Many taxpayers were relieved that the recent UK budget offered little in the way of changes to the taxation of individuals, despite concerns to the contrary. We therefore face a UK tax year end much like any other, offering a variety of things to consider, even for US citizens.
Avoiding that 60% income tax rate
The personal (tax free) allowance of £12,500 is tapered down by £1 for every £2 of income in excess of £100,000, giving an effective rate of a whopping 60% tax on income between £100,000 and £125,000 (40% income plus 20% income tax relief lost).
If your income is approaching this threshold as we move towards April, it may be prudent to consider if you can take steps to reduce your taxable income. These steps may include charitable donations, tax relievable pension contributions, and controlling the point at which you receive relevant types of income over the next few weeks.
Donations made to UK charities via the Gift Aid scheme will increase the amount of income taxed at 20%, reducing the overall effective rate of UK tax suffered.
Some charities are able to facilitate dual qualifying deductions, meaning that tax relief can apply in both the UK and the US. Even if a charity you have in mind is not able to facilitate a dual qualifying donation, there are various third-party organisations that can assist in structuring the donation to allow US and UK tax relief.
Remember that land, buildings and shares can be donated, not just cash. Any gains on disposal in this context will be exempt from UK Capital Gains Tax.
Contributions to pension schemes can offer tax savings, but it is important to ensure that the donations do not exceed the annual allowance which is £40,000. The annual allowance reduces gradually by £1 for every £2 of ‘adjusted income’ over £240,000, to a minimum of £4,000.
The allowance is said to be ‘gross’ of tax, both employer and employee contributions count towards the limit and any excess contributions are subject to an Income Tax charge. With all that in mind, and before rushing into an additional contribution before year end, please do seek professional advice in respect of how much annual allowance you have available for use. It can be a complicated calculation.
Importantly, if you do not use all of your allowance in a particular year, it can be carried forward for up to three years. But you need to have been a member of a registered pension scheme in order to utilise an unused allowance.
Lifetime allowance for pension savings
Funds that are held in pension schemes may enjoy tax-free growth, but there is a lifetime allowance to consider. The allowance applies to the aggregate amount across all of your pension pots. If that total exceeds the lifetime allowance, there are tax charges when you start to take pension benefits. The allowance for 2020/21 is £1,073,100.
Individual Savings Accounts (ISAs)
Income and gains on ISAs are free from Income and Capital Gains Tax in the UK. ISAs are now available in a variety of forms including the cash ISA, stocks and shares ISA and junior ISA (for those under 18).
The ISA limit for adults is £20,000. For a Junior ISA, the limit is £9,000.
The Lifetime ISA is also available for those aged between 18 and 40 years who can save up to £4,000 during 2020/21 and be entitled to a 25% Government bonus. Any Lifetime ISA allowance savings counts as part of the overall £20,000 ISA limit.
ISAs are subject to allowances that cannot be carried forward and are lost if they are not used. It is therefore important to maximise these tax efficient savings vehicles annually.
A family of four (two adults and two minor children) investing the maximum into ISAs could save up to £58,000 by 5 April 2021.
US persons must be careful not to inadvertently invest in a passive foreign investment company (PFIC) when holding ISAs. Most retail stocks and shares ISAs will contain PFICs and suffer a highly penal rate of US tax. ISAs are not tax free from a US tax perspective and therefore much of the overall tax benefit may be lost. You should seek tax advice before committing to ISA contributions.
If you and your spouse have permanently separated in 2020/21, then the transfer of assets prior to 5 April 2021 need to be considered. This can be done without Capital Gains Tax consequences in the year of separation.
Gains on transfers in the next tax year and beyond will generally be liable to Capital Gains Tax.
Appropriate tax and legal advice should be taken prior to the transfer of any assets.
Capital Gains Tax
The 2020/21 annual exempt amount for capital gains is £12,300. If you do not use this exemption, it is lost and cannot be carried forward. Consider selling assets standing at a gain where the gain will be covered by your annual exemption. If you have already used your exemption for 2020/21, it may be prudent to defer any other disposals until the 2021/22 tax year.
Capital losses are offset against capital gains when realised in the same tax year. If you own an asset that is currently sitting in a loss position, consider the timing of this disposal and the positive impact it could have on your overall Capital Gains Tax position.
Inter-spouse transfers are generally free from capital gains and the original base cost is usually retained. Where one spouse or civil partner has not fully utilised their annual exemption, consider a gift followed by a sale in the hands of the recipient to maximise available reliefs.
As always, if you own assets overseas you should be aware of the exchange rate fluctuations that may have occurred since acquisition. The resulting gain or loss in pounds sterling can sometimes be unexpected.
At all times you should consider the US tax impact of this planning.
Offshore Income Gains
In certain situations, market volatility can offer tax planning opportunities. If you hold any overseas funds that do not have ‘reporting status’ with HMRC, any gains on disposal will be chargeable to Income Tax rates (up to 45%) rather than Capital Gains Tax rates of 20%. If those investments are currently sitting in loss positions for UK purposes, there may be an opportunity to liquidate those funds and reinvest in something that is UK tax efficient.
Capital loss election
For non-domiciled taxpayers who claim the remittance basis, the default position is that no relief will be given in the UK for offshore capital losses. However, it is possible to elect to claim relief for these losses. 5 April 2021 is the deadline for this election for those who first claimed the remittance basis in 2016/17.
Making this election is not always an obvious decision for a number of reasons. It can be difficult to assess, especially as it can have unpredicted results if circumstances change in the future.
It is also an irrevocable election and so tax advice should be sought before moving forward.
If you think that a deadline of 5 April 2021 may be relevant to you, please seek advice.
Inheritance Tax (IHT)
Non-UK domiciled individuals are subject to UK IHT on their UK situs assets. UK domiciled individuals, or long-term residents of the UK who are deemed domiciled, are subject to UK IHT on their worldwide estates.
An individual has a £325,000 ‘nil rate band’ for UK IHT purposes and any unused amount can be transferred to a surviving spouse.
We recommend that wills are reviewed on a regular basis and after any significant events.
Gifts made to individuals are free of IHT if the donor survives for seven tax years. With that in mind, succession planning can be very effective in removing assets from the IHT net, especially when considered alongside the US estate tax exemption of around $11,700,000. If you are minded to make gifts, you may wish to do this prior to 5 April 2021, but please seek advice first.
Would you like to know more?
If you have any questions or would like to discuss your specific circumstances, please get in touch with your usual Blick Rothenberg contact or one of the Partners whose details are on this page.