.

  • Capital Gains Tax (CGT):

    • Basic Rate: 18% for gains that fall within your basic income tax band and 18% for residential property gains.

    • Higher/Additional Rate: 24% for gains that fall within your higher or additional income tax band and 28% for residential property gains.

    • Annual Exempt Amount: You have an annual exempt amount for CGT, which is £3,000 for the 2024/25 tax year. This means you can make up to £3,000 in capital gains without paying tax to the HMRC. You may, however, have to pay CGT to the IRS. See Important Considerations below.

    Dividend Tax:

    • Tax Rates: The dividend tax rates depend on your income tax band and the amount of dividend income you receive.

      • Dividend Allowance: For the 2024/25 tax year, you have a £500 dividend allowance.

      • Basic Rate: 8.75% for dividends that fall within your basic income tax band.

      • Higher Rate: 33.75% for dividends that fall within your higher income tax band.

      • Additional Rate: 39.35% for dividends that fall within your additional income tax band.

    Interest Tax:

    • Personal Savings Allowance: UK residents have a Personal Savings Allowance, which allows them to earn a certain amount of interest tax-free.

      • Basic Rate: £1,000 tax-free interest allowance.

      • Higher Rate: £500 tax-free interest allowance.

      • Additional Rate: No tax-free interest allowance.

    • Tax Rates: Interest income above the Personal Savings Allowance is taxed at your regular income tax rate.

  • Double Taxation Agreement (DTA): The US and UK have a DTA in place, which is designed to prevent double taxation of the same income in both countries. This agreement allows for the use of foreign tax credits and specifies which country has taxing rights on different types of income.

Important Considerations

  • Tax-free allowances: The U.S. does not have specific tax-free allowances for capital gains, interest, or dividends like the UK's Personal Savings Allowance or Dividend Allowance. Taxpayers can, however, take advantage of standard or itemized deductions to reduce their taxable income.

  • The U.S. tax rates applied to capital gains will depend on the taxpayer's income level and filing status. Unlike the U.S. the U.K. does not differentiate between short - and long-term capital gains.

  • The U.S. has preferential tax rates for long-term capital gains (assets held for over one year). These rates are generally lower than ordinary income tax rates. Qualified dividends (from U.S. corporations and certain qualified foreign corporations) are also taxed at the lower long-term capital gains rates.

  • Avoiding Double Taxation: It's essential to utilize the FEIE, FTC, and the DTA provisions to mitigate the risk of double taxation.

  • Tax Filing Deadlines: Be aware of the different filing deadlines in each country. The U.S. tax year is the calendar year, with a typical filing deadline of April 15 for the previous year's taxes. The UK tax year runs from April 6 to April 5, with a filing deadline of January 31 for online returns.

  • Retirement Accounts: The tax treatment of your US retirement accounts (e.g., 401(k), IRA) in the UK, and vice versa if you have UK pensions, can be complex.

  • Intergovernmental Agreements (IGAs): The U.S. has established IGAs with many countries, including the UK, to facilitate FATCA reporting and ensure compliance.

  • State Tax Returns: Depending on your residency status, you may also be required to file a state tax return. State tax laws vary, so it's important to check the requirements for your specific state.

  • State Taxes: It's important to note that U.S. states may have their own taxes on capital gains, dividends, and interest, and these rates can vary significantly.

  • Professional Advice: Tax laws change frequently, and individual circumstances can affect tax obligations significantly. Given the complexity of tax laws and the potential for significant financial implications, it is advisable to consult with tax professionals who are experienced in expatriate taxation issues in both the U.S. and UK.

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Last Updated: 3/20/2025