UK Tax Implications For Currency Traders

While many traders appear to have made an emotional judgment on the subject, focusing on the tax implications for accounts held in the United Kingdom, specifically England, is useful. Note the following information was derived from extensive research by a researcher/trader and not a tax advisor.

DOUBLE-TAXATION AGREEMENT
Because the UK has a double-taxation agreement with the United States and 100 other nations, US residents are exempt from paying capital gains taxes twice. Instead, capital gains taxes are paid once to the resident nation, the US. The key to the agreement is Article 23, where tax avoidance is available to “qualified persons.” In the eyes of US tax law, a “qualified person” is considered a limited liability company. So for those who trade under an LLC, this is legal and accepted by the US and treated the same as if the account were held in the US. This agreement was agreed to in 2002 and enforced in March 2003 with a renewal in 2009.

To further determine residency and nonresidency for tax liability in the UK, IR 20 forms have been replaced by HMRC 6 (Her Majesty’s Revenue and Customs Office Form 6). Two important aspects are you don’t pay capital gains on foreign currency for personal use outside the UK, and further to Article 23, when capital gains are excluded from gilt purchases. Gilts are the equivalent to our Treasury bonds. The US taxes its residents based on their worldwide income so US citizens are exempt from any certificate of overseas residence demanded by the UK. Instead, the IRS may ask traders to file Form 6166, a residency certification and tax exclusion form.

The most important of all forms to be filed is the Report of Foreign Bank and Financial Accounts (FARB). This falls under the purview of US Code Title 31. To file a FARB, traders must file TDF 90-22.1, especially if the account has or will transfer $10,000 or more. This form must be filed by June 30 of the following year or when the account has met the $10,000 threshold. No extensions are permitted. This form is a separate document from normal tax forms and must be sent to the Department of the Treasury in Detroit, MI, and declared on an IRS Form 1040.

Failure to file TDF 90-22.1 can result in civil penalties and/or criminal prosecution with a maximum of five years in jail. A negligent violator will be assessed up to $500, nonwillful violations can cost up to $10,000 for each violation, patterns of neglect can cost no more than $50,000, and willful violations can cost a trader up to $100,000 or 50% of the account. TDF 90-22.1 records must be maintained for five years. Failure to do so can result in criminal and civil penalties. According to USC 31 531405, flagrant violations of these rules can cost a trader a penalty in excess of his or her account. For a husband and wife whose names are joint on the account, only one TDF 90-22.1 Form Item 14, Part 3 needs to be filed.

How do you know when you have achieved the $10,000 threshold in the eyes of the IRS? Calculate the maximum value of the account based on the last quarterly statement or the highest value during the year. If a different denomination of currency other than US dollars is used, use the exchange rate as of the end of the year. The $10,000 figure is derived from the 1971 Bank Secrecy Act. Civil and criminal penalties have strengthened in recent years with Anti Money Laundering and Patriot Act laws due to the focus on terrorism and unlawful criminal dealings by major actors.

Sub Chapter S Corporations are legal entities that can be used to trade overseas accounts. There is no tax on income for Sub Chapter S Corporations. Instead, income, losses, and credits are passed to shareholders. Form 1120S are the official forms for filing returns on Sub Chapter S Corporations. Shareholders must file Schedule K-1 1120S.

Partnerships are not taxable entities. Income, gains, losses, and credits are passed through to the partners according to IRS Publication 541. Returns are filed on K-1. Gains are reported on Schedule D, IRS Form 1040 while ordinary income is filed on Schedule E, Form 1040. If a husband and wife file a joint return, they can form as a qualified joint venture instead of a partnership. Each must file separately on Schedule C or Schedule C-EZ on Form 1040.

What if a trader holds positions for long periods and earns carry interest? US Company 2002 Forms SI 2002 is used by US companies, mutual funds, pensions, or trusts receiving interest from the UK. For filing purposes, traders must attach IRS Form 6166, an exclusion from taxes forms, and fill out parts A, B, C, and F, then claim full relief from taxes.

Capital gains and losses are treated just as they were in prior years for US tax purposes. Gains and losses are reported on Schedule D, Form 1040, but transferred to line 13 on the 1040 form. More information can be found in IRS Publication 505. Publication 505 says you must estimate your taxes if you still owe for the prior year. Currently, 2008 capital gains tax rates are zero, 15%, 25%, and 28%. Losses can be deducted up to $3,000, $1,500 if filing separately.

Here’s another debatable question: Should currency traders file IRS Form 255, foreign earned exclusion forms? The speculative answer is no, because we are not earning capital gains by sale of houses, properties, and dividends from foreign stocks or some tangible asset.

HOW MUCH IN TAXES?
Are US citizens subject to nonresident alien taxes in England, HMRC Form P85? The speculative answer is no due to treaty obligations. Then are US citizens subject to stamp taxes? If currency traders were bond or stock investors, the answer would probably be yes.

One aspect of vital importance is the speculation that President Barack Obama’s 2010 budget calls for the strengthening of foreign reporting and strengthening of brokers. Will this pass? We don’t know.

In the end, currency traders are subject to the same taxing standards as well as the ability to trade the markets as they desire.

SUGGESTED READING
Twomey, Brian [2009]. “Forex Rules,” Working-Money.com, August 12.