As 2020 finally draws to a close, hopefully signalling the start of the end of the pandemic. It also represents the time for American families to review their tax affairs and take advantage of year-end planning before the 31st of December deadline.
Everyone is curious to see what 2021 will bring and with the cost of COVID-19 mounting globally, individuals on both sides of the Atlantic are wary of potential tax reforms. Early suggestions from Biden seemed to attack the lifetime Gift & Estate Tax exemption and suggest increases to Income and Capital Gains taxes. With the composition of the Senate unknown until January, it is impossible to know how much legislation (if any) Biden will be able to pass next year.
With this in mind, Annie Hughes (Tax Manager at Blick Rothenberg) and Joshua Moss (Associate Director at London & Capital) look at four key areas for Americans living in the UK to consider:
01 Capital Gains Planning
In a year which has seen unprecedented events disrupt the status quo of everyday life, it has also seen the return of market volatility. Whilst the basic principles remain important planning tools, for example, taking advantage of appreciated securities that have been held for over 12 months, to the extent that you have capital losses in that year (or loss carryover from earlier years). There are additional considerations for Americans living in the UK:
- HMRC thinks of assets in GBP and the IRS thinks of assets in USD, which means any fluctuation in the exchange rate between the date of purchase and sale of a security, could create an unforeseen gain in either currency. Approach the notion of “net perfect tax position” with caution when dealing with different currencies.
- Avoid ‘bed and breakfasting’ (rebuying the same asset within 30 days) as this may allow the HMRC or IRS to disallow losses incurred.
- Individuals should remember that under both tax regimes, capital losses can be carried forward indefinitely*. These could also be a useful tool to offset any future tax increases. Unfortunately, losses cannot be carried back and so ensuring losses are realised before or in the same year, as gains, is a useful planning tool.
- US individuals who do not offset gains will need to bear in mind the Net Investment Income Tax, which is payable on any investment income and cannot be offset by tax suffered in the UK.
There is certainly a chance that capital gains tax rates will increase in both the US and the UK in the upcoming year. So, from a tax perspective at least, there may be a drive to sell appreciated assets before the end of 2020.
*Additional consideration is required for those who have made the capital loss election and still file on the remittance basis; please speak to your tax advisor.
02 Foreign Tax Credit Planning Opportunities
What are Foreign Tax Credits?
Due to the differing fiscal years in the US and the UK, individuals who claim foreign tax credits on a paid basis, may be required to accelerate their UK tax payment into the current calendar year.
Making an advanced payment in December 2020 will ensure that there are tax credits available to offset any 2020 US tax that would otherwise be due. Failing to do so may lead to a timing issue, as payments for tax due on income realised in 2020 may not be due to HMRC for some time.
It is important to be aware of the type of income you have, and ensure you have sufficient tax credits in the corresponding US basket. Due to the higher UK rates, individuals who have paid UK tax on their worldwide income for a number of years will likely have built up excess foreign tax credits in certain baskets.
How can I utilise them?
A way to consider using these credits is by utilising UK tax efficient planning still caught by the IRS net of taxation such as UK pension contributions.
In the UK, the annual allowance for pension contributions benefitting from tax relief is your total earnings up to £40,000 (subject to your threshold/adjusted income being below £200,000/£240,000 where it is tapered down) for the 20/21 tax year.
In addition to this, you are able to make use of any annual allowances unused during the three previous UK tax years, provided you were part of a registered pension scheme, which can result in a contribution level of up to £160,000 being available.
With the annual limit for pension contributions from a US perspective at $57,000 per annum (again exchange rate fluctuations are to be reviewed here), anything in excess of this, is treated as employment income and therefore taxed at ordinary income tax rates.
However, any foreign tax credit carryovers can be used to offset this.
03 Required Minimum Distributions
Individuals who hold an IRA, SEP or SIMPLE IRA must take a required minimum distribution each year from the 1st April, following the year in which they turn 72. These rules prevent taxpayers who have reached retirement age accumulating tax free returns indefinitely. Failure to take the minimum distribution results in the required distribution being taxable at 50%.
In 2020, the Coronavirus Aid, Relief and Economic Security (CARES) Act waived the requirement to take a required minimum distribution for 2020.
Funds within a recognised retirement account by both the US and UK such as an IRA are highly tax efficient vehicles. With the above changes in mind, it may make sense to take any required income from a taxable account and leave the funds within the retirement to continue to grow tax-free, until you are required to take a distribution again in 2021.
04 Annual Gifting Allowances & Donations
The idea of gifting assets away can be unnerving, especially if you are near or at retirement and have spent the majority of your life building a pot to live on.
However, seeking advice to become comfortable with the idea of gifting can be rewarding in seeing those people/ charities you care about benefit whilst you are still around; reducing the portion of your estate given to the relevant tax authorities after your death and profiting from an immediate tax benefit.
How can I make gifts?
Using the annual gift exclusion, a US person can gift up to $15,000 in 2020 to any number of people without incurring gift tax. Beyond this, the lifetime gift and estate tax exemptions currently allow individuals to pass up to $11.58m to others tax free. In the UK, gifts will typically be tax free if survived by the donor by 7 years.
When considering making substantial gifts or gifting non-cash assets, please discuss the capital gains implications with your tax advisor.
Beyond gifting to friends and family as a useful estate tax planning tool, those feeling generous and looking to reduce their income taxes may wish to make charitable donations.
Donations paid within 2020 will be deductible on US returns in full, under the CARES Act. In the UK, donations made under gift aid extend the amount of income subject to tax at the lowest rates. For US/UK individuals it is important that any donations are made to dual-qualifying charities to allow for relief in both jurisdictions.
Do not forget there is also the ability to donate shares, rather than cash, which provides tax relief on the fair market value of the shares and avoids capital gains tax for the donor.
By understanding how your total assets can be organised and co-ordinated to provide you with income and cash requirements over the course of your life, it becomes easy to identify surplus amounts available for you to gift.
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Annie Hughes is a tax manager in the US / UK private client team at Blick Rothenberg, who specialises in US / UK tax advisory and compliance services. She sits within the High Net Worth team and provides US and UK advisory and compliance services to sophisticated taxpayers with a range of assets and interests.