A deferred bonus in London can fall within Section 409A of the Internal Revenue Code when the person receiving it is a US taxpayer. The rule does not care that the employer is British or that the plan is drafted under English law. It asks when the right to the pay is earned and when it is paid, and a plan that gets those dates wrong can bring the whole deferred amount into US tax early, with an additional tax and interest on top.
This post is for US citizens and green card holders on a UK payroll whose bonus is paid in instalments, held back for several years or delivered after they leave. It goes further than the deferred compensation section of our guide to US-UK tax for founders, fund managers and executives. It covers how HMRC and the IRS time the same bonus, the short-term deferral exception, the features of UK plans that cause trouble, the cost of a failure and the questions to put to the employer.
Does Section 409A apply to a bonus paid by a UK employer
Yes, where the employee is taxed in the United States. Section 409A governs the timing of deferred pay for a US taxpayer, and a US citizen or green card holder remains one wherever they live. The identity of the employer and the governing law of the plan do not take the arrangement outside it.
The rule looks at any arrangement under which pay earned in one year is paid in a later year. A bonus plan is a common example. If the plan fails the statutory conditions on when deferral can be elected and when payment can be made, the amount deferred is included in income and carries extra charges. The statute is section 409A of the Internal Revenue Code, read with Treasury regulations that exclude some arrangements.
The regulations also carve out certain foreign plans, such as amounts excludable under a bilateral tax treaty, including the US-UK tax treaty (opens the official IRS page in a new tab), and a narrow class of broad-based foreign retirement plans. A discretionary bonus deferral arrangement should not be assumed to be one of them. Each exclusion has conditions, and the plan documents have to be read against them before anyone relies on one.
When does the UK tax a deferred bonus compared with the US
The UK taxes a bonus as employment income under Income Tax (opens the official GOV.UK page in a new tab) when the employee receives it, and HMRC treats money earnings as received at the earlier of payment and the date the employee becomes entitled to payment. The US tax position follows its own rules, and for a deferred amount Section 409A decides whether the timing of payment is acceptable.
HMRC's employment income manual says the test is entitlement to payment, which is not the same as having acquired a right to be paid at some later date. A bonus that is conditional on staying employed until a vesting date is therefore generally taxed when that entitlement arises, and the payroll operates PAYE (opens the official GOV.UK page in a new tab) on it. Repaying or waiving the sum afterwards does not rewrite that history.
The two countries can therefore reach the same bonus in different tax years. The UK tax year runs from 6 April to 5 April and the US year is the calendar year. A bonus can be UK income in one year and US income in the next, and a failed plan can pull the US tax forward to the vesting year. Our guide to US and UK tax returns for Americans in the UK covers the personal returns on which both appear.
What is the short-term deferral exception and does it cover a London bonus
The short-term deferral exception takes a payment outside Section 409A when it is made soon after the right to it stops being at substantial risk of loss. In the regulations the payment must be made by the fifteenth day of the third month after the end of the year in which the risk lapses. For a calendar-year employee and employer that is generally mid-March of the next year.
The exception depends on a substantial risk of forfeiture. The regulations describe it as entitlement conditioned on substantial future services, or on a condition related to a purpose of the pay, where the possibility of forfeiture is real. A requirement to remain employed until a stated date is the usual form. A bonus that is earned in full, and merely paid late, has no such risk and gets no help from the exception.
Many London plans fit the exception without trying to. A bonus that vests on a stated date and is paid in the next payroll run is usually within it. The difficulty comes when the plan lets vested money sit for years, pays on a fixed date later than the window, or lets the employee elect when it is paid. Those features take the arrangement into the main rules, and each needs checking.
Which features of UK bonus plans cause problems under Section 409A
The features that cause most trouble are those that give the employee or the employer discretion over timing after the right has vested. Section 409A expects the payment date, or a permitted payment event, to be fixed at the start, so a plan that leaves it open invites a failure.
UK bonus deferral is often designed around the employer's regulatory or retention needs, with tax treated as an afterthought. Clauses that read naturally in an English contract can be treated differently by the IRS, particularly where payment is linked to leaving, to a company sale or to the board's decision.
- Payment on leaving, where the trigger is worded loosely and does not match a separation from service as the regulations define it
- An employee election of the payment date made after the year of service has begun
- Employer discretion to pay earlier or later than the stated date
- Garden leave, notice pay or a settlement agreement that changes when the bonus is paid
- A vesting or payment date changed by amendment after the award is made
- A bonus converted into shares or a cash-settled award with its own payment rules
What happens if a deferred bonus fails Section 409A
If a plan fails, the amount deferred under it, to the extent no longer at risk of forfeiture, is included in the employee's gross income for the year of the failure. A further additional tax is charged on that amount, and interest runs at a premium over the underpayment rate from the time the amount first vested. These charges fall on the employee, not the employer.
The charge applies to the amount deferred under the plan, which can include earlier years, so a bonus plan that has run for several years can create a large inclusion in one return. The IRS has published correction programmes for certain inadvertent failures, with relief that depends on how soon the error is put right. Corrections made in the same tax year are generally treated more favourably than later ones.
There is a UK dimension as well. HMRC will already have taxed the bonus when it was received, or will tax it when it is paid, so the US inclusion may arrive in a different year from the UK tax. The foreign tax credit then depends on timing, and our guide to US-UK double taxation explains how credits are matched to income. Some states add their own tax to a failure, so the state position needs a separate look.
How do the foreign tax credit and the timing mismatch work together
UK income tax on a bonus is generally creditable against US tax on the same income under the foreign tax credit (opens the official IRS page in a new tab) rules, claimed on Form 1116. The credit is limited, and it only helps if the UK tax and the US income fall in years that can be matched. A failed 409A plan can separate them.
Where the US includes the bonus first, the UK tax may not yet have been paid, and a credit claimed on an accrual basis follows the year the tax relates to. Unused credit can be carried back one year and forward ten, subject to the category limits that Publication 514 (opens the official IRS page in a new tab) sets out. Wages and bonuses for work in the UK generally sit in the general category. Whether any credit can be set against the additional tax is a separate question that we do not assume.
The foreign earned income exclusion is rarely the better route in the UK, where tax rates are generally higher than US rates and the credit preserves carryovers. The exclusion is not the default. Our guide on the foreign tax credit or the exclusion in the UK covers the choice, and the timing is better planned before the bonus is awarded than corrected afterwards.
What should a US citizen ask before accepting a deferred bonus
Ask for the plan rules and the award letter, and read the payment clause first. Consider a US citizen employed in Manchester whose bank offers a bonus that vests in three annual instalments and is paid within the following payroll run. The payment dates sit inside the short-term window, so the plan is likely to fall under the exception, and the UK tax arrives as each instalment vests.
Change one fact. The plan lets the bank pay vested instalments up to six years later at its discretion. The exception no longer covers those payments, and the plan is tested under the main rules. The employee should ask the employer for its 409A analysis, or for a statement that the plan is intended to be exempt, and keep the answer with the plan documents.
Our individual tax returns service prepares the US return alongside the UK one, and our cross-border tax team reviews plan wording before an award is accepted. Where the bonus is paid partly in shares, the position for RSUs when you move between the US and the UK sits alongside this one, and the guide for founders, fund managers and executives covers equity awards that follow different rules.
- The plan document, award letter and any later amendment or waiver
- The vesting date and the date each instalment is actually paid
- Whether payment can be delayed by the employer or elected by the employee
- How leaving the firm, a sale or a settlement agreement changes the payment date
- Payslips, P60 and the amounts HMRC taxed in each UK year
General information, not advice. The right answer depends on your circumstances and the tax year concerned.
