In 2016, while serving as the UK’s Foreign Secretary, Prime Minister Boris Johnson renounced his US citizenship. He was one of more than 5,000 individuals who chose to do so that year, up from less than 300 a decade previously. Johnson, who was born in New York but lived in America for only five years, fell foul of the US tax authorities in 2014 when he sold his London home.
Unlike most countries, America taxes all citizens, regardless of their US residence status, on their worldwide income and gains, and a strong tax-enforcement campaign in recent years has had a big impact on dual citizens, who are liable for taxes in both countries. While Johnson was Mayor of London and paying tax in the UK, he was still liable under US law to pay capital gains tax on the sale of his main residence, which is subject to tax relief in Britain. He reportedly owed more than $50,000 in US tax on the gain which arose on the sale of his Islington home.
His story is just one of the more high-profile examples of the growing phenomenon of the ‘accidental American’, individuals who may have amassed considerable wealth and reached middle age before becoming aware of their exposure to the US tax authorities.
Suzanne Willis is a Partner at Blick Rothenberg where she practises US and UK tax. She says: “Some people don’t realise that they are entitled to US citizenship. If they were born in the UK and one of their parents happened to be American, that can be the case. Similarly, we have had clients born in the US because their parents were there for work purposes temporarily. They left as a baby, but they are a US citizen even though no-one else in their family is.” While US citizenship has many potential benefits, America’s approach to expatriate tax means people in this situation do need to get to grips with the intricacies of its tax system.
Willis adds: “When you have an accidental American who has had a portfolio for 20 years and then suddenly discovers this exposure, it can be a really big issue.”
Luniah Cohen, Client Adviser at UBS Wealth Management, cites the example of a Canadian client who had been in London for five years and had previously briefly worked in the US. The client had been certain he was neither an American citizen or a green card holder, but on closer inspection it transpired his green card was still valid – a revelation which opened a whole ‘can of worms’ from a tax perspective that required a thorough review with the client’s tax advisers, and a review of their wealth planning.
“We do see quite a number of people who are confused about what it means to be a US citizen, and there are big implications from a tax perspective if you have any kind of US connection,” says Cohen.
As families become increasingly international and a growing number of people choose to work on both sides of the Atlantic, there are now countless examples of high-profile individuals whose children are potentially impacted by this status. This includes the offspring of stars like Piers Morgan, David and Victoria Beckham and Robbie Williams, as well as the royal baby, Archie Harrison Mountbatten-Windsor – perhaps the most famous youngster facing these issues as a result of his US/UK parentage.
The rules also cover children who may have only one US parent, if that parent has spent enough time in the US to satisfy certain residency requirements.
Elizabeth Carson, Family Partner at Penningtons Manches Cooper, says: “In many cases a US citizen parent will pass their citizenship to their child, not realising that there is no ‘opt out’ clause. So if you meet those residency requirements and you have the ability to pass on your US citizenship, the child is a citizen whether they have a US passport or not, and they have an obligation to comply with US tax and reporting requirements.”
“Where you have taken out a non-us dollar mortgage overseas, if you can be deemed to have made a gain when you repay that mortgage, then you can be taxed on that gain.”
The sale of a primary residence and its exposure to US tax is one of the classic taxation traps encountered by accidental Americans. “Where you have taken out a non-US dollar mortgage overseas, if you can be deemed to have made a gain when you repay that mortgage, you can potentially be taxed on that gain,” says Carson. “A shift in the exchange rate that takes place during the life of that mortgage can lead to that capital gain being, on paper, quite considerable.” This is the case even if no profit has been made in pounds sterling.
Carson adds: “In family cases, we advise our clients to take detailed US tax advice if one of the individuals involved is a US citizen.”
There are a number of investment products that create unintended tax exposures for US citizens, too. Willis points to collective investments such as exchange-traded funds and unit trusts as typical components of a structured investment portfolio, but if interests in those are sold for a gain, they are taxed at the highest US tax rate – currently 37% – as well as being liable for an interest charge based on the holding period.
STEPS TO RENOUNCEMENT
The process of renouncing US citizenship can be complicated. Individuals are required to:
- have a second nationality to fall back on
- prove mental capacity
- schedule a number of appointments with the US embassy to discuss their case, sign documents and later complete a final tax return (and potentially pay expatriation taxes)
- pay a renunciation fee of c. $2,000
US citizens should also take advice if they are considering investing in Individual Savings Accounts (ISAs), which work like normal savings accounts but come with an exemption from UK income and capital gains tax for UK citizens. That exemption does not apply for Americans.
“These days, most of the banks and investment houses are aware of these issues for Americans and know that certain products are not suited to American clients,” says Willis. “That is fine, as long as they know they are dealing with an American.”
Often that does not happen. Carson points to another example of a client with a UK passport who listed Boston as his birthplace. The individual involved had always assumed that place was Boston, Lincolnshire, in the UK; in fact, after some investigation, it turned out it was Boston, Massachusetts, in America.
One option for accidental Americans who want to avoid US taxes is to renounce their citizenship, as Johnson did. The number of Americans opting to do this has grown significantly in recent years, hitting a record high of 5,411 in 2016 compared to just 278 a decade earlier, in part as a result of the clampdown by the US tax authorities on dual citizens. In addition to the tax exposures, US citizens abroad also now face cumbersome reporting and disclosure requirements.
“You may want to live or work in the us at a later date and dual citizenship may be enormously valuable.”
“In some cases, there is an exit tax to pay on expatriation,” says Willis. “You are deemed to be doing it for tax purposes if you have net assets over $2 million, your average income tax over the last five years has been over a certain amount, or if you can’t certify that you have complied with the last five years of US tax filings. In that case, you are treated as if you have sold all of your assets the day before you expatriate, and any gain you make on those assets is subject to US tax. Obviously, that can be very expensive.”
Not all US citizens will choose to renounce their citizenship, even if they discover late in the day that they are accidental Americans.
James d’Aquino, Private Client Partner at Penningtons Manches Cooper says: “We have clients who have very much encouraged their children to keep their US citizenship from the age of 18, which is the earliest you can expatriate, until they decide where they wish to live. Those parents are very conscious that the world is changing. Expatriation may seem an attractive option from a tax perspective, but equally you may want to live or work in the US at a later date and that dual citizenship may be enormously valuable.”
Carson, who is American herself, adds: “Many Americans are proud to be US citizens and would never consider renouncing their citizenship. Instead they work with a network of advisers who can help them to comply with the tax rules and their obligations.”
In France, the Accidental Americans Association is currently taking legal action against a group of French banks, claiming they are being discriminated against because the banks do not want them as customers. They are French citizens who are also US citizens, often without even knowing it, and are turned away from financial institutions because of their complicated tax status.
According to European newspaper The Local there may be as many as 10,000 accidental Americans in France and up to 300,000 across Europe – some of whom do not even speak English.
But the issues are not insurmountable for Americans in France, the UK or elsewhere. “You need an adviser who is alive to these issues,” concludes d’Aquino, “to make sure that what you are doing in the UK fits in with the US rules. As long as your adviser is conscious of all the complexities, and those are taken into account, the effect should be perfectly manageable.”
With the UK’s new Prime Minister and the youngest member of the royal family both accidental Americans by birth, others can certainly consider themselves to be in good company.
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