Tax treatment of Restricted Shares for Americans in the UK

This article briefly discusses restricted share awards received by US taxpayers working in the UK and the availability/advantages of the Section 83(b) and Section 431 elections.

 

Receipt of Shares

It is not uncommon for employers to award their employees with shares in the business to incentivise them to stay with the company and work harder to increase the value of their award.  These commonly take the form of “restricted shares” or “restricted share units” (RSUs).

The employee is granted shares, but full access is subject to conditions being met, at which point the shares vest and they are delivered to the employee. The conditions could be time related or based on financial performance, and shares would normally vest in the case of a “liquidity event” (e.g. the employer gets bought out or goes public).

For employees, the UK and US taxation of these awards is broadly similar. The fair market value (FMV) of the shares is treated as taxable compensation at the point the conditions are satisfied and the shares vest. The full value of the shares is taxable as additional earnings and should generally be subject to income tax and social security withholding. There is generally no cost to the employee in acquiring the shares (these are not share options where shares are purchased at a set price).

 

Sale

A common misconception made by employees when they sell their RSU shares is that they “have already paid tax on the shares” and that no further tax is due when they are sold. This is not entirely true. The employee has paid tax on the FMV of the shares on the vesting date.  If the value of the shares subsequently increases after vesting, the gain (net sale proceeds less FMV at vesting) will be a Capital Gain, which could be subject to UK and US tax.

Obviously, if the shares subsequently  fall in value after vesting, there will not be a capital gain and there will be no tax to pay.

However, there are elections available to improve tax efficiency on receipt and sale of restricted shares…

 

Elections

Both the UK and US tax authorities provide opportunities to convert the income arising on the vesting of restricted shares into capital gains. The highest marginal income tax rates in the UK and US are 45% and 37% respectively. The marginal capital gains tax rate in the UK is 20% and is also 20% in the US for property held for 12 months or more. The chance to convert this income to capital gains can be very attractive and would also allow the use of capital losses from other sources against these gains.

In the UK, a Section 431 election is available which must be made in writing within 14 days of the initial date of the award (the grant date). At that point, the fair market value of the shares will be subject to UK income tax. The UK will not recognise a taxable event when the shares vest and the cost basis in the shares will be the value on the date the award was granted to the employee. On the sale of the shares, all subsequent growth in value from the grant date will be subject to UK capital gains tax.

A section 83(b) election is available for US tax purposes and must be filed within 30 days of the date of the initial award. The effects are the same as the above election, where all future growth will then be taxed at capital gains tax rates in the US.

 

Points to consider

While these elections seems quite straightforward, other matters should be considered.  If the shares have a marketable value when they are initially awarded, there will be a “dry” income tax charge, meaning there will be tax to pay without receiving any compensation. The risk here is that this tax charge is not reversed if the shares drop in value or become worthless.

It is worth mentioning that if you are self-employed, you can use the US section 83(b) election but not the UK’s section 431 election.

 

Tax planning opportunity

Many US citizens living and working in the UK will, for US tax purposes, build up a pool of unused foreign tax credits, due to relatively high UK income tax rates. An opportunity to use these credits may arise where an employee has the option to make a section 431 election in the UK but no Section 83(b) election in the US.

By making an election in the UK and not in the US, the employee will include taxable earnings on their US tax return when the shares vest. The US tax liability arising on the additional income can then be offset by unused foreign tax credits that have been carried forward.   This same event will not attract any UK tax liability due to the section 431 election in place.

By not “converting” income to gain for US tax purposes, you also reduce the exposure to Net Investment Income Tax when the shares are sold associated with a Section 83(b) election.

The only complication with this arrangement is the differing cost basis that needs to be tracked separately for UK and US tax purposes. A knowledgeable and reliable tax consultant will be able to do this for you without any trouble.

We would always recommend seeking professional advice on these matters and would be happy to assist.  Just don’t wait too long!