The short answer: they are now a smart move. With recent changes to the UK tax regime, shifting your tax liability to the US can be an effective way to reduce your overall tax burden.
Since their introduction in 1999, Individual Savings Accounts (ISAs) have been a cornerstone of tax-efficient investing for UK residents. With an annual contribution limit of £20,000 for the 2024/25 tax year—frozen until at least 2030—they remain an attractive savings vehicle.
However, for Americans living in the UK, ISAs present a complex and often controversial choice.
Should US taxpayers contribute to an ISA? The answer hinges on a few critical factors: Passive Foreign Investment Companies (PFICs) and the divergent tax treatment between the UK and the US.
The PFIC Pitfall
If you're an American attempting to invest in an ISA, you may have been turned away by major UK banks. While this can be frustrating, it’s actually a blessing in disguise.
The IRS classifies most non-US mutual funds and ETFs as PFICs, subjecting them to punitive tax treatment. The tax burden is severe, with complex reporting requirements that can lead to excessive tax bills. Even if you elect for Qualified Electing Fund (QEF) status, the administrative burden remains significant. In short, investing in non-US mutual funds through an ISA can create unnecessary tax headaches for Americans.
At Dunhill Financial, we mitigate this by ensuring we avoid all securities that could be considered PFICs, preventing these tax complications.
The Tax Dilemma
ISAs are designed to be tax-efficient in the UK, with no income or capital gains tax on distributions. However, the IRS does not recognize this benefit—to the US tax authorities, an ISA is simply a standard investment account. This means income and gains remain fully taxable in the US.
So, why would an American voluntarily shift their tax liability from the UK to the US? The answer lies in the comparative tax rates.
The Autumn 2024 Budget, announced by UK Chancellor Rachel Reeves, raised UK capital gains tax rates, making the US tax regime more attractive for many American investors.
US Capital Gains Tax Rates:
Income Range (Single Filers) | Income Range (Married Filing Jointly) | Long-Term Capital Gains Tax Rate |
$0 - $11,600 | $0 - $23,200 | 0% |
$11,601 - $47,025 | $23,201 - $94,050 | 0% |
$47,026 - $100,525 | $94,051 - $201,050 | 15% |
$100,526 - $191,950 | $201,051 - $383,900 | 15% |
$191,951 - $243,725 | $383,901 - $487,450 | 15% |
$243,726 - $518,900 | $487,451 - $583,750 | 15% |
Over $518,900 | Over $583,750 | 20% |
In the UK, capital gains have a tax-free allowance of £3,000 for the 2024/25 tax year, but once you exceed this, you will pay 18% tax if you are a basic rate taxpayer and 24% tax if you are in the higher rate band. Additionally, carried interest is taxed at 28%. For many Americans, this is higher than the long-term capital gains tax rates in the US, making it more beneficial to pay US taxes rather than UK taxes.
In addition to the CGT allowances, there is a dividend allowance of £500. Dividends above this are taxed at:
8.75% for basic rate taxpayers
33.75% for higher rate taxpayers
39.35% for additional rate taxpayers
The Solution: ISA-Compliant Portfolios for US Taxpayers
With all these complexities, very few firms offer ISAs in a way that works properly for US taxpayers.
At Dunhill Financial, we have partnered with Morningstar to provide compliant investments by selecting individual stocks and bonds. Whilst this approach needs to be considered in a careful manner, and is not suitable for everyone, it does allow US persons to use an ISA to shift their tax liability to the US from the UK.
Conclusion: Are ISAs a Smart Move for Americans in the UK?
Following the Autumn Budget and the growing gap between UK and US capital gains tax rates, we believe ISAs have become an even more viable option for Americans in the UK.
With UK capital gains tax rates rising relative to the US, deliberately shifting your tax obligations to the US through an ISA could be an advantageous strategy. By structuring your investments properly, you may reduce your overall tax liability while still benefiting from a tax-efficient savings vehicle.
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