US/UK tax – the basics
US citizens remain liable to US taxes wherever they live in the world. Official records indicate that there are at least 200,000 US citizens living in the UK. For these people (as well as any other US taxpayers living in the UK) it is essential to ensure that they are guided by integrated US/UK estate planning in order to avoid unnecessary exposures to tax in either jurisdiction.
For US taxpayers who fail to take proper advice, there are a number of significant traps for the unwary. This article will look at some of the issues that American’s living in the UK commonly encounter.
In reliance of US advice a large number of Americans undertake a common form of US estate planning involving a Revocable Trust (also sometimes known as a Living Trust). The Revocable Trust is created during the individual’s lifetime and is intended to avoid probate in the US because all (or most) of the individual’s assets are then transferred into the trust. Typically, the terms of the trust stipulate that the settlor has full access to the assets during their lifetime and then on their death or incapacity, the assets are to be held on new trusts for the benefit of their family.
From a UK tax perspective, the above planning can be highly problematic if the individual has significant UK situs assets or was domiciled or deemed domiciled in the UK at the time of its creation. In the absence of proper UK/US advice, many Americans are unaware that the transfer of assets into a lifetime trust along the lines described above can be a chargeable transfer for UK purposes that would trigger a charge to inheritance at a rate of 20%. For clients that have already transferred assets into trust in this way it may still be possible to argue that the trust is nothing more than a nominee arrangement during the settlor’s lifetime with the result that there would be no UK inheritance tax implications. Much will depend on the specific wording of the trust into which the assets were transferred and so specific advice should be sought and every case will turn on its own facts. Alternatively, if the individual has become domiciled or deemed domiciled in the UK since the creation of the trust then it might be preferable to leave the trust in place and claim that it is an ‘excluded property’ trust that protects all of the individual’s assets from UK inheritance tax.
The UK tax regime allows individuals to sell their principal private residence without any charge to capital gains tax (irrespective of the extent of any gains). This differs to the US regime which only gives relief against the first $250,000 worth of gains, with the balance of all sale proceeds being fully taxable. The limited US relief on property gains can result in US tax liabilities arising on the disposal of properties situated in the UK in areas of rapid property price appreciation or if the property has been owned for a significant period of time.
For couples where only one spouse is a US taxpayer one solution is to ensure that the non-US spouse holds the larger share of the property, thereby minimising the gains that crystallise in the hands’ of the US taxpayer. Care needs to be taken with this approach in order to avoid breaching US Gift Tax allowance limits and specialist advise should always be taken ahead of any proposed property purchase or prior to an inter-spouse transfer of beneficial interests in a property.
Many Americans living in the UK who are married to a non-US spouse do not realise that they may need a specific form of US trust (known as a QDOT) in their Will in order to obtain spousal relief in both jurisdictions. In the absence of a QDOT if the American spouse is the first to die the US will treat all assets passing to a non-US spouse as subject to Estate Duty. If the assets are above the US Estate Duty exempt amount this will cause an immediate charge to US death tax. There will then be a further charge to death duties (this time UK inheritance tax) when the surviving non-US spouse dies and passes the joint estate to the children of the family. As there is a mismatch in the timing of the taxes payable in the US and the UK respectively, the US/UK double tax treaty will not be available to eliminate double taxation.
By incorporating a QDOT into the US spouse’s Will in the above example, all US death taxes would have been deferred until the death of the surviving non-US spouse. This means that death duties in the US and the UK arise at the same time and so the double tax treaty will assist to secure relief from double taxation.
The above examples illustrate the importance of taking specialist advice in relation to cross-jurisdictional estates. If non-specialist advice is taken, or if jurisdictions are examined in isolation, the result is often that unintended or undesirable tax consequences arise. A properly coordinated estate plan is essential and with the ever increasing reach of the US tax authorities, this has never been truer for Americans living in the UK.