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Tax Regimes And The Implications Of Relationships For Us Citizens And “Accidental Americans”

Citizenship-based taxation is one in which Americans are subject to taxation on their worldwide income, regardless of residency. This necessitates careful planning and compliance with international reporting requirements. Our expert Erin Sawyer explains why US citizens need to choose their advisors carefully.

The citizenship-based tax regime for American citizens living outside the US has wide-ranging implications. Dealing with a divorce for a US citizen puts those implications under the microscope. There are different approaches to certain taxation points in the UK versus the US that can be overlooked which has extremely negative consequences if the parties, the lawyers and the Court are not alive to the potential issues. For example, it is widely known that, generally speaking, parties who have resided in an owner-occupied property (since purchase) are not likely to have to pay Capital Gains Tax (CGT)in the UK if they achieve an increase in value on their property on a sale. However, in the US, depending on the size of the gain, CGT may be imposed. Additionally, because of the citizenship-based taxation regime in place, American citizens who are living abroad and selling property held outside of the US, may be caught by this. This results in a charge for tax that otherwise is unlikely to be accounted for in the context of assessing the net asset value of a family home that might be sold in the UK on divorce. 

This scenario exemplifies why it is absolutely imperative that specialist tax advice is sought, often as part of an expert instruction on behalf of both parties to explore the tax exposure of certain asset disposals on both sides of the Atlantic, as well as to consider tax mitigation strategies that might be available. Otherwise, clients may, by omission, receive less than was envisaged under the settlement terms agreed - by virtue of a tax liability that was not accounted for in the calculations. This could have very serious consequences, particularly in circumstances where there is a finely balanced settlement outcome. 

It is also a crucial part of initial discussions with clients to explore what citizenships they hold. It is not uncommon to find that clients have multiple citizenships through birth, familial ties, and/or naturalisation, and there are certainly many “accidental Americans” who were born in the US to non-US citizens, and later leave but have not formally renounced their citizenship. This is potentially incredibly problematic because, not only is it important to ensure that tax implications of potential settlement outcomes are identified, but also, the “accidental” US citizen may need their US tax affairs regularised if they have failed to file US Federal Tax Returns annually (and of course, the US and UK tax years run over different periods; just to make it even more complicated!). This may also require specialist accountancy assistance to address. 

While there are special interest groups across the globe that lobby for the end of citizenship-based taxation, there is no end in sight at present, and it remains a bugbear amongst the US expat community. It is therefore imperative for US citizens, who are considering protecting their wealth in respect of new relationships and those who are experiencing relationship breakdowns, to carefully choose their advisors to ensure the appropriate expertise are meeting their particular needs. 

Visit our website for more information on international divorce