As an individual holding U.S. citizenship or Green Card status, with a pension sourced from a UK employer, you might be obligated to disclose this as a foreign trust. This disclosure imposes intricate reporting demands on the U.S. trust owners and beneficiaries.
To be eligible for a UK pension, it’s a prerequisite to reside and work in the UK with a genuine National Insurance Number.
Let’s clarify situations where your UK pension does not need to be classified as a Foreign Trust.
The requirement to report your pension as a foreign trust hinges on the proportion of contributions made by the employee versus the employer. Usually, if the employer’s contributions outweigh the employee’s, this does not induce complex U.S. tax obligations.
Your only responsibility is to state the balance of your employer-sponsored pension in your FBAR and Form 8938 (Statement of Specified Foreign Financial Assets), given that a Form 8938 filing obligation exists.
Due to its status as a qualified retirement plan under U.S. tax regulations, employee and employer contributions invested in the pension and any growth are exempt from U.S. tax.
When an employee’s contributions overshadow those made by the employer, complicated U.S. tax compliance typically ensues, unless the pension is contract-based, not trust-based.
For a pension to be deemed “employer-funded,” the lion’s share of the money funneled into the pension must originate from the employer. If this condition is not met, the pension cannot be labeled “employer-funded.”
In such circumstances, the pension is regarded as a Foreign Grantor Trust for U.S. tax purposes and must be declared to the IRS via Form 3520 and 3520-A.
We evaluate contributions from employees and employers in the context of the pension’s lifespan, not annually.
Even if the employee’s contributions superseded the employer’s in certain years, as long as the employer contributed the most from the pension’s inception through to the end of the U.S. tax year being filed, the pension would not need to be filed as a Foreign Grantor Trust.
In the case of a contract-based UK pension, even if your contributions surpass your employer’s, it will not be regarded as a Foreign Grantor Trust. Thus, Forms 3520 and 3520-A need not be filed if your UK pension is contract-based.
An alternate route…
An alternate route, courtesy of the US-UK Tax Treaty, can sometimes prove advantageous for U.S. taxpayers.
Although contributions, employer contributions, and growth must be reported on tax returns, no current-year tax will probably be due, as Foreign Tax Credits could offset the tax. The advantage arises when funds are withdrawn from the pension as it is no longer subject to U.S. taxation since it’s already reported as income.
Provided that the employer’s contribution into the account equals or exceeds personal contributions, everything remains in order. The situation becomes problematic when your personal contributions exceed those of your employer, thus rendering it a Foreign Grantor Trust. In such circumstances, it parallels the treatment of a Self-Invested Pension Plan (SIPP), where you have to file Foreign Grantor Trust Form 3520 and Form 3520-A. Form 3520 documents the existence of the trust and its transactions, while Form 3520-A offers a financial position statement and a profit and loss statement for the trust.
In cases other than a UK pension plan, whatever the trust income is, it will reflect on your tax return. As a UK pension plan, it’s covered by the UK-US Tax Treaty and any income generated by the trust will not show up on your tax return as it is tax-exempt.
Form 3520-A is to be submitted to the IRS every year by March 15. The trust may request a six-month extension by submitting Form 7004.
Foreign Grantor Trusts now must apply for an employer identification number (EIN), without which your Form 3520-A will be dismissed. Reach out to the IRS to procure an EIN and ensure punctual filing.
Even though many people only occasionally have to file Form 3520 and 3520-A, and these forms do not have the same regular reporting requirements as having a foreign bank account, it is crucial to file these forms accurately and promptly to avoid hefty penalties. A delay will lead to an automatic minimum penalty of $10,000 USD.
ISAs are a standard feature in the UK, exempt from further UK tax on the income generated within an ISA and free of capital gains tax. Nevertheless, they can pose difficulties for U.S. citizens or Green Card Holders.
The type of ISA determines when they pose issues for U.S. citizens or Green Card Holders. For cash-based ISAs, there’s no issue – the value of the ISA needs to be reported on your FBAR or Form 8938 (Statement of Specified Foreign Financial Assets). Any interest the cash-based ISA generates is reported as interest income on your U.S. tax return.
The more prevalent type of ISA, a Stocks and Shares ISA, presents more complications for U.S. citizens or Green Card Holders. The UK does not tax these ISAs, but the U.S. does, and at a steeper rate than a regular investment account.
Investments in a Stocks and Shares ISA may be classified as a Passive Foreign Investment Company (PFIC). You are obliged to file IRS Form 8621 for each investment deemed a PFIC, and this form is submitted along with your U.S. tax return. With this additional documentation, you will need to calculate the taxable account earnings in the U.S. Income and gains will probably be taxable by the IRS.
If I’m an American living in the UK, should I consider having a stocks and shares ISA?
The benefits of owning a stocks and shares ISA in the UK are often offset by the costs of U.S. tax compliance and the IRS’s stringent taxation policies.
This occurs because the U.S. discourages its citizens from investing their savings outside the U.S., imposing severe taxes. Improper paperwork can lead to a taxation at the highest U.S. tax rate of 39.6%.
The Internal Revenue Service (IRS) will tax you on the profits of the PFIC even if you have not sold them. In effect, you could profit on paper in your ISA, and the IRS may seek to tax you on this before you even access the funds.
Your unrealised gain is being taxed, raising the question of possible exemptions or exclusions to tax on your PFIC. There are ways in which you can have the income taxed at a lower level, but this depends on the individual situation and income. You can opt for a Mark-To-Market or Qualified Electing Fund (QEF) treatment for your PFIC.
Given the small returns that many ISAs typically yield, the reporting fees and heavy U.S. taxes outweigh these benefits.
We advise that you restrict yourself to opening a cash-based ISA.
A Lifetime ISA (LISA) can be either cash-based or stocks & shares-based. In the case of a cash-based ISA, no PFIC filing is necessary. However, if it is a stock & shares-based ISA, some of your investments might be deemed PFICs.
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