Stepping Stones: What Americans in the UK need to know about taxation for children.

If you are an American citizen in the UK with a child, your child may well have US citizenship, so you should view their US tax obligations the same way as for adults. We explore the US tax relief available when you have a child.

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When you have a child who is a US citizen, there are certain tax filing requirements that need to be considered and several factors that should be taken into account when making savings for the future. We examine the key areas that parents need to know to ensure their children stay tax compliant and also provide updates on the various tax reliefs that can be received.

US children – the importance of clarifying citizenship

A child born in the US will automatically be a US citizen. A child born outside the US to a US citizen parent, can also be a US citizen, but it is best to receive US immigration advice in these circumstances. A child can be a US citizen even if the child does not apply for a US passport. There are also a large number of “accidental Americans” that were born in the US due to parents being on a work assignment or on holiday. As a US citizen, US children must comply with the same tax rules as their parents, which includes worldwide taxation. It is possible to relinquish US citizenship but you normally need to wait until adulthood (18 years old) before this can be achieved. 

US tax on dependents 

Your child is your dependent for US tax purposes if they are a US citizen, under 19 (or 24 and in full-time education), and you pay more than half of their support. For years before 2018, you were able to claim a tax-free personal exemption for each of your children, which was deductible against taxable income. This is no longer the case as all personal exemptions have been scrapped from 2018. 

US children are subject to US tax on their worldwide income. It is possible that your child will need to file their own US tax return, however in many cases you are able to elect to include your child’s income on your tax return, if they are your dependent and meet other conditions. 

If your child's interest, dividends and other unearned income totals more than $2,100 (for 2018), amounts exceeding this may be subject to “kiddie tax” rates. The idea behind these rules is to prevent parents sheltering assets in their children’s name to benefit from the lower rates of tax. From 2018 onwards, if your child’s unearned income is in excess of $2,100 it will be taxed at rates applicable to trusts and estates, rather than at personal Income Tax rates. Trust rates hit the same top rate as individual rates (37%), but at $12,500 taxable income rather than $500,000. Earned income for dependents is taxed at their own marginal personal rates.

Case Study: The kiddie tax

Darren is a US person, and his daughter Daisy is also a US person. Daisy is 16 and Darren is dependent and therefore subject to the kiddie tax rules. Daisy earns $500 from a paper round. She also received $3,000 bank interest in 2018. Daisy will pay tax on the $500 at personal tax rates, and be subject to a tax rate of 15% on the interest income, after the $2,100 exclusion is given. If she was not caught by the kiddie tax rules, her income would have been fully covered by her own standard deduction and no tax would have been due. 

US tax relief for parents

You may be able to claim a Child Tax Credit of up to $2,000 per qualifying child under the age of 17. This is the maximum credit you can claim in 2018, double the amount in 2017, but is subject to income limitations.

Tax credits can also be given for qualifying childcare expenses. The amount of relief available is dependent on your adjusted gross income. 

Other filing requirements

Children must comply with IRS overseas filing obligations in the same that way you do. This includes the requirement to file a Foreign Bank Account Report, where the aggregate value in their non-US accounts exceeds $10,000 at any point in the tax year. If they hold shares in your non-US company, they may also have to file Form 5471, though it is possible for you to do so on their behalf. 

Saving for their future – college plans

A tax effective way of saving for your children’s future can be achieved by setting up a section 529 college plan. This enables you to save for their future college costs in a tax effective way, as funds used for “qualifying higher education expenses” are not taxed. Income earned in the plan does not need to be reported on you or your child’s tax return. This can also be a good way of gifting funds to your children for estate planning purposes, without giving them the ability to control the funds. 

As these plans are held under trust, care should be taken to ensure the plan does not become a UK resident trust, which could create a UK tax burden. If your child does not go to college there will be a tax charge on future distributions from the plan. If your child goes to a UK college there could be a tax charge on the child in the UK at the time of distribution of funds from the trust. 

UK matters

As always, UK-US taxpayers should consider the taxation by both countries for all income. 

Due to its tax-free status, creating a Junior ISA for your child can look appealing from a UK tax perspective. However, the IRS will not recognise its tax-free status and income will be taxable in full. 

There are similar anti-avoidance principles in the UK with regards to reporting and taxation of your child’s income. If your child gets more than £100 interest from money sources given by a parent, the parent will pay Income Tax on all of the interest. 

UK childcare tax saving schemes, such as employer childcare vouchers will save UK tax, however will not achieve the same saving in the US, which could lead to US tax due on such benefits. Note that from April 2018 employer childcare vouchers will be replaced with a new tax-free childcare scheme managed through NS&I. Childcare vouchers will continue to operate alongside the new scheme but will be closed to new scheme entrants from 6 April 2018. We expect the new 20% top up of childcare from the government to be seen as tax relief, so an adjustment to foreign tax credits would be required.

US children need to comply with the US tax rules in the same way that an adult would. There is no minimum age to become a US taxpayer. The IRS has anti-avoidance provisions in place to ensure taxpayers cannot avoid tax by holding assets in their children’s names. UK and US taxpayers should be mindful of schemes beneficial in one country, that can cause a tax issue in the other.

The full Stepping Stones series can be found here

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5 top tips for first time parents of a US child – from an expatriate tax expert and proud father.

 1.  Getting to know your baby.

You’re no doubt familiar with the hundreds of websites, books, videos and podcasts, all providing ample advice about how best to bond with your newborn. In addition to deciding what works for you on that front you will also want to know whether your baby is automatically a US citizen or not. Immigration laws have changed over the years so it is important to get the latest immigration advice to confirm a child’s US immigration status. Under current laws you are automatically a US citizen if you are born in the US. In most cases, and under current law, a US citizen parent will mean the child is automatically a US citizen. There are a few factors that influence US citizenship, including if the child is born outside of the US, has only one US citizen parent, and whether the US citizen parent has lived in the US for a sufficient number of years during adulthood. If a child is automatically a US citizen, then their parents will need to be aware of the US tax obligations that they could face.

 2. Supporting your baby.

The first few weeks after the birth will be a blur of getting to grips with everything from feeding schedules to sleep patterns through to the joy of analysis of poop. But of course your parental support does not end for many years and it is likely that you will have dependent children until potentially 23 years old. Whether your child has to file a US tax return generally depends on their earned and unearned income and whether they marry. Regardless of age, children who could be claimed as dependents must file if any of these conditions are met:

  • Investment (unearned) income > $1,050
  • Earned income > $12,000
  • Self-employed net earnings > $400
  • Earned and unearned total income that > larger of $1,050 or earned income plus $350.

Two ways children can file:

  • Form 8814 attached to parent’s return (if various condition met)
  • File their own return 

Tax Rates for children filing their own return:

The Tax Cuts and Jobs Act means all net unearned income over the threshold of $2,100 will be taxed using the brackets and rates for trusts and estates (see below for rates). The tax is calculated on form 8615, although this form no longer requires information from the parent’s tax return.

Tax Rate

  • up to $2,550 = 10%
  • $2,551 to $9,150 = 24%
  • $9,151 to $12,500 = 35%
  • all over $12,501 = 37%

3. Registering your baby with the appropriate authorities.

You will want to register your baby with a GP as well as register your baby’s birth with the local registrar office within 42 days of birth. If your child is a US citizen you will also need to register the birth with the US Embassy and file for a Consular Report of Birth Abroad. It is also recommended to submit an application for your child’s US passport and social security number at the same time. 

Reporting requirements may not end there, children may also be subject to US foreign informational reporting requirements such as a Report of Foreign Bank and Financial Accounts (FBAR) on FinCEN Form. A US citizen must file an FBAR annually if they have a financial interest in at least one financial account located outside the US, if the aggregate value of those foreign financial accounts exceeded $10,000 at any time during the calendar year.

 4. What if they are a trust fund baby?

It would be quite common for a US parent who marries into a wealthy UK family to have various structures in place for the benefit of children. This could include trust funds that could be there for the benefit of a new baby, who could be a US citizen. The trustees would need advice if there is a US beneficiary child as there might be some adverse US tax issues to consider. This could particularly start to become an issue when distributions are received indirectly, directly, or constructively (normally when school fees start to get paid). Investments within the trust structure would need to be reviewed, but an overall review of the structure would be recommended when a US beneficiary becomes involved.

5. Advice on sleep deprivation.

Welcome to the sleep deprivation society. To make the days a little easier draw on whatever support is available to you, be that midwives, family or, if you’re lucky, nannies or night nurses. Professional advisors are also here to help soothe any tax issues and make sure new parents have one less thing to keep them awake at night. US children need to comply with the US tax rules in the same way that an adult would. There is no minimum age to become a US taxpayer. The IRS has anti-avoidance provisions in place to ensure taxpayers cannot avoid tax by holding assets in their children’s names. US and UK taxpayers should be mindful of tax efficient planning beneficial in one country that can cause a tax issue in the other.

Buzzacott’s Expatriate Tax Services team of dual-qualified US and UK tax advisors can guide you in making decisions that work in both the short and long-term, while avoiding pitfalls and unexpected consequences.