One of the triggers that got me started with this site was my recent experience of opening a Stocks & Shares ISA. I’d like to share my experience so far with all of you, in the hopes it might help if you’re in a similar situations. I’ll also post periodic updates, to see how this experiment works over the next year or so.
Why a S&S ISA?
Due to a series of fortunate events, I have a little extra monthly income that’s looking for a home. I’ve already fully matched my employer’s contributions into my workplace pension, and I don’t want to lock more money away until I’m 55 or 57 (setting aside the questions of a foreign grantor trust, but that’s another small part of it). I’ve also fully contributed to Roth IRAs for myself and my wife – thanks COVID stimulus!
So, using The Flowchart, I’m at the box asking “Are you comfortable with individual stocks?”
To be perfectly honest, I’m not 100% sure what my answer to that question is, but I’m going to have a go! I’m still a big believer in passive investing and I’m not looking to go into serious stock picking, much less day trading, but the US tax system has pushed me to try out individual stocks so I can avoid the punitive PFIC regime.
Where to open my ISA?
There are loads of brokers in the UK that offer S&S ISAs – Monevator has a great comparison list here. Unfortunately, most of those brokers don’t want to work with US citizens (thanks FATCA!). Eventually, I’d like to put together a definitive list of brokers that will work with Americans, but for the moment, this Reddit post has a good starting list.
I went with Hargreaves Lansdown, for three reasons:
- They’ll happily work with Americans
- They’re an established company with a good track record – I’m not worried about them disappearing in the night, and trust they will be around for a while.
- Their fees are competitive – not the lowest out there, but not too bad:
- 0.45% annual platform fee – for holding shares, this is capped at £45, so if your ISA grows larger than £10,000, the fee doesn’t go up any more.
- £11.95 dealing fee (buying or selling of shares). This adds up quick, but I’m not planning on trading much. Also, if you set up automated monthly investments, this fee drops to £1.50.
Actually opening the account was easy – all online, and nothing extra complicated due to being a US citizen except needing to provide my US passport number. My account was open within a few minutes and the initial contribution went through my Nationwide debit card without any issues. Next step – picking the stocks to invest in.
Wait, why can’t I use index funds?
I’ll write a longer post going into the details of what a PFIC is and ways of dealing with this onerous US restriction. In the meantime, the Bogleheads wiki has a great explainer.
Very short version:
- Unit trusts (mutual funds in American) and ETFs are almost all PFICs.
- PFICs require the submission of an extra form on your US tax return, Form 8621. You need to do a copy of this form for each investment.
- There are a few options for how to report the PFIC gains/losses – even the least punitive (mark to market) is still painful, because you have to pay taxes on any gains every year, even if you don’t sell the investment.
- So the best option for most people will just be to avoid PFICs entirely.
Picking stocks for my ISA
Even though the US tax system has pushed me into individual stocks, I’m still a believer in passive investing generally. So I’m creating a “pseduo-index” or a “brew your own index fund” – trying to mimic the performance of an index using individual stocks.
Trying to actually own all the funds in an index would be hugely expensive due to the dealing fees – even at the lower £1.50 for an automatic investment, buying the whole FTSE 100 would cost £150, plus any additional investments later. That’s more than I wanted to spend on fees, plus owning 100 stocks makes for more bookkeeping headaches and more reporting on my US taxes.
So I decided to pick 20 of the largest stocks in the FTSE 100. Why the FTSE 100? Hargreaves Lansdown charges an extra 1.5% on foreign currency transactions, so I wanted to stick to stocks traded on the London stock exchange. I have a target of 10% UK stocks in my asset allocation anyway (future post to come on asset allocation more generally), so this counts against that.
Why 20 stocks? I did some crude backtesting against the overall FTSE 100, and found that 20 stocks felt like the sweet spot where it’s not so many stocks that it’s painful and expensive to manage, but not so few that the performance of any one stock will have a huge impact on the overall performance. This is not especially scientific – it just feels right to me.
So I got the list of all the FTSE 100 constituents, and started going down the list from biggest to smallest to pick the first 20. But as I looked, I realized some of these weren’t companies that I was particularly interested in over-investing in. These fell into two categories:
- Companies that made me feel a little icky. Many of these are materials companies with questionable human rights records and a long colonial history of exploitation, or banks that facilitate money laundering and other criminal activities. I also ruled out tobacco companies, but not alcohol – you may have different ideas about what makes a company “icky”, and that’s fine!
- Sectors that really don’t feel like a good investment in the current environment – for example, with interest rates so close to zero at the moment, I don’t see the environment for banks improving any time soon.
Both of these judgments are against the idea of index investing! But, this is an experiment, and it’s my money, so I’m going to try it my way. Worst case, this ISA will probably be less than 3% of my investments by the end of 2021, and even if one of these companies goes to zero, it’s a minor hiccup on my way to FIRE.
- It’s worth mentioning that I do still own some of these stocks through index funds in other accounts. I’m not going out of my way to complete divest from them, I’m just choosing not to over-invest in these particular companies.
I also decided to equally weight each of the 20 stocks, instead of market weighting. Why? Because it’s simpler and easier to manage. To rebalance, I just add money to whichever stock has the lowest value, no complicated math involved.
Which stocks did I pick?
Here’s the list of FTSE 100 stocks, from biggest to smallest, with either my decision to invest, or a quick reason why I didn’t. I stopped once I got to 20 “yes” votes.
| Company | Ticker | Decision |
|---|---|---|
| Unilever | ULVR | Yes |
| AstraZeneca | AZN | Yes |
| HSBC | HSBA | No – both a “slimy” bank, and a bank that I see struggling with low interest rates |
| Diageo | DGE | Yes |
| Rio Tinto | RIO | No – exploitative history, environmentally problematic |
| GlaxoSmithKline | GSK | Yes |
| British American Tobacco | BATS | No – tobacco |
| BP | BP | Yes |
| Royal Dutch Schell | RDSA/ RDSB | No – exploitative history, and I thought one mostly oil company was enough with BP |
| Reckitt Benckiser | RB | Yes |
| BHP | BHP | No – exploitative history, environmentally problematic |
| Prudential | PRU | No – when I did the whole list, having two insurance companies seemed like more than enough, and Aviva seems more likely to succeed to me. But that’s just a guess. |
| Anglo American | AAL | No – exploitative history, environmentally problematic |
| Vodafone | VOD | Yes |
| Glencore | GLEN | No – exploitative history, environmentally problematic |
| London Stock Exchange Group | LSEG | Yes |
| Relx | REL | Yes |
| Barclays | BARC | No – I see banks struggling for a while to come |
| National Grid | NG | No – two utility companies seemed excessive, and SSE seems like a better longer term bet with their focus on renewables |
| Flutter | FLTR | No – the way gambling works in the UK seems icky, and online gambling commercials drive me crazy |
| Lloyds | LLOY | No – I see banks struggling for a while to come |
| Compass | CPG | Yes |
| CRH | CRH | Yes |
| NatWest | NWG | No – I see banks struggling for a while to come |
| Experian | EXPN | Yes |
| Ferguson | FERG | No – overlap with CRH and Ashtead on the construction market, one seems like enough |
| Ashtead | AHT | No – overlap with CRH and Ferguson on the construction market, one seems like enough |
| Associated British Foods | ABF | Yes |
| Tesco | TSCO | Yes |
| Antofagasta | ANTO | No – exploitative materials |
| Legal & General | LGEN | No – one insurer felt like enough, and L&G always comes across as a bit scammy to me (totally subjective!) |
| Scottish Mortgage | SMT | No – PFIC in disguise! UK investment trusts look like stocks, but they’re actually PFICs. |
| BAE Systems | BA | Yes |
| Aviva | AV | Yes |
| Standard Chartered | STAN | No – I see banks struggling for a while to come |
| Ocado | OCDO | Yes |
| SSE | SSE | Yes |
| Skipped a few | lines | here, because I wanted the ones below |
| International Consolidated Airlines | IAG | Yes – wanted an airline, because I think they may come back from COVID faster than expected (but that’s just my guess!) |
| Intercontinental Hotels | IHG | Yes – wanted a hotel chain, because I also think they will come back faster than expected. IHG also has a somewhat COVID-resilient business model (they don’t own most of the hotels). |
I did do a comparison of this portfolio against the overall market weighting of the FTSE 100 – it’s not all that out of whack, even with those very subjective decisions above (numbers as of Feb 2021, although I don’t expect them to change too fast):
| Sector | FTSE 100 Weighting | My Weighting |
|---|---|---|
| Consumer Staples | 20% | 24% |
| Financials | 18% | 18% |
| Industrials | 11% | 12% |
| Materials | 11% | 6% |
| Health Care | 11% | 6% |
| Consumer Discretionary | 10% | 18% |
| Energy | 9% | 6% |
| Utilities | 4% | 6% |
| Communications | 3% | 6% |
| Technology | 2% | 0% |
| Real Estate | 2% | 0% |
Getting Started
Once I picked how I wanted to invest, getting started was pretty easy. I had funded the account initially with a few hundred pounds, which I invested into the top two companies. Then I set up a recurring plan to invest in the rest – I’ll do a large first month, because my annual bonus got paid in March, and then a few hundred pounds each month into whichever stock (or maybe 2 or 3) has the smallest value, with an aim to keep them all roughly equal.
I don’t plan on rebalancing through any sales, and I’m hoping I don’t need the money anytime soon. If I do, though, the flexibility of an ISA means I can take a withdrawal at any time and just pay the transaction fee and any US capital gains taxes.
Future Updates
There are a few things I’d like to explore some more over time, and will go into in future posts:
- Tracking my ISA vs an index fund: how am I doing? Better, worse, about the same?
- US taxes: since I started the ISA in early 2021, I won’t need to report anything until I do my 2021 US taxes, about this time next year. I’ll look at what records need to be kept, how the ISA gets reported on my taxes, and any pitfalls to avoid.
Is there anything else you’d like to know about a S&S ISA? Let me know in the comments!
FIRE Across the Pond 
I am delighted to have discovered your website after you cheekily mentioned it on the “US Expat Tax Questions” Facebook group. I can’t for the life of me find your post again – perhaps it has been removed 🙂 I think there must be only a select handful of people who are US citizen, UK tax resident, FI-style investors who have resorted largely to UK shares (and pension?) investments as a way to tread the fine line between US/UK/EU tax laws whilst also trying to keep costs down and avoiding expensive advisers. I’ve been investing one way or other in the UK for over 25 years, but more intensively over the last 10. I definitely think we should link up – in many ways you are my doppelganger! I’ve just been doing it for a bit longer… 😉 I’ve been living and/or working in the UK since the age of 6 as a US citizen (now UK/US dual) and our family plan to hit the FIRE button this year(!) Not including my UK wife’s final-salary pension, we are invested roughly 50%/50% split between SIPP and S&S ISA investments. The SIPP is all low-cost ETFs and is the result of the gradual merger of 3 employer, 1 personal, 1 stakeholder and 1 SIPP pension. I do take the opinion that the SIPP is US/UK tax friendly, but I follow the slightly riskier line that I don’t need to file IRS 3520/3520a forms. The ISAs, like yours, are invested in FTSE100 (and a few FTSE250) shares at Hargreaves Lansdown. Previously I was with X-O, then had to move to iWeb, then had to move to HL. I also manage my dad’s IRA, US pension, US social security, US and UK taxable brokerages, bank accounts (he’s now got dementia) – so you can imagine his US tax form is a nightmare! Our ISAs don’t follow the sector split of the FTSE100 (although I’m a huge fan of Monevator and the Lars Kroijer pure index ideology). Instead I follow a roughly 20-sector-equal-weight allocation across ~30 UK shares. I don’t have any qualms about “icky” investments. I’ve decided a long time ago that I don’t have to like a company’s products to invest in them. In fact I wouldn’t touch half the shares in the FTSE100 if I did! I lean heavily towards high-dividend payers to create cashflow, simplify my US tax return and take advantage of qualified dividends & long-term capital gains rates in the US. I almost never sell a share for the same reasons. I do have a Charles Schwab US brokerage, but without being able to use ETFs and the complexity of having shares in both countries I’m not currently using it. I will likely have an inherited IRA one day, but I will distribute and transfer that to the UK over about 5 years (it’s invested in US shares and one ETF that I can no longer add to). I think once lockdown has been lifted we ought to meet up at a pub sometime. I think we’d have a lot to talk about!
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Pleasure to meet you – and I agree, I think there aren’t that many people in this particular boat! Congratulations (almost) on reaching FIRE. I’m planning a few posts going into some details on my plans for what investments to hold and where, but the short version is that my UK investments are all in my employer pension with the exception of just starting a S&S ISA, US is a mix of TSP (with some previous 401(k)s rolled in), Roth IRA, and a little taxable brokerage (the IRA and brokerage are using a US address – TSP doesn’t care that I’m abroad, I’d roll the Roth IRA in there if I could). All low cost ETFs or similar, except for individual stocks in the S&S ISA. I’m inclined to agree with you on the SIPP approach – for the moment, I don’t really need one, but if/when I leave my current employer, it will become more pressing.
I’m interested in your approach on the ISA sector weighting approach – have you done any tracking of that vs the index? I’ll be the first to admit that my approach so far is not terribly scientific, but it’s a learning tool – tiny part of my investments for now, and I have a hard time believing it will do too much worse than the overall index unless I get really unlucky. The “icky” part isn’t even logically consistent, since I already own those companies through index funds! I like the idea of not selling shares – between the capital gains and the brokerage fees, I hope to do the same until well into retirement, if ever.
Definitely up for meeting up once the world gets a bit more normal – it’d be great to start to build a small community of like-minded people in this complicated situation!
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I have some good long term performance history on my UK shares. The total return including dividends and after all costs tracks a low cost FTSE All Share ETF very closely. I’ve actually advanced a bit ahead of it lately due to the value tilt my shares have. I think we are lucky to have access to the FTSE100 because it is so international. I’m less worried about the home bias, although I have that taken care of by having international ETFs in my SIPP. I don’t hold any bonds, because my wife’s guaranteed DB pension acts like a large perpetual index-linked bond. Yes, I’ll be holding shares until the day I’m die, I’m sure. I think if you have a family then everyone holds a portfolio with a potentially infinite holding period. At the moment I see our house as something to downsize or more likely completely sell when I reach my dad’s age/health to pay for care. My kids have Junior ISAs (moving them from iDealing to HL right now), also with UK shares in them. They are both dual US/UK citizens. I wanted to give them the option of working or studying in the US one day if they wanted. I include them on my US tax return. I had to remember to include the Junior ISAs on my FBAR because I effectively have signature authority. Another subject you can get your teeth into one day is the whole estate-planning / gift tax / IHT minefield…
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I started some research on the estate/gift/inheritence tax bit – even just for normal people, it gets complicated fast. I’ve got that research about 90% ready for a post, but it’ll just be the basics, that’s enough for the moment!
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Interesting stuff. The only other solution which I’ve seen mentioned is to buy US-based funds. This, in turn, causes an issue with HMRC which requires them to be “reportable” to avoid off-shore penalties, but there are many which are. This is what they describe as the “best” option here. https://thunfinancial.com/home/american-expat-financial-advice-research-articles/american-expat-pfic-uk-non-reporting-fund-investment-trap-article/
The only issue, is I have been unable to find any broker which will allow the purchase of such US-based, UK-reportable funds within an ISA wrapper. Maybe some boutique company somewhere will allow it…
And the second option to minimize fees is just put it all in Berkshire Hathaway. Their holdings are such that it’s almost an index fund if you squint. They are at least super diversified for the single £11.95 fee.
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Thanks for commenting! Agree with your solution, and the challenge you’ve found. I believe the key obstacle is actually being able to buy funds that don’t produce a “Key Information Document”, as required by EU (now UK) law. US funds don’t do it; I’ve heard there’s a conflict between what the EU requires and what the IRS requires, and they’re mutually incompatible, something about forward looking statements. Regardless of the detail, it means it’s almost impossible to buy a US fund as a UK/EU retail investor, if the broker knows you’re a UK/EU resident.
One way around it would be to become an accredited investor – I think it’s €500k+ investable with a set number of transactions and/or working in the financial industry. But that doesn’t help me! I think you can also get an broker to advise you to enable you to do it, but it’ll be some boutique company with high fees for that advice.
The Berkshire Hathaway idea isn’t a bad one, either. Could do some other companies with similar large portfolios, too (Softbank comes to mind, I’m sure there are others). Still get the added foreign currency fees, but it’s a lot of diversification.
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Yes I think you’re right. Although I *think* this is all due to UCITS rules, which the UK will no longer be subject to? Maybe they’ll start to be offered now that we’re out of the EU?
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I think it’s one of those things where the UK “could” diverge, but will see if they actually do, or if they stay close to the EU on financial regulations to ease UK financial companies doing business in the EU.
I also saw somewhere (can’t find it now) that there’s a campaign to relax the KID/UCITS/MiFID requirements for things like index funds, especially where there’s no “selling” to the investor involved. It’s all supposed to be about consumer protection, but it’s prohibiting consumers from making good decisions!
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Actually, it’s the MiFID II and PRIIPs rules. If anything, UK investor protection rules tend to be even stronger than European ones.
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Hi there, I love a good experiment and am glad I’ve come across this!
I’ve been running my own experiment for that past few years, my ‘Dogs of the FTSE’ portfolio, which is of course based on the Dogs of the Dow strategy. I’ve not been so ethically selective as you have been however.
It’s been hit and miss, although looking good for this year (aren’t all stocks though?)
In the past, I also ran an experiment based on the ‘blind-folded monkeys selecting stocks by throwing darts’, namely picking stocks at random! That was surprisingly quite successful and might be something I would consider again in the future.
All the best with your experiment!
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Thanks – I happened to see your update on the Dogs of the FTSE experiment through the weekly FIRE UK blog posts. Very interesting!
I fully admit the ethical part of mine is pretty arbitrary (why am I ok with bp and BAE but not BAT and Rio Tinto?) and inconsistent (I already own all the companies I skipped as part of index funds, and none of my index funds are “ethical”, just market cap based). But humans are irrational 🙂
The blind folded monkeys approach is interesting too – probably more scientifically valid than mine, if you’re trying to replicate the index, although you’d need enough stocks that you’ve got a representative sample, so the fees might kill you.
Good luck with your experiment as well!
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I used to follow Stephen Bland’s HYP (High Yield Portfolio) via his “Dividend Letter”. That ended in 2018 but he was a good teacher, so I’ve kept on following his style of investment. I’ve had a portfolio of individual shares since 2011, but only really switched to a “sector equal weight higher-yielding mostly FTSE 100 never sell”-style portfolio in 2013. I now have 20 sectors, with half of them split between two companies, like this:
BT
Vodafone
Imperial Brands
British American Tobacco
Severn Trent
United Utilities
BHP Group
Anglo American
Legal & General
Aviva
SSE
National Grid
BP
Shell
Land Securities
British Land
GlaxoSmithKline
Astra Zeneca
BAE Systems
Carnival
HSBC
IG Group
ITV
Marstons
Persimmon
Sainsbury
Standard Life Aberdeen
Unilever
WPP
You need to have been building up your sectors over a long period of time to have this number of shares without paying a fortune on trading fees. Over the past 10 years my average annual platform and trading fees have been 0.19% including stamp duty and a couple platform transfers. This is actually slightly cheaper than using a Vanguard ISA to invest in the Vanguard FTSE 100 Index Unit Trust, which I obviously can’t use, so I consider that a success cost-wise.
If I was starting a new portfolio today, I would happily buy any of these shares apart from probably WPP, AZ, Pearson, Marstons and Carnival. However, I wouldn’t sell any of these of I still held them. I practice what Stephen Bland used to call “strategic ignorance” 🙂
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Interesting approach, and seems sensible. Eventually I will likely need to formalize my strategy and diversify my ISA more – will see how big it winds up getting. For now, it’s my third priority, after my pension and Roth IRA, although the Roth is just slowly converting money from a US taxable account (or any more stimulus checks!), would like to avoid fees on transferring earned GBP to USD, with the expectation of some day having to go back to GBP.
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Note that the two REITs (British Land and Land Securities) are held by my UK wife. Don’t hold these if you’re a US person.
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Excellent post – thank you very much for this! One question – have you investigated which individual UK stocks on the FTSE100 or 250 are PFICS? You mention Scottish Mortgage as one, but do you know for sure that other bank ones are not – such as Lloyds, Barclays, HSBC, etc. I am about to do something very similar to you, and cannot find an answer to this question, perhaps you know?
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I haven’t put together a comprehensive list, by any means, but a few guidelines: 1) Any “investment trust”, like Scottish Mortgage, Pershing Square, 3i, etc., will definitely be a PFIC. 2) Same with any REITs like British Land, Land Securities, Segro, etc.
Both investment trusts and REITs make essentially their income by owning assets, not by producing active income through their operations, so this makes sense. Quick reminder, the actual PFIC tests are:
1. 75 percent or more of the gross income of such corporation for the taxable year is passive income, OR
2. The average percentage of assets (as determined in accordance with subsection (e)) held by such corporation during the taxable year which produce passive income or which are held for the production of passive income is at least 50 percent.
I’ve looked into most of the financial institutions other than investment trusts and REITs in the FTSE 100 and haven’t found any that smell like a PFIC. Most of the big ones have American listings as well, and their SEC reports will say something justifying them not being a PFIC. Search for “PFIC” in the following, for example:
Lloyds: https://sec.report/Document/0000950103-19-008032/
Barclays: https://www.sec.gov/Archives/edgar/data/312070/000119312518053870/d515301dposasr.htm
So I think you’re safe with the banks. Nobody knows 100% for sure – there isn’t any IRS-approved list of non-PFICs – but I’m pretty confident that a bank won’t count as a PFIC. They make their money mostly through actively loaning out money, not by owning investments. Similar story with the insurers, brokerages, etc. – they’re making their money through something active, not by holding passive assets.
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I agree with all of that. Of the FTSE 100, I would potentially also avoid fund managers such as M&G and Schroders, although I haven’t investigated them. The insurers like Legal & General and Aviva are probably okay. I still hold some Abrdn shares, but they have turned into more of an asset manager than an insurer. The company itself doesn’t even know if they are regarded as PFIC, but they recognise it is a potential risk to investors:
https://www.aberdeenstandard.com/docs?documentId=GB-280720-122228-1 (bottom of page 54 and page 143 onwards)
So I probably ought to move these shares into my UK wife’s name.
There are far more (70+) investment trusts in the FTSE 250 to avoid, but you shouldn’t really be looking at these smaller companies anyway.
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Thanks guys – this is fantastic and this blog is the one of the best things I have found in a long time, thank you! “FIRE across the pond”, you are doing God’s work for people like me, I’m so happy to be able to talk to people who are in a similar position. I wonder if either of you have thought or know if investing in UK venture capital schemes such as SEIS plans are US tax friendly? Some inks – https://www.gov.uk/guidance/venture-capital-schemes-tax-relief-for-investors and https://www.crowdcube.com/investments. My worry is that these may be PFICs, or who knows what else. I know this is quite niche at this point, but one reason to invest in these is to avoid the loss of the UK tax allowance for incomes > £100k as investment in these provides tax relief in the UK. I know that’s a good problem to have, still paying 60% tax doesn’t feel too good.
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Thanks – trying to help people out, and learning a lot along the way for myself 🙂
I haven’t done any specific research into any of the venture capital schemes aside from recognizing they exist. On the face of it and before my first cup of coffee, I’d think some general principles apply, like:
1. None of the UK tax advantages would apply to the US. Really the only reciprocal tax-advantaged accounts are pensions (UK pension, probably SIPP, 401k, IRA, etc.). Same problem as with 529 or ISA, if it’s not a pension under the treaty, the other country ignores the tax-advantaged wrapper. I can’t think of a reason why that wouldn’t be the case here, although I’m happy to be proved wrong.
2. Investing directly in individual companies would be fine, whether it’s a tiny startup or the biggest of the FTSE 100.
3. Investing via an intermediary gets complicated. We all have to use a broker for listed shares, so I don’t have any real worries about something like an ISA being treated as some weird trust/PFIC thing. But any sort of collective intermediary starts to smell like a PFIC (investing in a venture capital company that then invests in other companies, for example).
4. Investing enough that you start to have some control over the company could also get complicated. I haven’t looked into company directors and that kind of thing much except to know it’s complicated!
Jeff, any thoughts?
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I agree.
In addition you may need to watch out for the rules governing “foreign qualified dividends”. I try to stick to companies that you could invest in via a US brokerage to ensure the company dividends qualify for better US tax rates.
So I’m not even sure if AIM stocks would be a good idea. Although a lot of small companies don’t pay a big dividend, so it would be less of a concern.
Reading this article it appears for example that special one-off dividends and those as a result of hedging and options may not be qualified.
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This article:
https://www.investopedia.com/terms/q/qualifieddividend.asp
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I’ve done a quick search for a random selection of AIM shares on Interactive Brokers. Not all of them could be found using the search box. The bigger ones like Asos were okay. I think you would be pushing your luck to claim qualified dividends from any company that can’t easily be found by a US brokerage account.
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From the way I understand the rules, any “normal” dividend from a UK listed company should be ok, since we have a comprehensive tax treaty (IRS pub 550, page 19-20). I would think that applies to anything on AIM – but crowdfunding/venture capital gets murkier since they aren’t traded even on a UK exchange.
Safest is to stick to companies with a US listing (ADRs, etc.). Next safest would be UK only but easily purchased from US, as you say. Followed by UK listings that aren’t easily purchased from the US. Last would be unlisted UK companies, and I think that’s a big stretch.
Of course, the further down that list you get, the smaller the companies and higher the investment risk, too. Although many companies that small won’t have enough dividends to really matter!
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On a related topic. Correct me if I’m wrong, but I’ve recently discovered that if you have sold any non-US shares then it’s not classed as “foreign-source income” on foreign tax credit form 1116 if you paid less than 10% UK capital gains tax on the sale, (see https://www.irs.gov/instructions/i1116#idm140111522069776). So if you held the shares in an ISA or after the UK CGT exemption you didn’t end up paying any more than 10% UK tax on the sale then you can’t list this as foreign source on form 1116. My shares are all in an ISA anyway, but this could effect my dad. To be honest, it might slightly simplify form 1116 which gets more complicated if you start including small capital gains/losses anyway. Note that you would still need to report the gains/losses on 8949 & Sch D.
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FTC + tax treaty makes my head hurt again 🙂 But I ‘think’ you can use the treaty to re-source the income to be foreign-source, even without the 10% UK tax. Article 24 paragraph 6(d):
(d) for the exclusive purpose of relieving double taxation in the United
States under sub-paragraph (c) of this paragraph, profits, income and
chargeable gains referred to in sub-paragraph (b) of this paragraph shall be
deemed to arise in the United Kingdom to the extent necessary to avoid double
taxation of such profits, income or chargeable gains under sub-paragraph (c)
of this paragraph.
But then you potentially get into this income being “Certain Income Re-Sourced by Treaty” rather than “Passive Category” income for Form 1116, and now we’re so far into the nitty gritty that I’ve lost almost any comfort level. And it doesn’t help that the IRS training on sourcing of income doesn’t mention the 10% part: https://www.irs.gov/pub/int_practice_units/ftc_c_10_02_05.pdf, slide 15
From what you’re saying, I think this basically only applies if you’re taxed somewhere >0% and 10% then definitely can claim as foreign source income and foreign tax. But yes, yet another confusing little rathole in the US/UK tax problem.
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I used the “resourced by treaty” in 2020 for my dad’s IRA and company pension, although I probably could have got away with just treating it as foreign source income in the general category. It would certainly get complicated if I had both retirement income and passive income in the resourced category – I’m not sure exactly how I would do that. OLT software was totally useless at guiding you through the more complex aspects of form 1116.
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TurboTax was useless or actively counterproductive, too. To the point I looked at the IRS Free Fillable Forms since I’d read all the IRS instructions, but that was just a joke. Thinking I’m going to try something else next year, but doesn’t sound like any of them deal with FTC for people abroad very well.
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I tried printing out all the IRS instructions, related publications and special pages from the 1040 instructions and tried working through them line-by-line with a highlighter pen. But still they descended into labyrinthine, Kafkaesque and seemingly contradictory nonsense. Every time I thought I was doing it right I realised I probably over-looked or misinterpreted something. It’s another time where I was seriously tempted to pay someone to do the forms one year, just to see how they did it by reverse-engineering. The problem with that, is you would need someone who really knew their stuff, otherwise I wouldn’t be convinced they had it right either. Has anyone had a go using TaxAct?
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I’ve seen TaxAct and TaxSlayer mentioned a few times on various expat groups. Depending how busy I am next March, I might try a few and do a comparison (only ones that let you get almost all the way through without paying!). I can mostly bend TurboTax to my will now, although I did wind up hand-typing the second page of my 1040 for 2020 because it wanted to do something stupid about deferring <$100 worth of self-employment tax (despite getting a refund due to the child tax credit, so I'd just get $100 only to pay it back a few months later), and there was no option I could find to turn it off.
I'm in the same boat on paying somebody to do it – I've seen two many "professionals" who mess this stuff up too, even without taking a stance on the grey areas
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One question about this strategy I’m unsure of but you guys will know. When you have a S&S ISA, say with HL, how do you know the dividends and other ‘income’ that might arise? We need to report these to Uncle Sam’s Tax Man, so getting that information is vital. I would not want to open an ISA and find out that information is impossible to get. Thanks for any replies.
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All dividends are reported via the online sharedealing website. I personally keep a spreadsheet recording all the dividends for the calendar year and convert them to US dollars to report on my US tax return. That’s relatively straightforward. It gets more complicated if one of your companies does a merger, consolidation, split, demerger, return of capital, etc. In these cases you may need to investigate the actual tax consequences and any capital gain/loss or change to your cost basis. Don’t really expect any help from the share-dealing platform on this front. The corporate action usually comes with a prospectus explaining your UK tax consequences, but they can be a bit cryptic and it might not be reported in exactly the same way in the US (but I usually assume it will be). You won’t get a consolidated tax statement from HL, because it’s an ISA and anyway they don’t care about the US tax year.
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By the way, as my dividends are quite significant now, I use the exchange rate on the actual date of payment of each dividend, using the historical exchange rate table provided by the US treasury. This means it takes a little longer to fill in the spreadsheet. The other option is to use the average annual exchange rate that I believe is provided by the IRS. For reporting account values (eg FBAR) I typically use the end of calendar year exchange rate, or perhaps the rate when the account hit its peak value, if I happen to know when that was. It’s not something I stress over too much if it’s about right. It’s not like we live in Venezuela or something, so the rate doesn’t change too much.
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My approach mirrors Jeffrey’s. I’ve got a spreadsheet for all my ISA holdings, one sheet for capital gains (tracking cost basis and such), and another for dividends. One other caveat on dividends is that you’ll want to track whether they are “ordinary” or “qualified” dividends for US tax purposes. This is mostly based on the holding period – fairly easy to automate in Excel, but it does mean any given dividend paid might be part ordinary, part qualified, so winds up as a few lines. Haven’t had any corporate actions yet, but just had a “return of cash”, which is different from a dividend – will need to figure that one out.
On exchange rates, I’m moving towards just using the daily rates from the Fed for everything except FBAR: https://www.federalreserve.gov/releases/h10/hist/dat00_uk.htm. I used monthly HMRC rates previously, which is fine but less granular. There’s just a column in all my various tracking sheets (capital gains, dividends, bank account interest, etc.) for the exchange rate on that date.
For FBAR you’re I think you’re technically supposed to use the Department of Treasury Exchange rates for 31Dec of the year you’re reporting: https://fiscaldata.treasury.gov/datasets/treasury-reporting-rates-exchange/treasury-reporting-rates-of-exchange I just look that up in early January and add to my FBAR spreadsheet. Yes, I have a LOT of spreadsheets…
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Regarding qualified vs. ordinary dividends, I could be wrong, but if you are a buy and hold investor you shouldn’t need to worry. I looked into it once and it appears that the period from ex-dividend to payment is usually longer than the holding period required, so most or all of your dividends should be qualified. You would have to be careful when you sell a share, but this should be fairly rare. The good thing about a spreadsheet is that you can easily keep all your source information forever, in the unlikely event that you were ever audited. The only figure that actually goes on the US tax return is the total dividends per country after conversion to USD. You don’t need to send a breakdown with your return.
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For qualified dividends, the holding period is counted from the day of purchase to the ex-dividend date. So the vast majority of any buy-and-hold position will be qualified, but if you’re doing regular investing and not deliberately steering around the ex-div dates, it’s easy to have a regular investment that’s purchased within 60 days before the ex-div date. And as you say with sales, need to be careful not to sell within 60 days of the ex-div date (rules are in the 1040 instructions around line 3a). Found my answer on “return of cash” while looking it up, that was handy (it reduces cost basis, isn’t income but will increase capital gains eventually – now just have to figure out how to put that into my records).
Fully agree on the spreadsheets. I have a workbook created for every year of taxes, and retain those forever. Now that I have to keep track of dividends manually, one of the sheets in that workbook will be that year’s dividends (the capital gains sheet is in a standalone workbook, since those will practically all be held more than one year, anyway).
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Regarding qualified dividends… Are you sure? I believe the definition says: “You must have held the stock for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date.” So surely, if you buy a share (and don’t sell) during the 60 days before ex-div, then you still have a chance to hold the shares for a full 60 days during the 121 day period? The only issue might be at the end of the calendar year, but surely your 121 day period can carry on into the next year.
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Ah, I think you’re right – somehow got confused on this one. It’s even in the examples in the 1040 instructions
Example 2. The facts are the same as in Example 1 except that you bought the stock on July 15, 2020 (the day before the ex-dividend date), and you sold the stock on September 16, 2020. You held the stock for 63 days (from July 16, 2020, through September 16, 2020). The $500 of qualified dividends shown in box 1b of Form 1099-DIV are all qualified dividends because you held the stock for 61 days of the 121-day period (from July 16, 2020, through September 14, 2020).
Even simpler, you buy the stock on July 15, go ex-div on July 16, and never sell – clearly more than 61 days. I just completely read this one wrong!
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Great, thanks for the sanity check on the qualified dividend holding period. I had read this wrong initially as well. Perhaps the rule is designed to prevent people from trying to “harvest” dividends around the ex-div date, (which doesn’t really work anyway), but ends up being another example of obscure IRS small print that you have to watch out for.
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Exactly – and the way the numbers are presented it’s almost designed to be confusing. Definitely a disadvantage doing this ourselves instead of our brokerage just providing the information. Thanks for the catch – saves me a few bucks on 2021 taxes (or at least, prevent from wasting a bit of child tax credit)!
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