Once an American expat returns to the US, previous tax planning is likely to change. In this article, we summarise what to look out for so that you understand your position before you move back to the US.
We have advised numerous clients about the US and UK tax consequences of repatriating to the US and there are four main areas that we encounter.
Sale of a UK home
If you are a UK resident
There is Principal Private Residence (PPR) relief, which reduces the capital gain chargeable to tax if you have owned and lived in the property as your main home. If you leave your UK home and move into a US home, there is a period of nine months (which is a new rule from 5 April 2020) to sell the home before you get exposed to UK capital gains tax, as only a nine month period of absence in the final period of ownership will qualify for PPR relief.
If you are not a UK resident
There are Non-Resident Capital Gains tax rules which you must abide by. These rules include the revaluation/uplift in cost basis to 5 April 2015, if applicable. It also requires a Non-Resident Capital Gains tax return to be filed (and any tax paid) within 30 days of conveyance.
Key tax consideration
As a US citizen, you are also subject to federal income tax on any gain at 20% (long-term gain). Any UK tax paid can be taken as a credit to reduce the US federal tax. There is an exemption of up to $250k of gain per person if the home was owned and lived in for two out of the last five years before sale. If you are married to a non-resident alien (NRA) spouse, you could think about planning to gift the property to the NRA for them to sell before becoming a US resident, avoiding federal income tax.
If you are a US resident when the property is sold, the main difference for US tax purposes is if you are living in a State that has income tax. It is normally more tax efficient to sell the asset before moving to a State that has an income tax charge. The reason being is that it is an additional tax with no foreign tax credits allowed.
Unless you are of age to receive distributions from your UK pension, your UK pensions will continue to be reported on the foreign informational forms such as the Form 8938 (Statement of Specified Foreign Financial Assets), and for Form 3520-A/3520 (if the pension is classified as a Foreign Grantor Trust).
However, after many years of being in the UK, many of our clients have accumulated some tax free basis in their pensions, as most of the time employer contributions are taxable, employee contributions are not deductible, and growth (of earnings and accretions) within the pensions can be taxable (unless treaty relief is claimed). Therefore, moving back to the US and receiving pension distributions could be tax efficient.
Key tax consideration
It is important to distinguish between lump sum distributions and regular periodic pension payments. Lump sums are still taxable in the UK under the US/UK tax treaty, except for the 25% tax-free lump sum amount, which will be tax-free in both the US and the UK. Periodic payment amounts would be taxable in the US, although tax-free basis in the pension could mean the tax liability could be reduced.
Tax-free basis is a federal income tax rule and may not necessarily follow to a State income tax return. In particular, States like California will want to tax in full, as they do not necessarily follow the federal income tax return.
Back in the 2010/11 UK tax year, our client Melina made the maximum annual contribution to a Self-Invested Personal Pension (SIPP) of $212,500 for which basic tax relief of 20% was given. The relief was given within the SIPP, with the £212,500 contribution being grossed-up to £255,000. The US did not give relief for such a contribution, therefore the SIPP generated tax-free basis for US purposes. However, the income contributed to the SIPP was fully absorbed by foreign tax credits in that year and this had accumulated over the previous 10 years. This meant there was no US tax liability, even though no relief was given in the US on the pension contribution.
Melina then retired back in the US, and the amount already taxed on the US return of £255,000 will not be taxed again for US tax purposes (ignoring State tax issues). Under the current US/UK tax treaty, pensions are only taxable in the country of residence, so UK tax will not be payable on any periodic payments from the plan. For Melina, this meant that there was a permanent deferment of US and UK tax on £255,000 worth of income upon moving to the US.
Estate tax planning
If you have not had your estate or inheritance tax planning looked at for a while, and if it did not consider your return to the US, it would be sensible to have this updated. Factors such as the length of stay in the UK, whether UK citizenship was acquired and assets acquired over the period in the UK could all be relevant when it comes to estate and inheritance tax planning.
Larry is a US national who moved to the UK in 2000. Under common law in both the US and UK, Larry never had the intention to remain permanently or indefinitely in the UK, therefore he kept a US Domicile status. However, Larry is UK deemed domiciled as he was a UK resident for more than 15 out of the previous 20 years. Larry never acquired a UK citizenship. Where is he domiciled for treaty purposes?
Assuming his permanent home was in the UK, he will be UK treaty domiciled. He becomes US treaty domiciled if he sells his UK permanent home and moves to the US and obtains a US permanent home. This changes the estate tax and inheritance tax exposure dramatically.