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Should our son renounce his US citizenship to reduce tax liability?

We’re British but our son, 19, was born in the US and has dual US/UK citizenship. We live in Britain now and our son just started university but we understand he’s liable for US tax on his worldwide income. What are his obligations and how onerous are the implications? Is it just income tax above certain levels or could he face, for example, US capital gains tax on selling a future UK property? He’d like to keep the option to live in the US, but assuming he doesn’t, is it better financially to renounce his citizenship?

Jaime McLemore

Jaime McLemore, partner in law firm Withers’ US/UK tax team, says: Congratulations, you have . . . an American! While for some people a US passport can be a golden ticket, for others it can feel more like an ever-increasing burden. The US, almost uniquely (see also North Korea and Eritrea) taxes on the basis of citizenship, rather than just residence and domicile.

You are correct that this means your son is responsible for filing US tax returns and possibly paying some US tax on an annual basis on his worldwide income.

The threshold for having to file a US tax return is far lower than in the UK and, unfortunately, filing a US income tax return is just the tip of the iceberg. There are also information returns, such as the notorious FBAR (to report non-US financial accounts) and the dreaded Form 3520 for such things as gifts, UK pensions and distributions from trust. These might not even lead to an income tax liability but there is a high penalty for non-filing.

There are also some traps for US citizens living in the UK, one of which you have noted is US capital gains tax on the sale of a primary residence by your son.

Another is Individual Savings Accounts (Isas), which are not tax-free in the US. This can be a double whammy if you have a stocks and shares Isa, which is likely to be invested exclusively in what the US tax jargon calls “passive foreign investment companies”. Suffice it to say these are not good investments for your son as a US citizen.

Trusts set up by you or other family members for your son can also create additional tax and reporting burdens as these are almost certainly non-US trusts, the income and investments of which (remember PFICs?) need to be carefully managed so that your son does not face a disproportionate US tax liability when he receives distributions or benefits.

In spite of all this (and there is more), many US citizens will put up with the tax and compliance burden in order to keep their US citizenship. The decision to renounce US citizenship is a deeply individual one and there is no single metric to determine whether it is better to keep it or give it up.

The legal entitlement to live and work in the US at some point in the future can be enough of a benefit to put up with all of the angst. If your son wants to keep his citizenship, then the right advisers can make the US tax and compliance burden feel manageable and routine. If, however, he decides the benefits are not worth the costs, there is a process to expatriate available through the US embassy. Take care, however — but there can be a tax for that too.

We are selling our family home in the English countryside. The home is surrounded by paddocks and a small river with fishing rights on both banks. We believe that as it is our principal home, the sale with the land is free from tax. HMRC has suggested that this is not the case and that just 0.5 of a hectare qualifies. Is that correct?

Alice Pearson

Alice Pearson, a partner at chartered accountants Mercer & Hole, says: It is well known that main residence relief can exempt a gain realised on the sale of your home from capital gains tax. This includes garden or grounds up to the “permitted area”, defined as 0.5 of a hectare.

However, a larger plot of land could be included where it is “required for the reasonable enjoyment” of the house. This is a grey area that requires some careful thought.

First, you need to establish to what extent the land constitutes garden or grounds. If this is enclosed land surrounding your home that is perhaps used for recreation or growing flowers, it is likely to qualify. Even if the land is not actively used, your paddocks may constitute “grounds” provided there is no business use.

Second, you must determine how much of the garden or grounds are required for the reasonable enjoyment of the house considering its size and character. According to HMRC, “required” relates to need rather than what is simply desirable.

Case law recognises that it is the house you must consider and not the interests of the owner. Therefore, if you are a keen angler, this would not support an argument that the riverside land is required for the enjoyment of the property.

However, the fishing rights attached to the land provide privacy for the property. Without these rights strangers could access your garden to fish, which I imagine would hinder the enjoyment of the house. Therefore, arguably this land is required to take advantage of the rights and preserve the privacy of the property.

The rural location of your property should also be taken into account. It was successfully argued in a recent case of a property with land of 0.94 hectares that the rural location would appeal to somebody looking for a larger house and more space around it was required for privacy and outdoor pursuits.

The supportive evidence showed that similar houses in the neighbourhood all had larger gardens too and, as the taxpayer’s house was proportionately bigger, it required more grounds. With this in mind, I would suggest speaking to a local estate agent to look for comparisons and gauge the market expectation in your area.

This is a common area of disagreement with HMRC. If you do claim land in excess of half a hectare, I recommend full disclosure of the reasons on your tax return. This is to prevent extended HMRC inquiry deadlines and to protect your penalty position, if HMRC were to successfully challenge the claim.

The opinions in this column are intended for general information purposes only and should not be used as a substitute for professional advice. The Financial Times Ltd and the authors are not responsible for any direct or indirect result arising from any reliance placed on replies, including any loss, and exclude liability to the full extent.

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