UK ↔ US tax: a cross-border guide

If you are American living in Britain, British living in America, or hold both passports, you are in one of the most complicated corners of personal tax. Two countries, two systems and one income — but a web of treaties, credits and reporting rules is designed to stop you being taxed twice. This is the plain-English map of how UK and US tax fit together, and the traps that catch people who assume one country's rules are enough.

Citizenship-based taxation: the American difference

Almost every country taxes on residence — you pay where you live. The United States is the rare exception: it taxes its citizens and green-card holders on their worldwide income wherever they live, for as long as they hold that status. An American in London files a UK return as a UK resident and a US Form 1040 every year, even on income that never touches America. The UK, by contrast, taxes you on your residence (and, for some, domicile) status. The job of the rest of this guide is to make sure the same pound or dollar isn't taxed in full by both.

Two tools that stop double tax

A US person earning in the UK has two main ways to avoid double taxation on the same income, and the choice matters:

The treaty and the saving clause

The US-UK double taxation treaty allocates taxing rights and breaks ties when both countries claim you as resident. But it contains a saving clause that lets the US keep taxing its citizens almost as if the treaty didn't exist — which is why citizenship-based taxation still bites. A separate totalization agreement stops you paying into both Social Security and National Insurance on the same earnings, assigning you to one system.

The accounts you must report

Reporting is separate from tax — and the penalties for missing it are severe. A US person with foreign accounts has two overlapping duties:

The ISA and pension traps

This is where well-meaning UK financial planning collides with US rules.

A Passive Foreign Investment Company (PFIC)— which is what almost every non-US pooled fund is — triggers the punitive Form 8621 regime, with an "excess distribution" calculation that can tax gains at the highest rates plus an interest charge. The practical upshot: US persons in the UK often hold individual shares or US-domiciled funds rather than UK funds, and treat the ISA as a US-taxable account.

Pensions are friendlier but complex. The treaty generally lets UK pensions grow tax-deferred for US persons much as they do for UK purposes. The treatment of the UK 25% tax-free lump sum is contested — some advisers rely on the treaty to exempt it, the IRS position is less clear — so a workplace or SIPP pension is one area where you genuinely need a cross-border specialist before you draw.

Estate and gift tax

The two estate-tax systems are very different — the US taxes the estate of citizens and green-card holders on worldwide assets above a large exemption, while the UK charges inheritance tax based on domicile and UK situs. A separate estate and gift tax treaty allocates rights and provides relief, but for anyone with assets either side of the Atlantic this is specialist territory, especially around the UK's move to a residence-based inheritance tax.

Coming into compliance

Many dual citizens discover these rules late. If you are behind on US filings but the omission was non-wilful, the IRS Streamlined Filing Compliance Procedures let you catch up — typically three years of returns and six years of FBARs — usually without penalties. At the other extreme, renouncing US citizenship to escape the system can trigger an exit tax if you are a "covered expatriate", so leaving is rarely as simple as handing back the passport.

Which way are you going?