Mixed Nationality Couples

Mixed Nationality Couples

As a financial advisor, I work with all types of clients – married, divorced, civil partners, single, and widows/ers. Typically, at least one member of the household is a US tax filer. My clients live in the UK, the US and sometimes a third country – a client base that reflects the diversity of America itself.

However, as many find out the hard way, if your life partner is an American living in the UK, welcome to the jungle my friend. Your financial lives are about to get very complicated.

Let me introduce you to the US government agency who will forever be the “third wheel” in your relationship – the Internal Revenue Service or IRS – and the key issues that you will need to work through as a couple to ensure both your compliance and your sanity.

What is your legal relationship status?

Clarifying your legal relationship status is the first step in understanding your financial constraints, opportunities, and obligations as a mixed nationality couple.

In the UK, you can be single, married, or civilly partnered with the rights that accompany that status.

Civil Partnerships:

The US, however, does not recognize civil partnerships on a federal level. If you are in a civil partnership, it’s important to understand how this can limit your ability to gift money or assets to each other, provide social security benefits, and own real estate together. A civil partner will be considered single in the eyes of the US government and it’s important to understand the impact this status might have on your overall financial life.

Married Couples:

For both hetero and same sex couples, tying the knot is the relationship status with the most benefits and protections for mixed nationality couples. However, Americans who live in the UK and are married to non-Americans (non-resident aliens or NRAs, according to the IRS) will still need to navigate some tricky situations from a tax point of view.

What are your US tax filing obligations?

Americans are required to file taxes annually on their worldwide income which means they must continue to file tax returns on the federal level (possibly state, too) when they move to the UK.

What is your US tax filing status?

If you are Single (or considered single, as discussed above), determining your tax filing status is straight forward. If you’re married to a NRA, you must choose your tax filing status carefully and ideally with the assistance of a qualified accountant. Unlike the UK where each individual is taxed on her earnings, the US allows married couples to file Joint or Separate US tax returns and applies different tax rates to the income earned to each filing status. In an effort to keep the IRS away from the earnings and financial life of the NRA spouse, Married Filing Separate is the more common filing status but it is by no means a “given” so receiving proper advice on this is very important.

How are your banking and investment accounts owned?

It’s generally a good idea for mixed nationality couples to keep separate banking and investment accounts rather than owning them jointly with your NRA spouse. This will allow each of you to very clearly track your interest, dividend income, and capital gains to each owner and will make filing tax obligations a little easier. It will also allow you to identify cash gifts to each other, which is very important from a US tax perspective. You see, US citizens married to non-US citizens cannot freely gift any amount of money to their NRA spouse but are limited to $164,000 per US tax year.

Another reason why you should keep your investment accounts separate is because US taxpayers are subject to punitive taxes if investing in pooled investment vehicles, such as mutual funds and ETFs, that are registered outside of the United States. These types of investment vehicles are called Passive Foreign Investment Companies (PFICs) and should never be held by US citizens. It’s a far better idea for the NRA spouse to hold and own these investment vehicles in her own name only. Conversely, non-US taxpayers who own investments in the US will likely be subject to mandatory 30% withholding taxes on account interest, dividends, and capital gains within the account and will need to file a tax return with the IRS to retrieve their money. In these examples, it’s not only wise to keep your investments in a separate account from your mixed nationality spouse but keeping your investments in a different country is often the best solution.

How is your home and mortgage owned?

As far as the IRS is concerned, the privilege of home ownership does not extend to an unlimited capital gains allowance, as it does by HMRC. In fact, there is a $250,000 capital gains allowance on a primary residence which can only be used once every two years. If you are married and file jointly, this can be increased to $500,000 but as discussed, that’s not a typical filing status for American married to non-Americans. This limited capital gains allowance frequently catches people off guard and can cause a lot of grief in a marriage where the tax liability isn’t expected or planned for in advance of moving house. To avoid unpleasant US tax surprises, understand how much of the home is owned by the American taxpayer and keep an eye on the capital gain so you can sell before tax is due. You could also plan ahead by gifting ownership of the property to the NRA spouse, subject to annual gifting limits, of course.

Generally speaking, couples tend to own the mortgage in the same proportion as the house with joint ownership being the most common structure for married couples. Most people need to borrow money to buy their home but many Americans living abroad don’t realize the IRS views mortgage repayments differently if the money borrowed was in a foreign currency. If a mixed nationality couple owns a home jointly in the UK with a joint mortgage, any FX gains would be taxed at ordinary income tax rates to the US taxpayer in direct proportion to the amount owned. There’s no real “gain” but a phantom capital gain caused by the difference in exchange rates at the time the money was borrowed versus the time the mortgage capital was repaid. This scenario certainly applies to homeowners who bought houses with mortgages 15 years ago when the pound was nearly $2.00 to £1.00 and are refinancing their homes or paying off their mortgages now at $1:35 to £1.00 but also applies to people when they refinance or make a one-off over payment. Keep track of the FX rates carefully and try to time repayments to periods when the pound is stronger relative to you your initial borrowing date FX rate.

If you have children, are they US citizens?

It’s important to understand the nationality of your children and as basic as this question seems, if you are an American living abroad, the answer might not be straight forward as you would hope.  The laws in effect at the time of the child’s birth will determine US citizenship. Your child will either be considered a citizen at birth or can acquire citizenship after birth, depending on the circumstances.

A child born outside of the United States may acquire citizenship at birth if all of the following requirements are met at the time of the child’s birth:

  • The baby is a child of a US citizen parent(s)
  • The US citizen parent meets certain residence or physical presence requirements in the United States or an outlying possession before the person’s birth in accordance with the applicable provision, and
  • The child meets all other applicable requirements under either INA 301 or INA 309

Please note the requirements are slightly different depending on whether the child is considered born “in wedlock” or not.

If you’re unsure whether your child meets the requirements to be considered a citizen at birth, the first step is to apply for a US Citizen Birth Abroad. A US official can determine citizenship as part of a formal application although they will not process pre-assessments or provide advice. If you think your child might be a citizen, you should apply and register the child’s birth. If the child receives a US Citizen Birth Abroad Certificate she is eligible to apply for a social security number and a US passport, which every US citizen needs in order to be tax compliant and travel to the United States, regardless of dual citizenship status.

It’s important note that children considered US citizens at birth are required to comply with tax filing and travel requirements by the US government their entire lives. You cannot opt out of this by not registering the birth of the child as a US citizen.

Are you trying to save and invest for university education for the kiddos?

Well meaning parents who are planning ahead for university fees want to take full advantage of domestic programs that offer tax incentives to save and invest for their children.

The main issues with these programs are the facts they are relatively new and not covered under the US/UK tax treaty. This means the tax breaks afforded to residents in the UK for owning Junior ISAs, for example, is not honored by the IRS when that same UK resident is also a US citizen. A tax break in the UK but also US taxes at potentially punitive PFIC tax rates along with higher administrative burdens for US tax reporting. In other words, now you have to file a US tax return for your US citizen child with all the complexity you experience in your own US tax return reporting requirements.

There are also instances where a US citizen/UK resident child might be the beneficiary of a US based 529 plan. Often times these are set up by US based grandparents but sometimes are set up by parents before moving to the UK. If owned by UK resident parents, these plans can be particularly tricky to navigate from a UK tax perspective as they will be considered trusts and taxed accordingly by HMRC, even though the accounts are tax-free from a US perspective.

Are you saving into retirement plans in the US/UK or both?

  • Do you plan to continue to live in the UK or move back to the US (or another country?)
  • How do we split our retirement between the US and the UK?
  • Are you expecting an inheritance and is it in trust?
  • What happens if one of you becomes incapacitated?
  • What happens if your relationship ends in divorce or death?
  • Are you subject to IHT/ US Estate Taxes or both?
  • What if we have no heirs?

 

 

 

 

This is not advice or a recommendation. You should consult with your tax attorney and accountant to determine whether any of these actions are appropriate in your circumstances.

Certain investments carry a higher degree of risk than others and are, therefore, unsuitable for some investors. Past performance is not a reliable indicator of future results. The value of investments, and the income from them, can go down as well as up, and you may not recover the amount of your initial investment.

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