Alphabet shares work for a US citizen in the UK, but the two tax systems read them differently. HMRC asks whether a class given to a spouse is a genuine gift or mainly a right to income. The IRS asks how much vote and value each class carries, because that decides who files Form 5471, and it shares out the company's income by the rights each class holds, not by the dividends the directors actually voted.
This post is for owner-managers of UK family companies where at least one shareholder is a US citizen or green card holder, most often a director whose spouse holds a separate class. It goes further than the Form 5471 section of our guide to US-UK tax for founders, fund managers and executives. It covers the UK rules, the US filing categories, the allocation of company income, a checklist and a worked example.
What are alphabet shares in a UK family company
Alphabet shares are separate classes of share, usually labelled A, B and C, whose articles let the directors declare a dividend on one class without declaring the same rate on the others. Family companies use them so that each shareholder, often a husband and wife, can be paid by reference to their own tax position.
Company law still sets the outer limit. Under section 830 of the Companies Act 2006 (opens the official GOV.UK page in a new tab), a company may make a distribution only out of profits available for the purpose, broadly its accumulated realised profits less its accumulated realised losses. A dividend paid beyond that is unlawful whatever the class. Each declaration should be minuted class by class, with a voucher for each shareholder.
The articles matter as much as the minutes. A class can carry full voting, capital and dividend rights, or it can be stripped back to dividends alone. Both HMRC and the IRS build their analysis on those terms, so the articles and any shareholders' agreement belong in the file for both returns.
How does HMRC treat dividends on a spouse's share class
Usually as the spouse's own income, provided the shares were an outright gift carrying real rights. The settlements rules in Part 5, Chapter 5 of the Income Tax (Trading and Other Income) Act 2005 can instead tax the dividend on the person who arranged it, where the shares amount to little more than a right to income.
HMRC's manual on the settlor-interested rule (opens the official HMRC page in a new tab) explains the starting point: income from property in which the settlor keeps an interest, including where a spouse can benefit, is treated as the settlor's. An exception covers outright gifts between spouses, and HMRC's page on outright gifts between spouses or civil partners (opens the official HMRC page in a new tab) says it fails where the gift is subject to conditions or the property is wholly or substantially a right to income.
The same page gives two contrasting examples. Shares carrying no votes and no right to assets on a winding up, given to wives, produced dividends taxed on the husbands, following Young v Pearce. Ordinary shares carrying rights to capital, given by a consultant to his wife, produced dividends that remained hers, following the House of Lords in Jones v Garnett, the Arctic Systems case. HMRC's guidance on dividend waivers and the settlements rules (opens the official HMRC page in a new tab) adds an example where a dividend is voted on one class of equal-ranking shares and not the other, which HMRC treats as a bounteous arrangement.
- An outright gift with votes, capital rights and dividend rights usually stays the spouse's income
- A class with dividend rights alone is the pattern HMRC challenges
- Retained profits too low to pay every class at the same rate is a warning sign HMRC lists
- A spouse's dividend taxed on the director in the UK is still the spouse's in US eyes
Does a spouse's share class change who files Form 5471
It can. The Form 5471 categories are measured by vote or by value across all classes of stock, so a class with no votes can still count through its value. Whether the spouse's shares are added to the US citizen's own depends on which category is being tested.
The Instructions for Form 5471 (opens the official IRS page in a new tab) define control, for category 4, as more than half of the combined voting power of all voting classes or more than half of the total value of all classes, at any time in the filer's year. The regulation behind category 4 applies the family attribution rules of section 318, which treat a person as owning shares held by a spouse who is not legally separated. A citizen who holds her own class and is attributed her husband's can therefore be a controlling shareholder. The instructions excuse a category 4 filer only where she owns no direct or indirect interest and files solely because of attribution from a nonresident alien.
Category 5 works differently. It covers a US shareholder, owning ten per cent or more of the vote or value, of a controlled foreign corporation. For that test, section 958(b)(1) of the Internal Revenue Code provides that shares owned by a nonresident alien individual are not treated as owned by a citizen. A British spouse's class can therefore leave the company outside the definition. Our business tax returns service works through each category from the share register.
Why the US taxes each class on its rights, not its dividends
Where the company is a controlled foreign corporation, the US shareholder's share of its income is worked out from the distribution rights of her class, not from what the board chose to pay. The regulations look at the class terms and any shareholder agreement, and ignore the actual dividends declared during the year.
Section 1.951-1(e) of the Treasury regulations sets each US shareholder's pro rata share of subpart F income by imagining that the company distributes all its allocable earnings on the last day of its year. With more than one class, the imagined distribution follows the distribution rights of each class, judged on all the facts and circumstances, including the terms of the shares, any agreement among the shareholders and, where appropriate, the relative market value of each class.
This is where alphabet shares bite. Paying the husband's class a large dividend and the director's class nothing does not by itself move income away from her on the US return, because actual distributions are left out of the facts and circumstances. The share entered in column (e) of Schedule B, Part I also feeds her net CFC tested income, formerly GILTI, explained in our post on net CFC tested income. That regime was amended by 2025 legislation for tax years beginning after 31 December 2025, so treat the method as an option to review.
Which facts about each share class should you gather
Every class needs the same short record before either return is prepared: who holds it, what it can vote on, what it receives on a winding up, how its dividends are decided and what was actually paid. Each fact feeds a different filing, which is why one gap can affect both returns.
The list below is our constructed checklist, not an official one. Form 5471 itself asks for it in two places: Schedule A describes each class of stock with the number of shares issued at the start and end of the company's year, and Schedule B, Part I lists each US shareholder with the class held, the shares held at each date and the pro rata share of subpart F income.
On the UK side, the voting and capital rights are the facts HMRC weighs under the settlements rules, and the dividend vouchers support each shareholder's Self Assessment return. Our UK Self Assessment service reports the dividends in the right name and year.
- Holder of each class and their US status: decides who is a US person for every category
- Voting rights per class: the vote limb of the category 2, 3, 4 and 5 tests
- Capital rights on a winding up: the value limb in the US and the settlements analysis in the UK
- Dividend terms and any shareholder agreement: the class-by-class allocation of company income
- Dates of every issue, transfer or reclassification: category 3 and the Schedule A and B share counts
- Minutes and vouchers for each dividend: the UK returns and the US dividend income
A worked example with two share classes
Take a US citizen director in Leeds and her British husband, who is not a US person. Her company has A shares, which she holds, and B shares, which he holds. Each class has half the votes, equal rights to capital and dividends declared separately at the directors' discretion.
For category 4, she is attributed his B shares under the family rule, so on our reading she controls the company and files, because she owns her A shares directly. For category 5, his shares are not attributed to her, she holds half the votes but not more, and the company is a controlled foreign corporation only if her class carries more than half the value. Equal capital rights point against that, but value is a question of fact to document. If the company is not a controlled foreign corporation, no subpart F or tested income share arises for her.
If the B shares instead carried no votes and no capital rights, the answer would move on both sides. HMRC could treat his dividends as hers under the settlements rules, and her A shares would hold all the votes, making the company a controlled foreign corporation with her as its only US shareholder. Our international tax service models both versions before a class is created or altered.
How are the dividends themselves taxed in the US
As dividend income on her Form 1040 when she receives them, and only on her own class. A dividend may be a qualified dividend taxed at the lower rates, depending on the treaty test, the PFIC exclusion and the holding period, which our post on qualified dividends from a UK company explains.
Publication 550 (opens the official IRS page in a new tab) sets out the general treatment of dividends, and the UK charges its own tax on dividends (opens the official GOV.UK page in a new tab) on the same payment. Credit for that UK tax is claimed on Form 1116, where dividends generally sit in the passive category. Where the company is a controlled foreign corporation, earnings already taxed on her are tracked on Schedule P and are treated differently when later paid out.
One mismatch needs care. If HMRC taxes the husband's B share dividend on her under the settlements rules, the US still sees it as his income. UK tax charged on income the US does not treat as hers may not be creditable against her US tax, so it should be reviewed before the structure is used. For the wider picture, return to the guide to US-UK tax for founders, fund managers and executives, or contact us with the articles and share register.
General information, not advice. The right answer depends on your circumstances and the tax year concerned.
