How the UK Budget impacts US citizens

On 30 October 2024, Chancellor Rachel Reeves delivered the Labour Government's UK Autumn Budget (the 'Budget'). It was widely anticipated that the Government would radically change how the UK taxes its so-called 'non-domiciled' residents. The Government did not disappoint in this regard, completely overhauling the UK tax treatment of non-doms from both a UK inheritance tax ('UK IHT') and a UK income and capital gains ('CGT') perspective.

US citizens and domiciliaries living in the UK now face unique challenges and opportunities as a consequence of these changes.  

In this article, we cover:

• Inheritance Tax
• Income and Capital Gains Tax

Inheritance Tax

The United States gift and estate tax system turns on whether an individual either is a US citizen or is 'domiciled' in the United States at his or her death.  Very generally, an individual is regarded as being 'domiciled' in the United States if he or she is living in the US with no intent to leave permanently or indefinitely or has left the United States and intends to return one day.  A US citizen or domiciliary is subject to worldwide US federal gift and estate tax to the extent the value of his or her estate exceeds an inflation-adjusted lifetime exemption amount (the 'unified credit') which can be used to make lifetime gifts, pass property on death, or a combination of both.  The unified credit currently stands at $13.61 million for the 2024 calendar year but, due to sunset provisions in the relevant US legislation, currently is slated to be reduced by approximately half from 1 January 2026.  Since the recent re-election of Donald Trump as President it is more likely—albeit far from guaranteed—that the unified credit amount will remain at its current indexed level beyond 2025.

Under current UK rules, a person who is UK domiciled or deemed domiciled generally is liable for UK IHT on his or her worldwide estate, to the extent that value exceeds the 'nil rate band' exemption amount of £325,000.   The estate of a US citizen or domiciliary who is subject to worldwide UK IHT based on domicile or deemed domicile is, very generally, entitled to claim a foreign death tax credit for any UK IHT against his or her US federal estate tax liability.   However, because the UK nil rate band is significantly lower than the unified credit amount, a US citizen or domiciliary in this situation will lose most of the economic benefit associated with the more generous unified credit.

For Americans living in the UK, the main strategic objective in relation to UK IHT estate planning is to preserve the significant 'delta' between the US unified credit and the UK nil rate band, particularly in relation to non-UK situs assets.

A number of measures contained in the Budget change these considerations in fundamental ways.  First, the Government confirmed that from 6 April 2025, the concept of domicile—currently the lynchpin of the UK IHT system—will be dispensed with entirely and replaced by a more mechanical system based purely on the number of years an individual has resided in the UK.   Second, a UK IHT 'tail' will be imposed on so-called long-term residents that will subject these individuals to worldwide UK IHT even after they have permanently left the UK.   Third, the Budget measures would make it significantly more difficult to decrease UK IHT liability through the use of trusts.  Taken together, these changes could lead to significantly more UK-resident Americans becoming caught in the worldwide UK IHT net. 

Nonetheless, the Government confirmed that the UK's ten existing Inheritance Tax Double Tax Conventions—including the 1980 US-UK Estate and Gift Tax Treaty (the 'Estate Tax Treaty')—will remain in effect.  It has stated that 'there are no changes to the treaties or how these operate.'   This concession is welcome news for Americans living in the UK who still maintain at least some personal and economic ties to the United States.  Americans may rely on the Estate Tax Treaty for significant relief from the new rules, whether in respect of assets held personally by an individual on death or by permitting Americans to establish non-UK trusts to shield against UK IHT in ways not available under new Budget measures. 

Basic framework

At present, a person may be liable to UK IHT either because that individual is UK domiciled or deemed domiciled at death.  For UK IHT purposes, a person's domicile is determined under principles which are similar (but not identical) to those used to determine US domicile.  Additionally, an individual generally is considered UK deemed domiciled to the extent he or she has resided in the UK for at least 15 out of the preceding 20 years.  An affected individual's estate must generally pay UK IHT at a rate of 40% on, among other things, (i) personally held assets, and (ii) assets held in certain trusts which were previously settled by that individual and from which he or she  retains certain benefits—for example a power to revoke the trust or being named as a permissible beneficiary ('Gift with Reservation of Benefit' or 'GROB Trusts').  In addition, trusts settled by persons who are UK domiciled or deemed domiciled broadly are subject to the UK's 'relevant property regime' which applies periodic UK IHT charges (an approximate 6% charge on trust property on each 10-year anniversary) and a further charge when such property exits or is deemed to exit the trust.  The relevant property regime generally applies regardless of whether the settlor has retained any benefit from, or control over, the trust, i.e. regardless of whether the trust is a GROB Trust.   

Under current UK rules, where an individual settles non-UK assets into trust before he or she becomes UK domiciled or deemed domiciled, those assets generally become exempt from UK IHT and relevant property regime charges, even if the trust is a fully revocable GROB Trust with the settlor as a named beneficiary.  This is known informally as the 'excluded property trust' regime.

The Government confirmed that from 6 April 2025, a new residence-based system will treat an individual's personally held assets as within the scope of worldwide UK IHT if that individual has been UK tax resident for 10 out of the previous 20 tax years (hereinafter 'long-term residents').  A UK IHT 'tail' also will apply to those who have recently left the UK; the tail can persist for up to ten years after that person's exit date (the 'ten-year tail'). The old excluded property trust protections also will cease to apply, subject to some limited grandfathering relief, as discussed below.  As a result, trusts settled by long-term residents will be within the scope of personal UK IHT if the trusts are GROB Trusts and also within the scope of periodic relevant property regime charges irrespective of GROB Trust status.  In cases where a settlor ceases to be a long-term resident, and therefore ceases to be personally subject to UK IHT, an 'exit charge' will apply to any property held within a trust at that time (calculated as a proportion of 6% of the trust assets, depending on how much time has passed since the trust's most recent 10-year anniversary). 

Limited grandfathering relief applies to trusts established prior to 30 October 2024 by individuals who were neither UK domiciled nor deemed domiciled as of the relevant trust's settlement date.   These grandfathering rules provide that the settlor of a pre-30 October GROB Trust generally will not be subject to a personal 40% UK IHT charge on the trust's assets on death.   However, no grandfathering protection is available against the relevant property regime or exit charges, even for trusts established before the Budget date.  Trusts settled post-30 October 2024 also will be subject to a 20% 'entry charge' on funding if the settlor is a long-term resident at the time assets are contributed to a trust.   Conversely, no entry charge will apply if a settlor is not long-term resident at the time non-UK assets are contributed to a trust, but the relevant property regime charges will still apply to such trusts once the settlor has become long-term resident.

American citizens and the US-UK Estate Tax Treaty

The Government confirmed that the Estate Tax Treaty will remain in effect even after the Budget measures are enacted.  This was not a foregone conclusion because much of the architecture of the Estate Tax Treaty is premised on the notion that both the US and the UK impose estate or inheritance tax, at least in part, on the basis of an individual's 'domicile.'  The Estate Tax Treaty's survival, despite the Budget changes, will be encouraging news to UK-resident Americans on a number of different fronts.

Article 5(1) and personally held assets

The core operative provision of the Estate Tax Treaty is found in Article 5 (Taxing Rights).  According to Article 5(1)(a), the country in which a person was 'domiciled' at the time of his or her passing (within the meaning of the Estate Tax Treaty) has the exclusive right to impose inheritance tax on that individual, apart from a narrow class of property that may be taxed by the situs country (generally, real estate and active business assets).  

For purposes of the Estate Tax Treaty, the term 'domicile' is determined by reference to Article 4 (Fiscal Domicile).  Under Article 4(1), a person's domicile is initially determined by looking at the domestic law in each of the two countries.  Under internal US rules, a person is considered to be domiciled in United States if, very generally, he or she has the subjective intent to remain in or return to the United States permanently or indefinitely.  According to Article 4(1)(a), a US citizen will be treated as domiciled in the United States for Estate Tax Treaty purposes if he or she has been domiciled in the United States, according to that internal US definition, at any time within the last three years (even if they have not been resident in the US during those years).  Article 4(1)(b) states that an individual is treated as being domiciled in the UK for treaty purposes if that person was 'domiciled in the United Kingdom in accordance with the law of the United Kingdom or is treated as so domiciled for the purpose of a tax which is the subject of this Convention.' Going forward, the legislation expressly states that an individual will continue to be regarded as UK 'domiciled' for treaty purposes under the current, pre-Budget rules. If an individual is considered to be domiciled in both countries under Article 4(1), then a person can invoke a series of 'tie-breaker' tests to assign exclusive treaty domicile status to one country or the other.    The first of these tie-breaker clauses, Article 4(3), provide that if an individual is domiciled in both countries, then that person will be entitled automatically to tie-break to exclusive US domicile status, and away from UK domicile status, if at the time of death he or she: (i) is a US citizen; (ii) is not a UK citizen; and (iii) has not been resident in the UK for seven or more years within the preceding ten-year period.   If Article 4(3) does not apply, then a second tie-breaker test in Article 4(4) comes into effect, relating to an individual's personal and economic links to each of the two countries.

An American who qualifies as a long-term UK resident will be incentivized to use the Article 4 tie-breaker provisions to tie-break away from long-term UK residence status and back toward exclusive US domicile status.  If an American in this situation is eligible to invoke Article 5(1) relief, his or her estate may be protected against significant UK IHT liability, even if he or she is a long-term UK resident at death or has a lingering UK IHT liability by virtue of the new ten-year tail rules.  It is noteworthy that under the Article 4(3) 'seven-year rule,' most US citizens will be automatically entitled to claim Article 5(1) tie-breaker relief away from worldwide UK IHT liability if they lived in the UK for less than seven years prior to passing away.     

Crucially, even if an individual is treated as exclusively US domiciled at the time of his or her passing under Article 4, no Article 5(1) relief is available if the individual had UK nationality at death.   Since until now it has been possible to 'plan out of' needing to rely on Article 5(1) (see below), there has typically not been seen to be tax-related disincentives to acquiring UK nationality and thereby becoming a dual US/UK citizen.  Yet as more Americans turn to Article 5(1) to limit UK IHT exposure, this decision is no longer an obvious one; acquiring UK nationality could effectively sacrifice the possibility of claiming Article 5(1) relief at death, thus conceding that the 'delta' between the UK nil rate bank and the US unified credit amount will be subject to UK IHT.   

Second, it is important to appreciate that a person must have been domiciled in the United States when he or she passed away or at some point within the preceding three-year period within the meaning of the US Internal Revenue Code.  Here an important distinction must be made between US citizenship and US domicile.  There is a common misconception that being liable to worldwide US federal estate tax on the basis of US citizenship automatically qualifies an individual to claim Estate Tax Treaty benefits.   Yet the Article 4(1) 'domicile' definition makes clear that simply holding a US passport is not enough for an individual to claim Article 5(1) relief.  Americans who have lived in the UK for decades now may be motivated to retain various personal and economic ties to the United States to preserve their eligibility to claim Estate Tax Treaty tie-breaker relief on death (under some combination of Article 4(1) and Article 4(4)).

Article 5(4) and assets held in trust

Under pre-Budget rules, Americans would often establish excluded property trusts prior to becoming UK domiciled or deemed domiciled.   This structuring technique generally protected non-UK situs assets from future UK IHT exposure, thereby preserving the delta between the UK nil rate band and the US unified credit amount once a person has become domiciled or deemed domiciled in the UK.  From a US perspective, an excluded property trust could be completely tax neutral or could serve some other US planning objective (e.g. utilization of the US unified credit amount).   In view of the Budget changes, those individuals who had previously set up excluded property trusts in anticipation of becoming UK domiciled or deemed domiciled may be feeling uneasy about their continuing UK IHT exposure, while others may feel hemmed in from undertaking estate planning going forward.   

One potential solution lies in Article 5(4) of the Estate Tax Treaty.  Article 5(4) provides that, except for UK real property and UK business assets, 'tax shall not be imposed in the United Kingdom on [property held in a trust settlement] if at the time when the settlement was made the settlor was domiciled in the United States and was not a national of the United Kingdom.'   The precise scope of the term 'tax' as used in this provision is somewhat vague and there does not appear to be any legal authority on point.  However, some leading commentators have suggested that the language in Article 5(4) should be read expansively to encompass both personal UK IHT exposure on GROB Trusts as well as ongoing relevant property regime charges (regardless of GROB Trust status).  This expansive interpretation seems to accord with the plain meaning of the provision.  Accordingly, there is a strong argument that Article 5(4) can effectively replicate large parts of the old excluded property trust regime for Americans who are eligible to take advantage of that provision.  

As a point of caution, however, we note that the trust's settlor must be US domiciled under Article 4 as of the funding date for Article 5(4) relief to apply.  Likewise, Article 5(4) relief cannot be claimed if the trust's settlor is a dual US/UK citizen when the trust is funded.  It is noteworthy that the same two restrictions apply in respect of Article 5(1) relief for personally held assets.  However, in the case of Article 5(1), the prohibition on holding UK citizenship and the requirement to have maintained a US domicile each apply in each case as of the individual's date of death.  By contrast, each of the two restrictions in Article 5(4) apply as of the trust's funding date.  This timing difference may impact the availability of Estate Tax Treaty relief depending on an individual's particular circumstances.  For instance, if an American anticipates that he or she will be in the UK for some time, that person might consider establishing an Article 5(4) trust to shield his or her non-UK situs assets from UK IHT at a point in time when that person's personal or economic ties to the United States remain relatively strong (and thus there is a robust claim of US domicile when the trust is funded, despite what may change between when the trust is funded and when that individual passes away).  

As a consequence of the Budget's grandfathering provisions, some Americans who previously established excluded property trusts before 30 October may invoke Article 5(4) to claim relief against relevant property regime charges.  At the same time, Article 5(4) may permit eligible Americans to establish Article 5(4) trusts going forward, taking the position that the Estate Tax Treaty insulates non-UK assets in those trusts from personal IHT liability (to the extent the trust is a GROB Trust) as well as relevant property regime charges.

These observations suggest that Article 5(4) may be a key estate-planning tool for UK-resident American citizens going forward.  Ideally, an American who wishes to take advantage of this provision should establish a trust as part of his or her pre-UK immigration planning when he or she has the strongest connections with the United States.   

We caution further that because Article 5(4) has been relatively untested and rarely invoked until now, there is little authority to guide taxpayers and advisors in understanding exactly how this provision will be interpreted by HMRC.   Therefore, there is some unavoidable risk inherent in relying on Article 5(4) to shield non-UK situs assets from UK IHT, at least until its contours and limitations become clearer.  In addition, HMRC may become less sanguine going forward about continuing to respect the Estate Tax Treaty in its current form; in the future there may be more of an appetite to revisit or renegotiate it.

Specific planning opportunities in connection with sunsetting of US unified credit

The unified credit amount currently is $13.61 million, and indexed for inflation to $13.99 million for the 2025 calendar year.   This amount is scheduled to roughly halve from 1 January 2026 to $5 million and indexed for inflation to approximately $7 million, unless Congress enacts legislation to the contrary.  Americans living in the UK may wish to take advantage of the opportunity to establish 'completed gift trusts' which are designed to utilize the high unified credit amount before it reduces.  Absent Estate Tax Treaty relief, these trusts could carry significant UK IHT costs going forward, due to the relevant property regime charges.   However, Article 5(4) may offer a solution and effectively eliminate the potential for UK IHT leakage on US completed gift trusts, particularly for individuals who have some appetite for planning risk and are willing to accept the possibility of HMRC adopting a narrower interpretation of Article 5(4) than the one set forth above.  The months leading up to the end of the 2025 will undoubtedly be a very busy period, so it is important that conversations and preparatory work start now.

Income and Capital Gains Tax

FIG Regime

The Foreign Income and Gains ('FIG') regime will generally allow new arrivals to the UK—specifically, individuals who have not been UK tax resident in any of the previous 10 tax years—to make a claim to be taxed only on their UK source income and gains for a period of four consecutive years.

The FIG regime may give newly arriving Americans the opportunity to take advantage of one-sided tax benefits without the need to worry about any 'matching' income or capital gains treatment on the UK side.  Below we explore what 'matching' treatment might mean in this context.

Care will still need to be taken in relation to any entities or trusts that an individual claiming the FIG regime owns or controls.  For instance, an eligible individual who manages and controls a company and who becomes UK resident may inadvertently cause that company to be UK resident for UK corporation tax purposes, notwithstanding any FIG benefits that apply at the individual level.   Likewise, a trustee of a trust who becomes UK resident could cause the trust to become UK tax resident even if the individual trustee has properly claimed FIG benefits for himself or herself. 

End of the Remittance basis

The United States is one of only two countries that taxes individuals on the basis of nationality alone.    Under general international tax principles, if an individual simultaneously qualifies as an income tax resident of two countries with a bilateral income tax treaty in effect, he or she can often tie break income tax residence to the country where he or she has closer personal and economic ties.   However, the United States has long insisted on inserting a provision in its income tax treaties famously known as the 'saving clause,' which effectively prohibits US citizens from tie-breaking their tax residency away from the US toward the UK (or any other tax treaty partner country).  

Taken together, these factors result in UK resident US citizens to be concurrently and annually subject to US federal and UK tax on all of his or her global income and gains.

Under pre-Budget rules, UK resident US citizens had two main strategies for alleviating this potential double tax burden.  First, these individuals could claim 'foreign tax credits' in one or both countries against their tentative US federal or UK tax liability, depending upon which country had primary taxing rights over a given item of income or gain.  Second, individuals who were not yet UK domiciled or deemed domiciled could claim the 'remittance basis' of UK taxation, thereby generally limiting the scope of their putative double tax problem to UK-source income only.

The Budget would abolish this second plank—the remittance basis system—from April 2025 for individuals who are no longer eligible for the FIG regime, leaving Americans living in the UK wholly reliant on foreign tax credits to avoid double taxation on the same economic income.  

While the foreign tax credit mechanism works reasonably well for taxpayers whose earnings come primarily in the form of wage income, serious distortions often arise in the following situations:

• A tax preferred item available in one country—for example, US Qualified Business Stock or tax-free municipal bond income—is not tax-preferred in the other country and instead taxed in the 'regular' way.  This mismatch can result in a total loss of any economic benefit associated with the tax-preferred item of income or gain.
• An asset class which is regarded as completely benign in one country is taxed on a punitive basis in the other country.  For example, regular UK mutual funds are often classified under US rules as 'Passive Foreign Investment Company' or 'PFIC' stock and subject to high effective rates of US income tax upon redemption and distributions.
• The two countries disagree as to the timing of a particular taxable event—in particular as to the taxable year in which the event occurred and/or who owned the taxable asset at the relevant time.   By way of illustration, when an individual gifts an appreciated asset to anyone other than a spouse, under UK rules the donor generally will be required to pay UK capital gains tax as of the moment of the gift.   Conversely, the US federal tax system generally treats gifts of appreciated property as tax-free nonrecognition transactions, with the built-in gain to be recognized on the recipient when he or she later sells the asset.
• There is disagreement as to the character or source of a particular item of income.  For instance, US limited liability companies generally are regarded as tax-opaque companies in the UK yet are typically treated as tax-transparent partnerships in the United States.  When a US citizen living in the UK sells his or her membership interest in a US LLC, has he or she incurred a passive capital gain on company shares or active gain on the sale of partnership business assets?   These questions bear fundamentally on which country has the primary taxing right on the gain and whether the foreign tax credit system will function smoothly to provide double tax relief.   

Under current rules an American who is not yet UK domiciled or deemed domiciled may paper over these issues by electing remittance basis treatment.  Beginning in April 2025, however, that will no longer be possible.    That person will now be forced to grapple in full with the vagaries of the foreign tax credit system.

Temporary Repatriation Facility

The new Temporary Repatriation Facility ('TRF') will allow former UK remittance basis users to bring unremitted foreign income and gains (i.e. the accrued income and gains historically protected from UK tax by the remittance basis) into the country for a flat 12% rate of tax.   The TRF facility will last for three years from 6 April 2025 to 6 April 2028, with the rate of tax rising to 15% for remittances made in the third year.

Importantly, the policy guidance confirms that remittances which are attributable to distributions from offshore trust structures will in principle be eligible for TRF relief.

Americans who have historically relied on the remittance basis system to smooth out the foreign tax credit system's rougher edges may have the opportunity to use the TRF to remit historic income and gains at a low rate of UK tax.  The main strategic consideration for Americans will be how to take full advantage of the lower TRF rate on a fully cross-border basis, taking into account the foreign tax credit system and the reality of being effectively tax resident in two different countries simultaneously.   

One currently unresolved question is whether the TRF charge actually counts as a creditable 'foreign income tax' for US foreign tax credit purposes.  Specifically, the TRF charge will apply during the year in which a person 'designates' a particular pool of offshore income or gains with TRF status on a self-assessment basis, with some scope also for paying the TRF charge on the UK tax base cost of illiquid assets.  It will be important for advisors to get comfortable that the TRF satisfies the basic creditability requirements—among other things, that the charge is genuinely a compulsory tax liability and not simply a voluntary payment of tax, and that whatever income or gains are being subject to the TRF charge represent or come close to representing realized net income in the US sense.

Increased CGT rate

The Budget increased the top rate of UK capital gains tax ('CGT') to 24%, up from the previous rate of 20%.

In general, US citizens currently pay US federal income tax on long-term capital gains at a maximum 20% rate.  In most instances, Americans must also pay a separate 3.8% Net Investment Income Tax ('NIIT') on top of the regular rate.  Thus, an American's total effective tax rate on long-term capital gains usually amounts to about 23.8%.  

At first blush, it might be assumed that, once foreign tax credits are taken into account, the UK CGT rate increase will not meaningfully affect an American's overall cross-border effective tax rate on long-term capital gains because the new 24% UK capital gains rate will be virtually the same as the existing 23.8% all-in rate on the US side.  However  the Code expressly precludes a US citizen from claiming foreign tax credits to offset the 3.8% NIIT.  Therefore, absent some other form of relief, an American resident in the UK will face a 27.8% effective cross-border tax rate on long-term capital gains—i.e. the higher 24% UK CGT rate plus the 3.8% NIIT—as compared with his or her effective rate of 23.8% under existing rules.   

Some recent court decisions suggest that a US citizen living in a country with which the United States has a double income tax treaty may claim a foreign tax credit against the NIIT under the position that the treaty's foreign tax credit article overrides the Code's statutory proscription.   Yet this issue remains unsettled as a matter of law.    Furthermore, none of these decisions specifically address the US-UK Double Income Tax Treaty (the 'Income Tax Treaty'), the foreign tax credit article of which is more narrowly drafted and less taxpayer-favourable as compared with similar provisions in the US-France, US-Germany, and similar double income tax treaties.

In sum, Americans resident in the UK are likely to suffer a meaningfully higher cross-border rate on long-term capital gains because of the interaction between the NIIT rules and the foreign tax credit provisions.

New carried interest regime

Under the current UK carried interest tax regime (the 'UK carry rules'), an investment professional receiving a payout on his or her carried interest in a fund is subject to UK capital gains tax at a special 28% rate (and even then only to the extent the payout is not recharacterized as regular compensation income under the Disguised Investment Management Fee or 'DIMF' regime or as income under the 'income-based carried interest' rules).  By contrast, under US tax rules, carried interest is typically subject to tax at the same 20%-23.8% rate as any other crystallized long-term capital gain (albeit a fund principal generally must hold his or her interest for three years—longer than the standard one-year holding period—in order to be entitled to tax at long-term capital gains rates).

The Budget would change the UK treatment of carried interest along a number of different dimensions.  In particular, as of April 2026, carried interest entitlements would be taxed under a so-called 'income tax framework,' with the applicable rate generally set at 72.5% of the then-applicable UK rate of income tax (which would equate to an effective rate of approximately 32.5%, under current income tax rates).  As an interim step, the UK capital gains tax rate on carried interest would increase from 28% to 32% beginning in April 2025.

The headline rate increases will clearly impact American private equity and venture fund professionals who are based in London.  It should be noted, however, that a 32.5% effective rate on carried interest is still likely to be lower overall than the total effective rate on carry for a person living in New York City or California once state and local taxes are factored into the calculus.

A more troubling technical issue may crop up depending upon the meaning of the phrase 'income tax framework' and specifically on what taxing carried interest under such a framework would actually entail.  One possibility is that the UK government intends to characterize an individual's entire economic return on a carried interest entitlement as compensation for services rendered rather than a share of the fund's capital underlying capital gain.   That treatment could cause headaches for Americans if the IRS continues to regard carried interest payouts as a kind of capital gain rather than as compensation income.  By way of illustration, Americans who have just arrived in the UK, or are in the process of leaving the UK, will often rely on Article 4 of the Income Tax Treaty to 'tie-break' away from UK tax residence during the first or last year as applicable.    With respect to these individuals, Article 13 of the Income Tax Treaty generally provides that the United States has the exclusive right to tax most kinds of capital gains on securities positions (and that by extension the UK cannot tax such gains) incurred during the tie-breaking period.  To the extent the two countries agree that carried interest payouts constitute capital gains rather than compensation income, then this strategy can function reasonably well.   Yet if a tie-breaking individual receives a carry payout during that part-year period, the two tax jurisdictions may disagree on whether that event is appropriately characterized as an Article 13 capital gain in the first place, ultimately creating friction and an audit risk regarding which country has the right to tax carried interest payments.

Protected Trust Status

Under existing UK rules, so-called 'protected trust' status means that any income and gains arising to a settlement are not automatically attributed to the settlor and taxed on the settlor as they are realized at trust level.  From 6 April 2025, however, income and gains incurred within certain 'settlor-interested' trusts will be taxed on the settlor as that income and gain is incurred at trust level if he or she is UK tax resident and no longer able to claim the benefits of the FIG regime.  
 
Although at first glance these changes may seem disadvantageous, most Americans will be relatively unaffected by the changes to the protected trust regime. In general, lifetime trusts established by Americans living in the UK are typically structured to qualify for so-called 'grantor trust' status from a US income tax perspective, whereby the settlor is taxable in the US on all trust income and gains as if the trust were simply disregarded. As a result, US citizen trust settlors generally ensure that any trust they establish while resident in the UK does not qualify for UK protected trust status, thereby causing the trust to be 'tainted' and requiring all income to be taxed from a US and UK perspective on a flow-through basis as it arises at trust level.  Broadly, this approach maximizes the availability of foreign tax credits to prevent double taxation on eventual distribution from the trust and minimizes tax leakage.  Nonetheless, some Americans had previously been establishing protected trusts to address the kinds of asset-specific or timing mismatches discussed previously and further planning may be required.

This is a high-level review of some inevitably complex matters and tailored advice should always be sought in specific scenarios.  We would be pleased to assist with any queries or planning in this area.  Withers LLP has a large team of US-qualified tax lawyers based in London and across our offices in the United States, Europe, and Asia.  The US team works closely with the firm's UK solicitors to provide seamless cross-border advice as well as innovative US/UK tax structuring solutions to individuals, their businesses, and their families.