A US citizen living in the UK is within the net investment income tax in the same way as one living in Ohio. The tax is 3.8% of the lower of net investment income and the amount by which modified adjusted gross income exceeds a threshold set by filing status. UK tax on the same income is generally not creditable against it under domestic law, and treaty-based claims are contested.
This post is for Americans in Britain with interest, dividends, gains or rent: employees with a brokerage account, and landlords with a let flat. It goes deeper on one paragraph of our guide to avoiding US-UK double taxation and covers who is caught, which income counts, how the threshold works for someone married to a non-US spouse, what the foreign earned income exclusion does to the threshold, and the two routes to relief that remain.
Does the net investment income tax apply to US citizens living abroad
Yes. The tax applies to individuals with net investment income and income above the threshold, and the Code exempts nonresident aliens, not citizens who live overseas. A US citizen resident in the UK is therefore within it, and so, in most cases, is a green card holder.
Section 1411 of the Internal Revenue Code imposes the charge in addition to the other taxes in its subtitle and switches it off only for a nonresident alien and certain charitable trusts. The IRS questions and answers on the net investment income tax (opens the official IRS page in a new tab) say the same in plain terms. Residence abroad, UK tax paid and the source of the income do not take a citizen outside it. The tax is figured on Form 8960 (opens the official IRS page in a new tab) and carried to Schedule 2 of Form 1040.
Green card holders need more care. The Form 8960 instructions (opens the official IRS page in a new tab) say a dual resident is generally treated as a US resident for this tax. Such a person is treated as a nonresident alien only if the treaty tie-breaker makes them resident in the UK, they claim that treaty benefit, and they file Form 1040-NR with a Form 8833 disclosure. Claiming the tie-breaker can have expatriation consequences, so it is not a step to take for this tax alone.
Which income counts as net investment income for an American in Britain
Broadly, interest, dividends, capital gains, rent, royalties, non-qualified annuities and income from passive businesses, less the expenses properly allocable to them. Wages and the profits of a business in which the person is active are outside it. Where the income arises makes no difference.
For a UK resident this reaches further than many expect. Interest on a UK savings account counts, as do dividends from UK shares and gains on UK funds. An ISA gives no US protection, so its interest, dividends and gains are counted like any others. Income from investments in controlled foreign corporations and passive foreign investment companies is generally included too, and the instructions describe an election that changes how income from some of those holdings is brought in, which belongs alongside PFIC reporting.
The exclusions follow the regular income tax closely. Gain on a main home that is excluded under section 121 is excluded here as well, though gain above the exclusion and gain on a second home can be net investment income. Rent is generally included whether or not the owner is actively involved, unless it comes from a non-passive trade or business, which has its own tests.
- Included. Interest from UK and US bank accounts, including easy-access savings
- Included. Dividends and gains on shares and funds, inside or outside an ISA
- Included. Rent from a let flat in the UK or a property in the US
- Excluded. Salary, bonuses and profits of a business in which you are active
- Excluded. Social Security benefits and distributions from listed US retirement plans
How the threshold works if you are married to a non-US spouse
The threshold depends on filing status, and married filing separately has the lowest, set at half the joint amount. That is the default status for a US citizen married to a non-US spouse, so the tax can arrive at a lower level of income than a married couple in the US would expect.
The thresholds are fixed in the statute and, as the IRS points out, are not indexed for inflation. The instructions say a US citizen married to a nonresident alien uses married filing separately to work out modified adjusted gross income, net investment income and the tax itself. The figure for each status is in the Form 8960 instructions (opens the official IRS page in a new tab). A dual-status filer, such as someone who becomes or ceases to be a US resident part way through the year, uses the full threshold with no proration.
There is an alternative. A couple who elect under section 6013(g) or (h) to file jointly can also elect to apply joint treatment for this tax, combining both spouses' items and using the joint threshold. The instructions say that election is made by ticking a box in Part I of Form 8960 for the first year in which the US spouse is subject to the tax. A joint return has costs for the regular income tax as well, set out in our post on filing status for Americans married to a non-US spouse.
Does the foreign earned income exclusion lower the threshold test
No. Salary excluded on Form 2555 is added back when modified adjusted gross income is worked out for this tax, after netting off the deductions and exclusions the exclusion disallows. Excluded earnings still count towards the threshold, although they never become net investment income themselves.
Section 1411(d) defines modified adjusted gross income as adjusted gross income increased by the amount excluded under section 911(a)(1), less the related deductions and exclusions disallowed by section 911(d)(6). Form 8960 applies that adjustment at line 13. In practice a US citizen who excludes salary up to the $130,000 limit on Form 2555 is measured against the threshold as if that salary were still in the total.
The exclusion therefore does nothing to keep investment income out of this tax, and it is one more reason the choice between the exclusion and the credit should be modelled rather than assumed. Our post on the foreign tax credit or the exclusion sets out how that choice usually falls for UK residents, where UK rates mean the credit often gives the better result.
Can UK tax on investment income offset the net investment income tax
Generally not under domestic law, and treaty-based claims are contested. The IRS says credits allowed only against the regular income tax, which include the foreign tax credit, may not reduce this tax. A UK resident can therefore pay full UK tax on dividends and still owe the US charge on them.
The domestic rule is short. The credit claimed on Form 1116 reduces the regular income tax, and the net investment income tax sits in its own chapter of the Code, outside that credit's reach. The IRS questions and answers (opens the official IRS page in a new tab) give the foreign income tax credit as an example of a credit that cannot reduce the tax. Re-sourcing US income under Article 24 works through the same credit, so on the domestic reading it reaches only the regular income tax.
The treaty argument runs differently. Article 2 of the convention, in the IRS treaty documents (opens the official IRS page in a new tab), covers the federal income taxes imposed by the Internal Revenue Code, excluding social security taxes, and Article 24 provides a credit for UK income tax against US tax on income. Article 24 is also on the list of provisions the saving clause does not override. Against that, Article 24 grants the credit in accordance with, and subject to the limitations of, US law. Whether those words carry the domestic restriction into the treaty is the point in dispute.
A filer who takes the treaty position must disclose it. Form 8833 (opens the official IRS page in a new tab) is the disclosure that section 6114 requires for a treaty-based return position, and our page on Form 8833 explains when it is needed. A disclosed position can still be challenged. Whether it is worth taking depends on the amounts, the years still open and the filer's appetite for a dispute, which our treaty relief service reviews case by case.
Can deducting UK tax reduce net investment income instead
Sometimes. Form 8960 allows a deduction for foreign income tax attributable to net investment income, but not for any foreign tax of the year if a credit was taken for any part of it. The deduction route therefore means giving up the credit for that year's UK tax.
The Form 8960 instructions (opens the official IRS page in a new tab) put the deduction at line 9b, alongside state and local income tax attributable to the same income, and point to section 275(a)(4) for the bar on taking both. The IRS page on choosing the credit or the deduction (opens the official IRS page in a new tab) adds that, as a general rule, the choice covers all qualified foreign taxes for the year, though it can change from one year to the next.
For most UK residents that trade is poor. Giving up the credit for UK tax on salary to save a smaller amount of this charge usually increases the total bill, and it also affects the carryovers on which later years depend. It can make sense where UK tax is modest and investment income is large, or in a year with little salary. The only reliable test is to compute both versions of the return, which is part of our tax planning work.
- Run the return once with the credit and once with the deduction
- Compare total US tax, including this charge, not the credit alone
- Check the effect on carryovers of unused foreign tax credit
- Revisit the choice each year as the mix of income changes
How the tax plays out for a US citizen in the UK
Take a US citizen employed in Edinburgh, married to a British spouse, with a US brokerage account and a let flat in Glasgow. Salary is relieved by the credit for UK tax. The dividends, gains and rent are taxed in the UK and, above the separate-filing threshold, can bear the US charge as well.
Because the spouse is not a US person, the default threshold is the separate-filing one, and the excluded salary, had the exclusion been used, would still count towards it. The tax is charged on the lower of the net investment income and the excess over the threshold. Rental expenses, allocable investment costs and UK income tax claimed as a deduction can reduce the net investment income. UK tax claimed as a credit cannot reduce the charge under domestic law.
The tax is also within the estimated tax rules, so a filer who expects to owe it should make payments during the year to avoid an underpayment penalty, which the IRS net investment income tax page (opens the official IRS page in a new tab) confirms. We prepare Form 8960 alongside the full return, with the total carried to Schedule 2. The guide to avoiding US-UK double taxation shows where the 3.8% charge sits among the reliefs that do reach the regular income tax.
General information, not advice. The right answer depends on your circumstances and the tax year concerned.
