It’s all about timing

by Jack Turner, in , , ,

US taxpayers living outside of the US will remain exposed to US tax and will also have tax obligations in their country of residence. To avoid double taxation, it is important to manage foreign tax payments to ensure that sufficient credits are available to reduce US tax liabilities.

Most US taxpayers in the UK will not need to worry about this. This is because a large majority of people in the UK are not required to file a UK tax return where most taxes are withheld via the PAYE system. Therefore, this article will be most relevant to those who have:

  • Received significant investment income that will need to be reported on a UK tax return
  • Made large capital gains – possibly looking to take advantage of the lower capital gains tax rate before it changed on 30th October 2024.
  • Started a new self-employment or joined a partnership and are yet to make any UK tax payments towards this
  • Started to take pension distributions without UK tax withheld (this could be a US pension)

As a rule of thumb, US taxpayers should be looking to pay the balance due with their UK tax returns before 31st December each year, but in some circumstances, they may need to make an additional payment. This would be an advance UK tax payment on income received and gains made in the calendar year.

Foreign Tax Credits

Foreign tax credits are the most common method of avoiding double taxation for US taxpayers living outside of the US. On a US return, these credits are (in most cases) accounted for on a “Paid Basis”, meaning that only foreign taxes paid in the year can be applied to the US tax return. So, although the deadline for UK tax payments is 31st January following the end of the UK tax year, careful consideration should be taken as to whether the tax should be paid a month early (31st December) or even a year in advance (more below).

“Accrual Method” – In more unusual cases, an accrual method is used to account for foreign taxes. If this is the case, this article can be disregarded entirely.

To be able to apply these foreign tax credits to a 2024 US tax return, the foreign tax liability must be paid by 31st December 2024.

Advance UK tax payments

In addition to paying the balance due with a tax return before the end of the year, it may also be worth making an advance UK tax payment. Due to the timing difference between the respective tax years, i.e. US calendar year vs. UK April-April, only the first 3 months of income from 2024 will have been accounted for on the most recent UK tax return. This leaves 9 months of potentially untaxed foreign income which may be exposed to US tax if an advance payment is not made.

For example, the UK tax due on a large capital made in October 2024, would typically be paid with a 2024/25 UK tax return, due on 31st January 2026. The unfortunate timing of this means that there will be no foreign tax credits available on the 2024 US tax return which will create a US tax liability. Even paying the tax due before 31st December 2025 would be a year too late. Ideally, the tax should be paid in the same calendar year as the capital gain i.e. before 31st December 2024.

How much to pay

How much additional tax to pay ultimately depends on the source and level of income. As a rough estimate, we suggest paying 37% tax on income and 20% tax on capital gains. Please note that this would only be relevant to income and gains in the period from 6th April to 31st December. Income and gains prior to this would be captured by the UK tax return.

This estimate is based on the maximum US tax liability that could arise. It is likely that this is more than is required to cover the actual US liability, but it is better to overpay in this situation than underpay. Also note that this payment may not be sufficient to cover the entire UK tax liability due to the higher UK tax rates. At this stage, it is only necessary to cover the US liability.

Once made, the payment will go to the taxpayer’s HMRC account and will sit there until the 2024/25 tax return has been filed. Note, it can be withdrawn in an emergency and any overpayment will be refunded with a tax return.

Making a payment

HMRC Payment options can be found  here – The payment reference is the taxpayer’s UTR number which can be found on a recently filed UK tax return.

 

In most cases this would only need to be a rough estimate. PJD are happy to assist with preparing more accurate calculations if required. A consultancy fee may apply. Please feel free to get in touch if you would like to discuss further.