Big caveat up front: I am not a lawyer! This is 100% a layman’s reading of the tax treaty – it’s entirely up to you to confirm my interpretations. I’ve tried to call out situations where there are various interpretations so you can make your own judgment or seek out professional advice. Don’t try to rely on anything I say in court!
This post is meant to be a high-level overview of the US/UK tax treaty, especially as it applies to US citizens living in the UK. The treaty is 61 pages long, and the US Department of the Treasury explanatory notes on the treaty are another 131 pages.
I am not going to do justice to a document of that length and complexity in a single post! But what I do want to do is start getting you familiar with what the treaty is, and dive a little bit into the key parts that are relevant for us.
The US/UK Tax Treaty in 3 Bullets
There’s a lot of detail below – I encourage you to read it. But if you take away just 3 things about the US/UK Tax Treaty, I think they should be:
- The treaty protects you from double taxation – you should only ever pay the higher tax imposed by the US or UK, but not a higher plus another lower tax (you might pay the lower tax to one country and then the difference to the other)
- There are a number of mechanisms to protect pensions (including 401(k), IRA, etc.) – the tax treaty helps you to save for retirement. It’s other rules that make it difficult (PFIC, FATCA, MiFID/PRIIP, HMRC Reporting Funds, etc.).
- Just because the treaty says you can do something, doesn’t mean you have to or its a good idea – prime example is that you can exclude your UK pension contributions from your US income, but you probably shouldn’t.
What is the US/UK Tax Treaty?
Officially, the UK/USA Double Taxation Convention of 2001, it’s an international treaty between the governments of the United States and United Kingdom, aimed at avoiding double taxation and preventing tax evasion. It replaces an older agreement from 1975.
The full treaty text is available here. The technical explanation is very helpful in understanding the treaty, although it’s written by the US side and isn’t necessarily binding. HMRC also has a “Double Taxation Manual” that helps interpret from the UK side. I haven’t seen any big areas where the countries disagree, at least so far.
The rest of this post will go through the key parts of the treaty one by one. I’ve included the actual text of the treaty, and then some plain language commentary from me about what that part means to the typical American in the UK, informed by the technical explanation and the double taxation manual. Once you’ve looked through this overview, I’d encourage you to dig deeper on any parts that are particularly interesting or concerning to you!
The Savings Clause
Most US tax treaties include a clause to the effect that the US can tax its citizens however the US wants, regardless of where they live, and the other country can tax its residents however they want. In the US/UK tax treaty, that’s at Article 1, Paragraph 4:
4. Notwithstanding any provision of this Convention except paragraph 5 of this Article, a Contracting State may tax its residents (as determined under Article 4 (Residence), and by reason of citizenship may tax its citizens, as if this Convention had not come into effect.
Fortunately, paragraph 5 gives us some exemptions, where the treaty applies to US tax on US citizens, and to UK tax on UK residents:
5. The provisions of paragraph 4 of this Article shall not affect:
a) the benefits conferred by a Contracting State under paragraph 2 of Article 9 (Associated Enterprises), sub-paragraph b) of paragraph 1 and paragraphs 3 and 5 of Article 17 (Pensions, Social Security, Annuities, Alimony, and Child Support), paragraphs 1 and 5 of Article 18 (Pension Schemes) and Articles 24 (Relief From Double Taxation), 25 (N0n-discrimination), and 26 (Mutual Agreement Procedure) of this Convention;
b) the benefits conferred by a Contracting State under paragraph 2 of Article 18 (Pension Schemes) and Articles 19 (Government Service), 20 (Students), 20A (Teachers), and 28 (Diplomatic Agents and Consular Officers) of this Convention, upon individuals who are neither citizens of, nor have been admitted for permanent residence in, that State.
Whew! That’s a lot of paragraphs, I know. In plain English:
- 5a says that all the paragraphs listed there apply to US citizens whether they live in the US or UK, and to UK residents in the UK. We’ll go through each of those paragraphs in the rest of this post.
- 5b says that those paragraphs don’t apply to people who are not citizens or permanent residents of the US or of the UK, depending which benefits you’re looking at. This mostly applies to people temporarily in a country as a student, teacher, government assignment, etc. Since this site is focused on Americans living in the UK permanently, or at least long term, I won’t go into this part in more detail in this post.
Article 9: Associated Enterprises
2. Where a Contracting State includes in the profits of an enterprise of that State, and taxes accordingly, profits on which an enterprise of the other Contracting State has been charged to tax in that other State, and the other Contracting State agrees that the profits so included are profits that would have accrued to the enterprise of the first-mentioned State if the conditions made between the two enterprises had been those that would have been made between independent enterprises, then that other State shall make an appropriate adjustment to the amount of the tax charged therein on those profits. In determining such adjustment, due regard shall be paid to the other provisions of this Convention and the competent authorities of the Contracting States shall if necessary consult each other.
This paragraph applies to businesses, and their managers and directors, that manage a business in the other country. It doesn’t apply to most typical Americans in the UK, so I’ll skip it, aside from saying that if you’re running a business with elements in both the US and UK, you should probably talk to a professional
Article 17: Pensions, Social Security, Annuities, Alimony, and Child Support
Now we’re getting to parts that apply to more of the audience of this site. We’ll go through each paragraph that isn’t excluded by the Savings Clause one by one.
Sub-Paragraph b) of Paragraph 1
(b) Notwithstanding sub-paragraph a) of this paragraph, the amount of any such pension or remuneration paid from a pension scheme established in the other Contracting State that would be exempt from taxation in that other State if the beneficial owner were a resident thereof shall be exempt from taxation in the first-mentioned State.
All the mentions of states and such gets confusing, so lets use clearer words typical of an American in the UK: You are a resident of the UK. Anything paid from a pension in the US that would be exempt from tax in the US if you were a resident of the US, is also exempt from tax in the UK.
For example, a distribution from a US 401(k) or IRA to a UK resident would be exempt from UK tax to the same extent it’s exempt from US tax if it was distributed to a US resident – for a Roth IRA, that’s tax-free, for a Traditional 401k, it’s taxable income.
This is potentially a very useful paragraph, because it means that even though the UK doesn’t have a direct equivalent to an IRA, you can still use your IRA and get both US and UK tax benefits on it. You can also hold on to any 401(k), 403(b), TSP, etc. that you have in the US and not be penalized when you withdraw from them in retirement.
3. Notwithstanding the provisions of paragraph 1 of this Article, payments made by a Contracting State under the provisions of the social security or similar legislation of that State to a resident of the other Contracting State shall be taxable only in that other State.
Another handy one – if you qualify for US Social Security, those payments can only be taxed by the UK, not by the US. Your Foreign Tax Credits might have taken care of any US tax anyway, but this provides further cover.
Note that this applies if you were to qualify for a UK State Pension and then move back to the US – the UK wouldn’t be able to tax you on your State Pension.
But it doesn’t apply for a UK State Pension if you stay in the UK. If you’re a US citizen living in the UK and receiving a UK State Pension, both the UK and US can tax the State Pension. In practice, you definitely won’t be double taxed, due to Foreign Tax Credits, and the same FTCs will probably wipe out any US tax at all, but it does add to the pain of your US tax return.
5. Periodic payments, made pursuant to a written separation agreement or decree of divorce, separate maintenance, or compulsory support, including payments for the support of a child, paid by a resident of a Contracting State to a resident of the other Contracting State, shall be exempt from tax in both Contacting States, except that, if the payer is entitled to relief from tax for such payments in the first-mentioned State, such payments shall be taxable only in the other State.
Divorce is an area of tax I’m luckily not very familiar with, so I won’t comment on this in any detail except to say that if you’re paying alimony or child support and you live in one country while your former spouse lives in the other, this is worth looking into further.
Article 18: Pension Schemes
Here’s another important one for Americans in the UK who are saving for retirement – and the term “pension scheme” is broader than it might sound at first.
1. Where an individual who is a resident of a Contracting State is a member or beneficiary of, or participant in, a pension scheme established in the other Contracting State, income earned by the pension scheme may be taxed as income of that individual only when, and subject to paragraphs 1 and 2 of Article 17 (Pensions, Social Security, Annuities, Alimony, and Child Support) of this Convention, to the extent that, it is paid to, or for the benefit of, that individual from the pension scheme (and not transferred to another pension scheme).
Plain English example: You are a resident of the UK. You have a pension (401(k), IRA, etc.) in the US. Income from that pension can only be taxed when it is paid to you, or for your benefit. It can’t be taxed just because you moved it to another pension (like rolling over a 401(k) to an IRA or changing IRA providers).
Converting Traditional to Roth IRAs is a little more complicated, I’ll write a dedicated post on that in the future because it’s potentially really helpful.
This is a long one, so I’ll break it down into sub-paragraphs:
5 (a) Where a citizen of the United States who is a resident of the United Kingdom exercises an employment in the United Kingdom the income of which is taxable in the United Kingdom and is borne by an employer who is a resident of the United Kingdom or by a permanent establishment situated in the United Kingdom, and the individual is a member or beneficiary of, or participant in, a pension scheme established in the United Kingdom,
(i) contributions paid by or on behalf of that individual to the pension scheme during that period that he exercises the employment in the United Kingdom, and that are attributable to the employment, shall be deductible (or excludable) in computing his taxable income in the United States; and
(ii) any benefits accrued under the pension scheme, or contributions made to the pension scheme by or on behalf of the individual’s employer, during that period, and that are attributable to the employment, shall not be treated as part of the employee’s taxable income in computing his taxable income in the United States.
This paragraph shall apply only to the extent that the contributions or benefits qualify for tax relief in the United Kingdom.
Plain English example: You are a US citizen who lives in the UK and works for a UK employer. Your employer has a workplace pension scheme, which both you and the employer contribute to. Your contributions and your employer’s contributions to that pension aren’t taxable as income in the US.
On the face of it, this looks like a useful benefit – you don’t have to pay US income tax on your or your employer’s pension contributions! But wait, think about how this would work if you chose not to apply it (which you’re allowed to do):
- You include both your contributions and your employer’s contributions to your pension in the income on your US tax return.
- You’ve paid UK income tax on all your other income, at higher rates than the US (maybe 40% for income that’s only taxed at 12% in the US – simplified example, stay with me)
- You get a Foreign Tax Credit for all the UK income tax you paid.
- That FTC wipes out all your US income tax – you owe $0
- As far as the IRS is concerned, you’ve now “paid” income tax on those pension contributions, so you’ll never get taxed again, like a Roth 401(k).
This is one that’s very situation dependent and will depend on your overall financial & tax picture, but the example above is fairly typical. If you did elect to exclude the pension contributions from your US income, you’d still owe $0 to the IRS, but when you go to withdraw those pension contributions and the growth on them, that would all be taxable income. Sure, maybe you wouldn’t owe US tax then either, again because of the Foreign Tax Credits, but situations change – it might be better to lock in the tax-free nature now.
- Like everything in life, there’s no free lunch. The advantage to using the treaty and excluding the pension contributions is that you’ll have a larger Foreign Tax Credit to carryover to the next year, because you won’t use so much in offsetting your US tax. If you’re in the UK long term, you’ll probably have more FTC carryovers than you know what to do with, but this could be useful for some people or if you’re planning to move back to the US.
- Also, if you do elect to exclude your pension contributions, you need to tell the IRS directly by filing Form 8833 with your US tax return.
OK, on to sub-paragraph (b)…
(b) The reliefs available under this paragraph shall not exceed the reliefs that would be allowed by the United States to its residents for contributions to, or benefits accrued under, a generally corresponding pension scheme established in the United States.
Plain English: you can’t get more benefit from a UK pension that you would from a similar US account, like a 401(k). That means you’re limited to the lower contribution limits of the US 401(k), at $19,500 for 2021 plus $6,500 catch-up contributions if over 50, and $58,000 combined employer and employee contributions, instead of £40,000 per year. The UK lifetime cap and taper still apply.
Some more obscure US limits can also come in to play for highly compensated individuals (that is, you own more than 5% of the business or made more than $130,000) – if you’re in that situation, you’ll want to do some more research.
(c) For purposes of determining an individual’s eligibility to participate in and receive tax benefits with respect to a pension scheme established in the United States, contributions made to, or benefits accrued under, a pension scheme established in the United Kingdom shall be treated as contributions or benefits under a generally corresponding pension scheme established in the United States to the extent reliefs are available to the individual under this paragraph.
This paragraph mostly clarifies some of the limits above – the US will treat your UK pension contributions the way the US would treat 401(k) contributions, basically. There’s some nuance here, but that’s the gist of it.
(d) This paragraph shall not apply unless the competent authority of the Untied States has agreed that the pension scheme generally corresponds to a pension scheme established in the United States.
This is a good point to jump to the “Exchange of Notes” that is attached after the end of the treaty, because it calls out which pension schemes “generally correspond”. They are the ones in the note to sub-paragraph o) of paragraph 1 of Article 3 (General Definitions):
(a) under the law of the United Kingdom, employment-related arrangements (other than a social security scheme) approved as retirement benefit schemes for the purposes of Chapter I of Part XIV of the Income and Corporation Taxes Act 1988, and personal pension schemes approved under Chapter IV of Part XIV of that Act; and
(b) under the law of the United States, qualified plans under section 401(a) of the Internal Revenue Code, individual retirement plans (including individual retirement plans that are part of a simplified employee pension plan that satisfies section 408(k), individual retirement accounts, individual retirement annuities, section 408(p) accounts, and Roth IRAs under section 408A), section 403(a) qualified annuity plans, and section 403(b) plans.
I wanted to save you the pain of reading the “Income and Corporation Taxes Act 1988” and trace through which schemes are covered. However, that act was repealed and replaced by the Finance Act 2004. The treaty benefits will go to the successor plans, but confirming exactly which products are approved under these chapters is best left to a lawyer. By my understanding:
- Definitely included: workplace pensions, both defined benefit and defined contribution
- Maybe included: SIPPs
- Not included: ISAs
On the US side, it’s easier to trace these through, although still complicated. My list probably isn’t exhaustive, but includes:
- 401(a): Governmental, educational, and non-profit plans, roughly similar to a 401(k)
- The Thrift Savings Plan should fall under this too (it’s technically created by a separate piece of legislation, the Federal Employees Retirement System Act of 1986), but is treated as a trust under 401(a)). I have not come across any arguments that TSP isn’t a generally corresponding pension scheme.
- IRAs: Traditional, Roth, SEP, and SIMPLE
- Individual retirement annuities
- 403(a): These are qualified annuity plans that are fairly rare now, but they’re covered
- 403(b): Similar to a 401(k) but for schools and tax-exempt organization
If you have a different kind of “pension scheme” not mentioned above, I’d be interested to hear about it and see if we can confirm that we should add it to the list.
Article 24: Relief from Double Taxation
This is a long article, and a lot of it isn’t very relevant to typical Americans in the UK. The whole thing is specifically excluded from the Savings Clause, so it does apply to us, but I don’t happen to personally own an oil well 🙂
Some key takeaways:
- The US and UK are both required to offer Foreign Tax Credits, to avoid double taxation.
- There are some special rules specifically for US citizens in the UK but with US source income. This gets complicated, but the two key elements are:
- No double taxation
- The state of residence gets first dibs
- If you own a company or trust, there’s lots in here for you – take a look, and get advice if you need it
Article 25: Non-discrimination
Another long article without a lot of specific relevance to most Americans in the UK. Key points:
- The UK can’t tax US citizens who are resident in the UK any more severely than they tax UK citizens resident in the UK. Same with the US taxing UK citizens resident in the US.
- However, taxes can be different without being more burdensome – and we all know they are different!
- The same applies to deductions – they can’t be any worse, but they can be different
Article 26: Mutual Agreement Procedure
This one is basically a mechanism for resolving issues and problems related to the treaty. It’s probably nothing you’ll ever need to worry about, but it’s there if you need it.