By Laura Johnson, EA
In the United Kingdom, Individual Savings Accounts, or ISAs, are common investment vehicles, providing their owners with years of tax-deferred or even tax-exempt income and growth. It can come as a nasty shock for an ISA owner to learn that, under the US tax system, an ISA is nothing but an investment account – possibly one with particularly onerous reporting requirements and unfavorable tax treatment. How does an ISA end up in the purview of the US Internal Revenue Service (IRS)? Here are two common scenarios:
- A US citizen or green card holder, living in the UK becomes eligible to contribute to an ISA and sets one up.
- A UK citizen and ISA owner becomes a tax resident of the US.
The latter situation perhaps being the more common scenario as so many UK people have ISAs.
Generally, foreign persons residing in the US for periods of time which exceed certain thresholds are taxed as US residents. US residents are taxed just like US citizens, that is, they report and pay tax on worldwide income. And while tax-favored in the UK, an ISA is not given any special consideration by the IRS.
ISAs take either of two forms: Cash or Stocks and Shares.
Cash ISAs get more straightforward treatment: interest income is taxed just as it would be if earned in a US savings account.
Stocks and Shares ISAs are generally harder to handle. Such accounts typically own foreign mutual funds or ETFs. In the US tax system, foreign investment vehicles are usually classified as so-called passive foreign investment companies, or PFICs. It is beyond the scope of this briefing to discuss complex tax rules surrounding PFICs. Suffice to say:
- Distributions (ie. receipt of dividends) are taxed at unfavorable rates and subject to additional interest charges.
- Dispositions (ie. sales of stock) are taxed at unfavorable rates and subject to additional interest charges.
- The forms reporting such distributions and dispositions are complex and difficult to calculate resulting in additional professional fees.
- And each foreign mutual fund in the account must be accounted for separately. That is, the tax reporting forms for a PFIC are not completed on a per account basis, they are completed on a per fund basis.
Further, if non-US assets, such as ISAs, exceed certain thresholds, a US taxpayer must disclose detailed information about the assets, or face harsh penalties.
At John Schachter + Associates, we help our clients comply with all tax rules involving ISAs. At least as important, we also help clients plan, so they can manage or mitigate any consequences. Talk to us. Let us know how we can help you!