The UK Finance Manager, Rachel Reeves, announced the new tax budget last month, which contained significant changes. Most significant to the US expat is the fact that the new budget includes a provision to raise UK capital gains taxes. The lower rates in the UK will go up from 10% to 18%, and the higher rate from 20% to 24%. This is now higher than the US capital gains rates (0%, 15% and 20%) What does that mean for you?
The simplest answer is to take advantage of the lower US capital gains rates by investing in an ISA (individual savings account).
Capital Gains Differential
In the new UK budget, the capital gains rate has increased. The capital gains tax-free allowance is now down to £3,000, and capital gains tax rates have moved from 10% to18% in the basic tax band and from 20% to 25% in the higher bands. Therefore, you may be better off paying US capital gains taxes and avoiding UK taxes by placing the money in an ISA.
US Long-Term Capital Gains Tax Rate 2024 are as follow:
Capital Gains Tax Rate | Single | Married Filing Jointly |
0% | $0 to $47,025 | $0 to $94,050 |
15% | $47,026 to $518,900 | $94,051 to $583,750 |
20% | $518,901 or more | $583,750 or more |
(Short-term capital gains are taxed as ordinary income according to federal income tax brackets)
ISAs
In 2024, as a UK resident, you can contribute up to £20,000 annually to an ISA. The UK recognizes this investment much like the Roth IRA. It is not income tax deferred when you contribute, but grows tax deferred and is never charged UK capital gains taxes. However, the US does not recognize ISAs as a tax deferred vehicle and will tax them as an ordinary account, so you will be subject to US capital gains taxes. But now, the US capital gains rate is much lower than the UK rates so this could be to your advantage.
There are two primary types of ISAs:
Cash ISAs - A Cash ISA functions mainly in the same way as a standard savings account. However, if you have a Cash ISA, you will not pay UK tax on the interest you earn, whereas if you have a savings account with a bank or building society, you will pay Income Tax on earnings over £1,000.
Stocks and Shares ISAs - Your money can be invested in assets like shares, bonds, property, and commodities. For US expats you will want to stay with shares and bonds, not ETFs for Mutual Funds as they can be considered PFICs and cause you an undue tax burden, In a Shares ISA (also known as an investment ISA), and you don't have to pay UK tax on capital gains or income (interest and dividends). But, you will pay the lower US capital gains taxes.
PFICs
If you walk into many high street banks, they won’t permit you to buy one of their off-the-shelf ISAs (except for a cash ISA). With this, they are doing you a favor as the IRS in the United States would classify these investments as PFICs (Passive Foreign Investment Companies). PFICs are subject to strict and complicated tax guidelines set by the IRS to close tax loopholes on US citizens avoiding taxation on foreign income.
Taxes vs Diversification
If you think that an ISA might be right in your specific circumstance, you should also consider the fact that you may be giving up some opportunities for diversification. Since it is not recommended that you use a mutual fund in your ISA because of the PFICs, you will need to purchase individual shares in US companies. Mutual funds and ETF positions offer diversification through the various investments inside of the fund. Single stock positions are not. So, be sure you consider your risk exposure if you decide to invest in an ISA.
Dunhill Financial has partnered with Morningstar Wealth Platform (formerly Praemium) to provide compliant portfolios that can be utilized in an ISA. Morningstar Wealth Platform (formerly Praemium) issues 1099s to make your US taxes as simple as possible, and we ensure that we use no PFICs (i.e., all US-listed securities). Contact our expert advisors to see how they can help in your situation.
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