The "Source" of Income: Where do I owe tax?
For taxpayers who are "dual resident" for tax purposes in the US and another country (as is the case for all American citizens or green-card holders living overseas), determining where certain income is taxed can be complex. The "source" of income for tax purposes, generally defined as "the country that has the first right to tax the income", is not always the same as the country from which the income actually originated. For taxpayers with cross-border considerations, there are various rules affecting the way that different types of income are sourced between countries.
Employment Income
In general, employment income such as wages, salaries, and self-employment earnings is "sourced" to the country where the work was performed (assuming the taxpayer is tax resident in that country). This remains true even for taxpayers who remain on payroll in a different country to their primary place of work. This is easily determinable for taxpayers who perform the entirety of their services in a single country, but for globally mobile individuals there are a few important considerations – particularly in instances where a taxpayer receives deferred compensation such as Restricted Stock Awards, where the income is sourced based on where the taxpayer worked during the period between the grant and vest date.
US taxpayers residing in the UK are largely protected from taxation headaches relating to short business trips to the US thanks to the US/UK tax treaty, which allows income resulting from these workdays to be "re-sourced" to the UK, meaning the UK has the first right to tax the income instead of the US.
Pensions & Social Security
For US/UK taxpayers, pension distributions and social security payments are generally taxable in the country of residence, under the terms of the US/UK tax treaty. This means that, even if you earned the funds in your pension while working in the US and choose to retire in the UK (or vice versa), the tax will still be principally owed to the country in which you are resident at the time of any distributions. One exception to this rule relates to lump-sum distributions, which are generally sourced to the country in which the pension is based.
Capital gains
In general, capital gains are taxed first in the country where the taxpayer resides. For US citizens living in the UK, this means that the UK usually has the first right to tax any gains from around the globe – even gains that result from sales of US stock in US brokerage accounts. Some exceptions apply; particularly, capital gains resulting from the sale of real estate are primarily taxed in the country where the property is located.
Property & Rental Income
As with capital gains, rental income associated with real property is sourced to the jurisdiction in which the property is physically located. For UK residents with income from US rental property, for example, this can mean that you will remain liable to US federal tax (and potentially state tax) on that income – even if you are not a US citizen or green card holder.
Interest & Dividends
Under the terms of the US/UK tax treaty, foreign interest income can be "re-sourced" to the country where the taxpayer resides, meaning a UK resident would principally pay UK tax on both their UK and US interest income. The exception to this rule is if a UK taxpayer does not earn enough interest to exceed the taxable interest threshold in the UK and therefore does not pay UK tax on their interest. In this case any US interest will remain as US-sourced, and any UK interest may even be taxed in the US.
The rules on dividend sourcing are a little more complex. For example, the US/UK tax treaty allows US persons living in the UK to re-source some of their US dividend income from the US to the UK, under the provision that the US can only charge a maximum tax rate of 15% on the total dividends; the UK is entitled to the rest of the tax. For UK residents living in the US, the opposite is true.
Tax-free income
The "source" of income for tax purposes is defined as the country that has the first taxing right to the income. The key word here is first – if income is sourced to a country that does not then tax it, as with tax-free lump-sum pension distributions, or UK ISA income, or certain capital gains (see Sale of your Home), the taxing right passes to the other country, and the income may be subject to tax in the other jurisdiction. The same rule applies to income which is taxed at a lower rate in the source country, in which case the second country with a higher tax rate may "soak up" any excess.
In practicality, while certain exceptions apply, this means that US/UK taxpayers can often lose the advantages that come with tax-free or low-taxed income, as the effective rate of tax will be the same as whichever jurisdiction has the higher rate of tax.
Employment Income
In general, employment income such as wages, salaries, and self-employment earnings is "sourced" to the country where the work was performed (assuming the taxpayer is tax resident in that country). This remains true even for taxpayers who remain on payroll in a different country to their primary place of work. This is easily determinable for taxpayers who perform the entirety of their services in a single country, but for globally mobile individuals there are a few important considerations – particularly in instances where a taxpayer receives deferred compensation such as Restricted Stock Awards, where the income is sourced based on where the taxpayer worked during the period between the grant and vest date.
US taxpayers residing in the UK are largely protected from taxation headaches relating to short business trips to the US thanks to the US/UK tax treaty, which allows income resulting from these workdays to be "re-sourced" to the UK, meaning the UK has the first right to tax the income instead of the US.
Pensions & Social Security
For US/UK taxpayers, pension distributions and social security payments are generally taxable in the country of residence, under the terms of the US/UK tax treaty. This means that, even if you earned the funds in your pension while working in the US and choose to retire in the UK (or vice versa), the tax will still be principally owed to the country in which you are resident at the time of any distributions. One exception to this rule relates to lump-sum distributions, which are generally sourced to the country in which the pension is based.
Capital gains
In general, capital gains are taxed first in the country where the taxpayer resides. For US citizens living in the UK, this means that the UK usually has the first right to tax any gains from around the globe – even gains that result from sales of US stock in US brokerage accounts. Some exceptions apply; particularly, capital gains resulting from the sale of real estate are primarily taxed in the country where the property is located.
Property & Rental Income
As with capital gains, rental income associated with real property is sourced to the jurisdiction in which the property is physically located. For UK residents with income from US rental property, for example, this can mean that you will remain liable to US federal tax (and potentially state tax) on that income – even if you are not a US citizen or green card holder.
Interest & Dividends
Under the terms of the US/UK tax treaty, foreign interest income can be "re-sourced" to the country where the taxpayer resides, meaning a UK resident would principally pay UK tax on both their UK and US interest income. The exception to this rule is if a UK taxpayer does not earn enough interest to exceed the taxable interest threshold in the UK and therefore does not pay UK tax on their interest. In this case any US interest will remain as US-sourced, and any UK interest may even be taxed in the US.
The rules on dividend sourcing are a little more complex. For example, the US/UK tax treaty allows US persons living in the UK to re-source some of their US dividend income from the US to the UK, under the provision that the US can only charge a maximum tax rate of 15% on the total dividends; the UK is entitled to the rest of the tax. For UK residents living in the US, the opposite is true.
Tax-free income
The "source" of income for tax purposes is defined as the country that has the first taxing right to the income. The key word here is first – if income is sourced to a country that does not then tax it, as with tax-free lump-sum pension distributions, or UK ISA income, or certain capital gains (see Sale of your Home), the taxing right passes to the other country, and the income may be subject to tax in the other jurisdiction. The same rule applies to income which is taxed at a lower rate in the source country, in which case the second country with a higher tax rate may "soak up" any excess.
In practicality, while certain exceptions apply, this means that US/UK taxpayers can often lose the advantages that come with tax-free or low-taxed income, as the effective rate of tax will be the same as whichever jurisdiction has the higher rate of tax.
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