How to Invest as an American in the UK — The Hedge (2024)

In this article, we’ll explain what the rules are for investing in the UK as a US citizen, and the options you have for looking to grow your wealth as an expat.

How Are US Citizens Taxed Overseas?

The US tax system is very unique in the way that it assesses tax liability. In almost every other country in the world, your tax status is based on your residency. This makes sense. If you’re living in a country, particularly on a permanent basis, you are using the resources of that country and therefore should be liable to pay tax there.

As an American living in the UK, you’re using the NHS, the motorways, building up eligibility for the State Pension and maybe sending your children to school. By definition, this also means that you’re not accessing any of these things in the United States. You aren’t a burden on the public sector at all, because you don’t live there.

Most countries recognise this situation and therefore don’t tax its citizens who are living in another country. The US doesn’t do that. American citizens who are living abroad are subject to income tax in exactly the same way as they would be if they were still living back home.

Because of this unusual situation, US expats have the requirement to report their financial circ*mstances to the IRS every year. Regardless of how long it’s been since you last lived in or even visited the US, you are still required to report to the IRS each year and potentially pay additional tax to them.

Do US Citizens Pay Double the Amount of Tax?

This sounds pretty frightening. If you’re picturing the need to pay 80% tax after you’ve paid off both HMRC and the IRS, don’t worry, it’s not quite as bad as it initially seems. That’s because the US has what’s known as a Double Taxation Agreement (DTA) with almost every country in the world.

A DTA basically means that you can’t be taxed on the same money twice. So if you’re an American living in the UK, any income or capital gains that you make that has been subject to tax by HMRC is unlikely to be taxed again by the IRS.

Now this might seem like it solves the problem entirely, but unfortunately it’s not that simple. Whilst you can’t be taxed on the same money twice, it can mean that some of the tax breaks that are available to UK citizens or expats from other countries, aren’t available to you as a US citizen.

One example is capital gains on the family home or main residence. Here in the UK, your main residence doesn’t attract Capital Gains Tax. We’ve all seen episodes of Escape to the Country where a couple who bought a house in a once run down part of London in the 1980’s have sold it off for millions. They’re able to pocket this profit completely free of tax. In the US, your family home does attract capital gains tax, and therefore even if HMRC doesn’t expect any tax from your sale, the IRS probably will.

Another example is the use of tax-free Individual Savings Accounts (ISAs). For most people, these accounts are a great way to grow wealth, because any income or capital growth within the account is completely free of tax. Because there isn’t a direct equivalent in the US, the IRS treats ISAs the same as any other taxable account, completely eliminating the benefits of them.

What is FATCA?

These regulations have been around for a long time, and there have been reporting requirements in place since 1970. The problem for the IRS though, is that it has historically been very difficult to gain the information required to audit and track whether US citizens are reporting everything.

This all changed back in 2014 when the Foreign Account Tax Compliance Act (FATCA) was introduced. This bill means that all non-US banks and financial institutions must now report to the IRS. That’s right, every year your UK bank sends a report to the IRS which gives them a full rundown of your assets, liabilities and income, so that they can double check that Uncle Sam hasn’t missed out.

On top of the rules being a hassle for US citizens abroad, it now also means that it’s a massive hassle for the banks themselves. The reporting obligations under FATCA are strict, and there are big penalties that can apply to banks and financial institutions that don’t comply.

Because it’s such a headache, a lot of companies have simply decided that it's not worth it from a business case standpoint. It’s for this reason that, as an American citizen, you may have fund certain companies who simply decline to do business with you.

How to Invest as an American in the UK?

Ok so now you understand why this problem exists, what are some of the things you can do to minimise its impact? The overriding theme to always consider is how the tax on your financial decisions would apply if you were still in America. As outlined in the examples at the beginning of the article, you need to consider what the potential tax consequences would be for HMRC but also for the IRS.

Going back to the main residence exemption for capital gains tax, the process you would need to go through would be to look at the tax consequences first here in the UK. Once you have assessed these, you then need to look at what the tax consequences would be if you were making the same transaction in the US.

If you will have a higher level or the same level of tax in the UK as you would in the US, you are unlikely to have further tax to pay to the IRS due to the DTA. If the tax liability to HMRC is less than you would pay in the US, then you can expect the balance to be payable to the IRS. There are certain exemptions and exclusions that you can apply for, but it is best to work off a worst case scenario initially until you are able to get proper tax advice.

What Can US Expats Invest in?

One of the main concerns for a US citizen investing in the UK, is that investing via pooled investment products such as funds and ETFs can come with big tax consequences. Using a structure like an ETF or a managed or index fund to invest is one of the most widely given pieces of investing advice. It allows for a significant level of diversification, as well as the ability to outsource the day to day investment management to a professional third party.

The problem with this form of investment for US citizens, is that funds in the UK are classes of “non-US pooled investment products”. The IRS classifies these as Passive Foreign Investment Companies (PFICs), which they really don’t like and therefore charge a highly punitive level on them. The end result is that really, you need to avoid any investment that falls into this category, and the vast majority of off the shelf investment funds or ETFs will.

Individual Stocks and Shares

So what can you invest in? Well individual securities are one obvious option. You obviously need to be careful with having a portfolio that is too concentrated, but you can purchase individual company stocks and shares via a regular taxable investment platform or app. These will still attract income and capital gains tax, but not at the punitive rate of PFICs.

US Funds with UK Reporting Status

The other option is to invest in a fund that has been specifically setup for US citizens in the UK. These are funds that are domiciled in the US, and therefore they are by definition not non-US pooled investments and avoid the PFIC regulations. By receiving reporting status with HMRC, they are able to be classed as an onshore UK investment fund, rather than an offshore one, which comes with its own tax complications in the UK.

You will have to do a bit of hunting around to find these, as the rules state that they can’t be marketed to non- US residents. Because of the nature of advertising, this is difficult to do and therefore they don’t tend to be advertised at all.

Can Americans Invest in a UK Pension?

A notable exception to the PFIC regulations are for UK pension schemes. The DTA that covers the UK and the US includes recognition of retirement savings plans like pensions and 401(k) plans.

This means that generally speaking, investing within a pension fund doesn’t come with the same restrictions as investing personally. You should be able to select from the standard investment selection within the scheme, without causing problems with the IRS.

You should still be careful about making additional contributions into a pension fund, and tax specialist tax advice to make sure you are complying with IRS regulations with any additional funds you contribute.

Summary

As an American in the UK, your investment options are more limited. You should be very careful with investing in pooled investment structures such as managed funds and ETFs, as they are likely to fall under the IRS’s punitive Passive Foreign Investment Companies (PFICs) tax regime.

The main things you can invest in are direct securities like stocks and shares, and US domiciled funds that have received HMRC reporting rights. This can be a complex area, so it's worth seeking out a professional who can make sure you’re keeping both HMRC and the IRS happy.