US Tax Year End Planning Considerations for Business Owners

22 November 2022

As we approach the end of the tax year for US tax filers, there are opportunities for year-end tax planning. This article will focus on the tax planning aspects for US connected business owners living in the UK. It is intended for general informational purposes rather than specific advice.

Foreign Tax Credit Planning

US taxpayers living in the UK can claim a credit on their US tax return for UK taxes paid. Those on the paid method can claim a credit for UK taxes paid on foreign income during the calendar year. Due to differing tax years in the US & UK, the matching of payments and income can become an issue. For UK tax purposes, the tax is not due until January 31^st after the corresponding US calendar tax year. Therefore, US taxpayers should generally aim to file and pay their UK taxes prior to December 31^st unless:

• Tax has been withheld throughout the year and/or
• Excess accumulated tax credits are available in the appropriate tax basket

Furthermore, certain calendar year income arising after April 5^th may need an additional pre-payment to HMRC prior to December 31^st. This will ensure the availability of a corresponding credit in the appropriate tax basket on the 2022 US tax return.

Below are five general examples of where this may apply:

Sole Proprietors

Self-employed taxpayers do not have monthly payroll withholding and are responsible for paying in their own taxes. Those who are new to the UK may unknowingly pay their UK tax in January following the US calendar year. Furthermore, they generally will not have accumulated carryforward foreign tax credits available for US tax purposes. This can result in a US tax liability with no corresponding tax credit offset. While there is a one-year carryback mechanism in place, this cannot be claimed until the following US tax filing year. This can cause unexpected cash flow issues. Therefore, a determination should be made as to whether a payment to HMRC is needed prior to December 31st.

Partners of UK Partnerships

Partners are not considered employees and will be responsible for paying in their own taxes. Those who become a partner during the year will need to consider the tax due on their calendar year profit. They will likely need to make a UK tax payment on their calendar year partnership profit prior to December 31^st.

Investment Income & Capital Gains Arising Post April 5^th, 2022

Investment income and/or capital gains arising after the 5^th of April may require a pre-payment to HMRC before December 31^st. This is generally due to a shortage of tax credits in the passive tax basket. Investment income will be classified as passive income for US tax purposes. Most taxpayers will have excess foreign tax credits from employment which sit in the general limitation tax basket. However, general limitation foreign tax credits will not be allowed as an offset for passive income.

One off Taxable Events

Certain one-off events such as the sale of a business may require a payment to HMRC before December 31st. A distribution from a trust may also warrant the need for a payment. The nature of the income and the taxpayer’s excess foreign tax credit position will determine if a payment is needed.

Moving from the Remittance to the Arising Basis

Taxpayers moving from the remittance to the arising basis may need to make a payment to HMRC before December 31st. This will generally be due to the lack of accumulated excess foreign tax credits.

Key Takeaway:  If any of the above situations apply, it is recommended to seek advice from a US tax advisor.

Timing of Taxable Events – 2022 vs 2023

Where possible, consideration should be given if:

• Income can be recognized in the year where the marginal rate of tax will be lower or
• Expenses can be deducted in the year where the marginal rate of tax will be higher.

Alternatively, if the marginal tax rate is not expected to change between 2022 and 2023:

• Accelerating a deduction such as a charitable contribution (subject to individual AGI limits) can generate tax savings in 2022 or
• Deferring taxable income to 2023 can assist with overall cash flow and timing of tax payments for one year.

Items to consider for acceleration in 2022 or delay until 2023:

• Sale transactions
• Crystallizing losses to offset potential gains
• Timing of dividend payments from your business
• Charitable contributions of cash or appreciated securities (subject to individual AGI limits)

Considerations for Founder Shareholders of US Corporations Operating on a Calendar Year:

• Write-off of business bad debts that are uncollectible
• Pay out of year-end bonuses
• Purchasing property and equipment qualifying for bonus depreciation

Key Takeaway:  Each individual situation is unique and dependent on the individual facts and circumstances. The nature and sourcing of the income alongside the taxpayer’s foreign tax credit position can impact the overall tax efficiency. Therefore, it is recommended that you consult with a US tax advisor.

Review of State Tax Positions of US Business Operations

 
State Income Tax Nexus

Businesses which operate in the US may be considered doing business (creating nexus) in certain States. This can be through in-State sales, property, employees, or contractors. The lack of a physical presence may not necessarily protect an overseas business from State income tax obligations. Many states and locales, including California and New York, have implemented economic nexus thresholds for income tax purposes. Sales over a certain threshold in a State or locale can trigger registration and filing obligations. Furthermore, foreign businesses who rely on the Federal tax treaty will not be protected for State tax purposes. Certain protection may be afforded depending on the nature of the business activities. In particular, businesses selling tangible goods. Internet based activities can also trigger nexus and should be reviewed.

State and Local Sales Tax

Sales tax, similar to VAT, is a separate tax assessed by States and locales on certain sales and services. Remote sellers can also trigger nexus depending on their activities. Sales tax nexus can be triggered at certain thresholds, generally $100K of sales, requiring registration and collection of sales tax. The tax is remitted to the State by filing sales tax returns. Businesses should review its activities by state and assess whether their services or products are taxable for sales tax purposes.

Key Takeaway: States are closely monitoring companies that sell or provide services into their State and assessing harsh penalties for non-compliance. Therefore, it is important to review the rules to determine if your business will trigger nexus for sales tax purposes. Everfair can assist in assessing the State tax exposure for your business.