UK Premium Bonds and Taxation for US Citizens: Risk of IRS seeing as Gambling Income
National Savings and Investments (NS&I) Premium Bonds present a unique savings vehicle in the UK. However, the tax-free status of their winnings in the UK does not extend to the United States. In fact, under the US Internal Revenue Code (IRC), there is a significant and technically grounded argument that prizes from Premium Bonds should be classified as gambling income, subjecting them to specific tax regulations and reporting requirements.
This analysis examines the technical aspects of why UK Premium Bonds winnings may be considered gambling income for US tax purposes, citing relevant US legislation and regulations.
Understanding UK Premium Bonds: A Hybrid of Savings and Chance
UK Premium Bonds are a savings product issued by the UK government. Instead of earning regular interest, investors’ bond numbers are entered into a monthly prize draw. The prizes range from £25 to £1 million, and all winnings are exempt from UK income tax and capital gains tax. HM Treasury fully guarantees the capital invested. This structure, which replaces guaranteed interest with a potential for tax-free prizes based on a random draw, is the crux of the issue from a US tax perspective.
National Savings & Investments (NS&I), the provider of Premium Bonds, explicitly warns potential U.S. resident investors. Their website states, “For example, the US has strict gaming and lottery laws which mean that it might not be possible or practical to hold Premium Bonds while in the US.” This cautionary note highlights the potential for a clash with US legal and tax frameworks.
The US Tax Framework: Worldwide Income and the Definition of Gambling
The United States taxes its citizens and residents on their worldwide income, regardless of where it is earned.7 This fundamental principle means that any winnings from UK Premium Bonds must be reported to the Internal Revenue Service (IRS). The central question then becomes the character of this income: is it interest income or gambling income?
The classification is critical because the tax treatment can differ. While both are generally taxed at ordinary income rates, the classification as gambling income brings specific rules regarding the deduction of losses and potentially different reporting thresholds.
The Internal Revenue Code (IRC) provides a broad definition of gross income. IRC § 61(a) states that, except as otherwise provided, “gross income means all income from whatever source derived.” This includes, but is not limited to, items such as interest, prizes, and awards.
The Argument for Classification as Gambling Income
The core of the argument for treating Premium Bond winnings as gambling income lies in the definition of a “wager” and the element of chance.
1. The Element of Chance Over Skill:
The IRS and US courts have consistently distinguished between income derived from skill and income derived from chance. Winnings from activities where chance is the dominant factor are generally considered gambling winnings.9 In the case of Premium Bonds, the prize is awarded based on a random number generator (ERNIE – Electronic Random Number Indicator Equipment).10 The bondholder has no skill-based input that can influence the outcome of the prize draw. This aligns with the fundamental characteristic of a lottery or wager.
2. The Definition of a Wager and Lottery under the IRC:
While the IRC does not provide a single, all-encompassing definition of “gambling,” various sections shed light on what constitutes a wager. For instance, IRC § 4421, in the context of excise taxes on wagering, defines a “wager” to include “(A) any wager with respect to a sports event or a contest placed with a person engaged in the business of accepting such wagers, (B) any wager placed in a wagering pool with respect to a sports event or a contest, if such pool is conducted for profit, and (C) any wager placed in a lottery conducted for profit.”
A “lottery” is further defined in the same section as including “the numbers game, policy, and similar types of wagering.” While NS&I is a state-owned savings bank and not a commercial casino, the mechanism of pooling funds (the total of all invested capital) to generate a prize fund that is then distributed to a small number of participants based on a random draw is functionally analogous to a lottery.11 The “profit” motive for the entity conducting the lottery can be interpreted broadly to include the benefits the government derives from this form of raising capital.
3. Prizes and Awards vs. Gambling Winnings:
IRC § 74(a) explicitly states that “gross income includes amounts received as prizes and awards.” The regulations under this section, 26 CFR § 1.74-1(a)(1), clarify that this includes “amounts received from radio and television giveaway shows, door prizes, and awards in contests of all types.”
However, the instructions for Form 1040, which US taxpayers use to file their annual income tax returns, direct taxpayers to report “gambling winnings, including lotteries, raffles, etc.” on the “Other Income” line of Schedule 1. This suggests that while all gambling winnings are a type of prize, they are a specific category with their own reporting line. The determinative factor often comes back to the presence of consideration and chance. In the case of Premium Bonds, the “consideration” is the capital invested, which is put at the “risk” of not earning any return, for the “chance” of winning a prize.
Reporting and Tax Implications for US Persons
Assuming Premium Bond winnings are classified as gambling income, US persons must adhere to the following:
- Reporting: All winnings must be reported on Schedule 1 (Form 1040), “Additional Income and Adjustments to Income,” under the “Other income” line, with the specific notation “Gambling winnings.” The total amount of the prize, converted to US dollars at the prevailing exchange rate on the date of receipt, must be reported.
- Deducting Losses: A significant aspect of gambling income is the treatment of losses. IRC § 165(d) states that “Losses from wagering transactions shall be allowed only to the extent of the gains from such transactions.” For a Premium Bond holder, the “loss” is not as straightforward as a losing lottery ticket. A plausible interpretation is that the “loss” is the foregone interest that would have been earned on the invested capital in a standard interest-bearing account. However, this is a complex argument to make, and it is more likely that for most casual investors, there are no directly deductible “losses” to offset the winnings. Professional gamblers can deduct other ordinary and necessary business expenses, but this is unlikely to apply to the typical Premium Bond holder.
- No Withholding by NS&I: Unlike winnings from US-based gambling establishments, NS&I does not withhold any portion of the prize money for US tax purposes. This places the full responsibility on the US person to accurately report and pay the required tax.
Taking a Prudent Approach
Given the absence of a definitive IRS ruling or court case that specifically addresses the tax treatment of UK Premium Bond winnings, a conservative and technically sound approach for a US person is to treat them as gambling income. The core features of the Premium Bond scheme—the pooling of funds, the distribution of prizes based purely on chance, and the waiver of a guaranteed return in exchange for the possibility of a larger, tax-free (in the UK) prize—align closely with the characteristics of a lottery under the US Internal Revenue Code.
US citizens and residents holding UK Premium Bonds are strongly advised to consult with a qualified tax professional who is experienced in expatriate tax matters. Such an advisor can provide personalised guidance on reporting these winnings correctly, ensuring compliance with all applicable US tax laws and regulations, and navigating the complexities of foreign-source income. Failure to report such income can lead to significant penalties and interest charges from the IRS.
How much do earn in Premium Bonds
While Premium Bonds offer the security of getting your initial investment back and the slim chance of winning a large, tax-free prize, their potential return is based entirely on luck. Comparing to some other top tax free investment accounts there are better earning opportunities.
| Product | Stated Rate (Tax-Free) | Nature of Return |
|---|---|---|
| Premium Bonds | 3.60% (from Aug 2025) | Variable prize fund rate; return is based on chance and not guaranteed. |
| Top Easy Access ISA | 5.00% AER | Guaranteed interest rate; funds remain accessible. |
| Top 1-Year Fixed ISA | 4.35% AER | Guaranteed interest rate for the term; funds are locked in. |