What Are U.K. SIPPs and ISAs, and How Are they Reported for U.S. Tax Purposes?
Note: This is the first of three articles on United States Income Taxation of British Self-Invested Pension Plans (“SIPPs”) and Individual Savings Accounts (“ISAs”).
Many United Kingdom citizens reside in the United States, and vice-versa. Many such individuals have Self-Invested Pension Plans (“SIPPs”) or Individual Savings Accounts (“ISAs”) available under U.K. law.
SIPPs and ISAs Under U.K. Tax Law
A SIPP is a highly-advantageous personal retirement plan. An employer establishes a SIPP for the benefit of an employee, and makes contributions to it. The employee-beneficiary of the SIPP excludes from U.K. taxable income the employer’s contributions to the SIPP up to the employee’s earned income for the tax year (6 April to 5 April). But if total contributions to SIPPs exceed £40,000 for a tax year, the employee-beneficiary is subject to a U.K. tax charge of up to 45 percent of the excess.
SIPP income, whether interest, dividends, or net capital gain, is not currently subject to U.K. income tax. After the SIPP beneficiary reaches age 55, 25 percent of each withdrawal from the SIPP is free of U.K. income tax. The beneficiary is subject to U.K. income tax on the balance of withdrawals from the SIPP.
An ISA resembles a U.S. Roth IRA. A U.K. taxpayer may contribute up to £20,000 to ISAs in 2019-2020. ISA contributions are not deductible in determining U.K. taxable income. An ISA holder is not subject to U.K. income tax on interest, dividends, or net capital gains realized in the ISA. Distributions from an ISA are free of U.K. income tax.
U.S. Tax Reporting With Respect to SIPPs and ISAs
A United States citizen or resident (“U.S. person”) is subject to U.S. income tax on his or her worldwide income, and to worldwide information reporting to the U.S. Internal Revenue Service. A U.S. person who is deemed the owner of a foreign trust under the grantor trust rules of Internal Revenue Code §§ 671-679 must report the trust on Form 3520, Annual Return to Report Transactions With Foreign Trusts and the Receipt of Certain Foreign Gifts, and on Form 3520-A, Annual Information Return of a Foreign Trust With a U.S. Owner. Form 3520 is due to be filed by April 15th following close of the U.S. deemed owner’s calendar tax year, and is extended by timely filing of Form 4868, Application for Automatic Extension of Time to File U.S. Individual Income Tax Return. Form 3520-A is due by the 15th day of the third month following close of the U.S. deemed owner’s calendar tax year, and it is extended by timely filing of Form 7004, Application for Automatic Extension of Time To File Certain Business Income Tax, Information, and Other Returns.
A threshold question is whether a SIPP or an ISA is a trust. A trust exists when a third party trustee holds property for the benefit of a beneficiary. A trust may exist where an employer establishes a SIPP for the benefit of an employee, and funds it. A trust is less likely to exist where an individual who controls a company establishes a SIPP through the company for his own benefit, or where an individual establishes an ISA for his own benefit.
If a SIPP was established and funded by a third party not controlled by the beneficiary, and hence is a trust, it is not a grantor trust until the beneficiary reaches age 55, and may begin receiving distributions from the SIPP. See IRC § 678. Therefore a U.S. citizen or resident beneficiary of a SIPP need not begin reporting the SIPP on Forms 3520 or 3520 until he or she reaches age 55.
The penalty for failure to file Form 3520 is the greater of $10,000 or five percent of the value of assets reportable on Form 3520. A like penalty obtains for failure to file Form 3520-A. The penalties may be abated for reasonable cause. Where a Form 3520-A is late-filed with a timely-filed Form 3520, the IRS should not penalize the late-filing of the Form 3520-A. Internal Revenue Manual 22.214.171.124. Internal Revenue Service voluntary disclosure programs may also provide penalty relief in a given case.
Next up: U.S. income taxation of contributions to ISAs and SIPPs.
Stephen J. Dunn, CPA, J.D. LL.M, is a tax attorney and the founder of Dunn Counsel PLC, Troy, focusing primarily on assisting U.S. taxpayers comply with U.S. laws concerning foreign accounts, assets, and income.