Crossing the pond (without getting wet)

The UK and US both have tax rules that have developed over decades to balance the competing issues of political reality and public approval common to all democratic societies. In each case, this has resulted in a taxation system that can levy tax outside of the jurisdiction and, as such, the two countries’ rules frequently come into conflict with each other. This leaves the taxpayer in the middle, trying to work out how to jump over a hurdle in one country without landing in a pitfall in the other.

Residence

An individual can often be simultaneously tax resident in two jurisdictions by splitting time sufficiently between both in a given tax year. However, the risk of double taxation with the US is greater because US citizens (and certain green card holders) are automatically exposed to US taxation on a worldwide basis, irrespective of their physical residence. The risk of double taxation therefore applies to any UK‑resident US citizen. For such individuals, the question of which jurisdiction will retain primary taxation rights and which country may (but not always) allow a foreign tax credit will be determined by the UK/USA Double Taxation Convention.

The cessation of UK residence can largely resolve this conundrum, since a non‑UK resident is subject to UK income tax on only UK‑source income and to UK capital gains tax on only UK land and property‑rich companies. That said, these revenue streams may still be liable to US tax and so double taxation would still need to be considered. Another way for a UK‑resident US citizen to avoid double taxation would be to expatriate; however, this may come with significant potential US tax pitfalls that must be considered carefully beforehand.

Domicile

Of separate concern, but equal importance, is if an individual is considered a domiciliary of both the UK and US. In such circumstances, the individual is exposed to US gift and estate taxes and UK inheritance tax (IHT) on their worldwide estates. This is particularly important for UK emigrants to the US, and the US practitioner should not assume that the individual is automatically outside the worldwide scope of UK IHT simply because they have left the UK. For example, settling assets on a lifetime trust can carry an immediate charge to UK IHT at 20 per cent over GBP325,000, and this may include trusts that do not give rise to a corresponding US tax charge, such as US revocable living trusts.

Even if the individual moves to the US and acquires a US domicile of choice, they will remain deemed UK domiciled for at least a further three years and will therefore continue to be exposed to UK tax as if they retained their UK domicile. Therefore, any UK domiciliary who settles in the US must be advised to consider these UK tax issues for at least the first three years from their arrival in the US.

Once the individual has escaped both UK domicile and deemed domicile status, they will only be subject to IHT on their UK assets. In fact, over time, it is possible for that IHT exposure to be cut down further. Generally speaking, under the US‑UK Estate and Gift Tax Treaty, an individual who is US domiciled under both UK and US law is only exposed to IHT on UK real property and business assets.

Conclusion

As a final warning, US practitioners should take great care with individuals born in the UK with a UK domicile, even if they have since lost that UK domicile. If that individual resumes UK residence, this will cause them to become automatically deemed UK domiciled for some UK taxes in the first year of resumed residence, and then for all UK taxes from the start of the second. Among other effects, this deemed domicile status will cause all foreign trusts settled by the individual to become immediately exposed to UK IHT. As such, all prior estate planning should be carefully reviewed before that individual returns to the UK.

What an analysis of these rules shows is that great care must be taken before any estate planning is put in place. It is possible to find the rare arbitrages between the two jurisdictions where the taxpayer actually wins, but, more commonly, planning should focus on avoiding an inadvertent tax charge because the rules of the other jurisdiction were not adequately considered.