Get to know the authorIf you’re an American living in the UK, knowing about the US-UK tax treaty is essential. This agreement between the US and the United Kingdom offers some major tax benefits for Americans living and working in the UK (and vice versa).
But, with around 39 pages and tons of technical jargon, the treaty is far from an easy read.
Fortunately, that’s what Bright!Tax is here for. As a tax firm specializing in US expat taxes, we have extensive knowledge of international tax treaties. Below, we’ll go over tax obligations for Americans living in the UK, what benefits the US-UK tax treaty offers, how to avoid double taxation, and more.
Tax obligations for US expats in the UK
Before getting into the specific benefits of the US-UK tax treaty, let’s go over the basic tax and reporting requirements for US expats living in the UK.
Understanding US/UK tax residency
To understand how the US taxes your income vs. the UK, you need to understand your tax residency status for each country.
Tax residents in the US
The US’s definition of tax residency is sweeping. Every American citizen and permanent resident whose income meets the minimum reporting threshold is subject to US income taxes and must file a federal tax return.
This applies even to American permanent residents and citizens living abroad. So Americans who are also tax residents in another country may need to pay taxes on the same income twice: once to the US and once to their country of residence. Fortunately, there are ways to avoid double taxation — one of which is the US-UK tax treaty.
Tax residents in the UK
Tax residency in the UK, on the other hand, is a bit more complex. You will be considered a UK resident for tax purposes if you meet at least one of the following criteria:
- Spend at least 183 days out of the year in the UK
- Have your only home in the UK for at least 91 days out of the year
- Work full-time in the UK for 365 days
You will automatically be considered a non-resident if you meet at least one of the following criteria:
- Were classified as a tax resident in at least one of the last three tax years but spent less than 16 days in the UK in the relevant year(s)
- Were classified a non-resident in any of the last three tax years and spent less than 46 days in the UK in the relevant year(s)
- Worked full-time overseas and spent fewer than 31 days working in the UK and fewer than 91 days physically present in the UK
For those who don’t meet any of the above criteria, tax residency will be determined based on whether or not they maintain sufficient ties in the UK.
UK taxes
The UK taxes its residents on worldwide income and gains. In England, Wales, and Northern Ireland, tax rates on non-dividend income vary from 0% to 45%, depending on the total income earned. In Scotland, however, non-dividend tax rates range from 0% to 47%. Throughout the UK, taxes on dividend income range from 0% to 39.35%.
People earning less than £125,140 per year can exclude up to £12,570 of their ordinary income from taxation.
Other types of income taxes include:
- Trust income
- Dividends: 8.75% on the first £1,000; 39.35% on remaining
- Non-dividends: 20% on the first £1,000; 45% on remaining
- Capital gains income
- Residential property: 18% to 28%, depending on total income earned
- Other chargeable assets: 10% to 20%, depending on total income earned
- Note: The first £3,000 of capital gains are exempt from taxation.
- Corporate income
- Businesses earning £50,000 or less: 19%
- Businesses earning £250,000 or more: 25%
- Businesses earning between £50,000 and £250,000: Sliding scale between 19% and 25%
- Patent income: 10%
- Diverted profits: 31%
Pro tip:
UK tax residents who are non-domiciled (“non-doms”) in the UK are taxed differently than typical tax residents. Non-doms who earn less than £2,000 per year generally do not have to pay UK taxes on foreign earnings or gains as long as they do not remit that income to the UK. Non-doms who earn £2,000 or more per year may claim the remittance basis on foreign income.
Non-residents, meanwhile, typically pay taxes only for their UK-sourced income and gains according to the standard resident rates.
US taxes
The federal US government taxes citizens and permanent residents on their worldwide income.
Ordinary income is taxed at rates varying from 10% to 37%, depending on the total amount of income earned. Long-term capital gains — or gains from the sale of assets held for at least one year — are taxed at either 0%, 15%, or 20%, depending on your overall income amount. Depending on where you most recently lived, you may need to pay state taxes as well.
Living abroad may also affect your reporting obligations. You may need to file the following reports, among others:
- Foreign Bank Account Report (FBAR): Required of Americans whose foreign financial accounts total over $10,000 in aggregate
- Statement of Specified Foreign Assets (aka Form 8938): Required of Americans with more than $200,000 worth of foreign assets on the last day of the tax year or over $300,000 worth of foreign assets at any point in the tax year (vs. a threshold of $50,000 for Americans who reside within the US)
US-UK tax treaty benefits & limitations
The US-UK tax treaty’s goal is to clarify taxation for individuals who are subject to taxes in both the US and the UK. Among other things, the treaty defines residence, provides tiebreaker rules, states which country has the right to tax which income (also known as first taxing rights), and more.
If you’re an American living in the UK, the US-UK treaty can benefit you by:
- Capping the tax rates that the UK may levy on US-sourced dividends, interest, and royalties at 10%
- Exempting lump-sum withdrawals from UK-based pensions from taxation
- Making certain US-sourced payments (e.g., pensions/retirement accounts, Social Security, annuities, child support, alimony) taxable only in the UK
- Allowing you to deduct UK-based pension scheme and retirement plan contributions from your taxable income
- Exempting income earned from pension schemes and retirement plans in one country from taxation in the other
- Preventing the UK from taxing US-sourced payments or income directly related to education or training for one year (applicable to full-time students, trainees, and apprentices only)
- Allowing taxpayers to request assistance from the relevant governing tax bodies to resolve double taxation or other treaty-related issues
- Requiring each country to offer tax credits for income taxes paid in the other on all other types of income unless otherwise specified
What you must know about the Savings Clause
One big caveat, though, is that the treaty contains a Savings Clause, which lets the US reserve the right to tax citizens and permanent residents as if the agreement didn’t exist.
In other words, much of the treaty can be beneficial for non-Resident Aliens, but US tax residents (citizens and permanent residents) are generally excluded from taking advantage of most of the treaty. Fortunately, some provisions are exempted from the Savings Clause — particularly Article 17(1)(b), which allows for tax-free lump-sum withdrawals.
Another major exception to the Savings Clause is the ability to exempt US Social Security benefits from US taxes if they are paying taxes in the UK.
To claim the benefits of the US-UK tax treaty, you’ll need to file Form 8833.
Other ways to avoid double taxation
If you can’t claim a certain benefit from the US-UK tax treaty, don’t sweat it — there are other ways to offset double taxation. The IRS offers a couple of tax breaks specifically for Americans who live abroad, including:
- The Foreign Tax Credit (FTC): Provides Americans with dollar-for-dollar credits for foreign income taxes paid on foreign-source income. This essentially allows expats to subtract what they’ve paid in foreign income taxes from what they owe in US income taxes. Often, those who claim the FTC not only erase their US tax liability for that year — they end up with excess credits that can apply to future US tax bills.
- The Foreign Earned Income Exclusion (FEIE): Allows eligible Americans to exclude up to $120,000 of foreign earned income for the 2023 tax year (aka the taxes you’ll pay in 2024). To qualify, you must pass either the Physical Presence Test or the Bona Fide Residence Test.
Pro tip:
Americans who meet the Physical Presence Test or Bona Fide Residence Test also qualify for the Foreign Housing Exclusion/Deduction. This lets them deduct certain qualifying foreign housing expenses (e.g. rent, utilities, furniture rental, etc.).
Americans abroad can also claim many of the same tax breaks as they would if they lived stateside, like the Child Tax Credit.
Resources
Disclosure: Some of the links on this website may be affiliate links. This means that we may earn a small commission at no additional cost to you if you take any action through those links. We only recommend products and services that we have personally used or thoroughly researched. Your support through these affiliate links helps us continue to provide valuable expat tax services. Thank you for your support!
