Being a US citizen or Green Card holder living in the UK can make investing a headache. Traditional UK investment vehicles like ISA-ready mutual funds or OEICs are typically considered Passive Foreign Investment Companies in the eyes of the IRS. Edale build PFIC-free, IRS-aware portfolios for US persons — and making US tax reporting easier.
If you own shares in a PFIC, your investment income is subject to “punitive” taxation rates as high as 70-100% in some cases because of interest charges and the lack of Capital Gains treatment.
Here at Edale, our process is tailored to help you avoid this trap while maintaining complete transparency with both the IRS and HMRC. Our goal is to let you invest with the same ease your UK neighbors do, without IRS audits or surprise tax bills hanging over your head.
Building PFIC-Free Portfolios
Everyone knows we “manage” money. But at Edale, portfolios are “engineered” using a unique filtering process we call “US-Friendly”.
We start with what investable under US person constraints and then seek to construct a diversified portfolio within the confines of those rules. We think about diversification intentionally so that the portfolio isn’t shoehorned into a handful of holdings just to remain compliant.
Transitioning cautiously as well, since what typically causes US tax headaches isn’t necessarily “investing” but rather investing in the incorrect wrapper/vehicle or unintentionally creating PFIC exposure over time.
To ensure that your investments are PFIC-Free and IRS Compliant we:
- Hold Direct Equity & Bond Positions: Rather than investing in “pooled” UK domiciled funds (which are PFICs 100% of the time) we construct portfolios made up of individual stocks and bonds. Owning individual shares of a company avoids PFIC status entirely, though you still need to be aware of it.
- Intentional diversification: portfolios are built across industrial sectors and the largest companies in that sector so as not to shoehorn into a handful of holdings just to remain compliant.
- Active Administration: PFIC status can change year-to-year based on a company’s Balance Sheet (aka the 75% Income Test or 50% Asset Test). Edale’s investment committee actively administers holdings to maintain “Active” status with the IRS.
- Buy and hold in individual accounts:
Better than discretionary portfolios
Since discretionary model portfolios tend to be managed “top-down” (the model changes, then trades get pushed out to every client), they’re often less tax-efficient than an account-by-account optimised approach. The root problem isn’t discretion per se — it’s simultaneous trading across many clients.
Why rebalancing at the model level can cause tax headaches
Let’s start with why changes to the underlying model are likely to cause taxable events, regardless of whether you think they’re taxable events that clients should be taking. When the model changes (be it a regular rebalance, holding replacement, risk client update, manager view shift, etc. ), the trades needed to “catch” everyone up to the model get pushed to every client on the platform at once. Doing this creates several tax issues:
- Clients may realise gains they don’t need to: Let’s say one holding has gone way up since being purchased. Many clients will have large unrealised gains in this position. The model change could sell this position across all clients and realise those gains in a year you don’t want realised.
- Clients who sell will all realise gains in the same year: Clients aren’t harmonised on tax years. Many people realising gains in 2020 vs just a few might push clients into higher marginal rates or into problematic bands (e.g., US NIIT or UK higher/additional rate thresholds).
- Clients have unique cost bases and holding periods: Client A and Client B could both hold XYZ security, but Client A bought it in 2019 and Client B bought it in March 2020. The model change wouldn’t care — it would sell the holding for both.
- Creates unnecessary wash-sale risk / wash-sale harvesting coordination: If you’re contributing to and harvesting losses from the same account frequently, model changes that buy/sell indiscriminately increase your wash-sale risk. Even if you intentionally try to harvest losses during model changes, it’s a headache.
How Tax Harvesting is difficult with model portfolios
Tax-loss harvesting (and tax-oriented trading in general) must be done at the account level. There’s no way around this if you want to do it properly.
A discretionary model approach gets in the way of tax-loss harvesting because:
- The manager wants all clients running the “same” model: The goal here is not tax optimisation, but investment consistency. If client A should really not sell that position because it creates a taxable gain, or should sell twice as much to realise losses, that creates deviation from the model.
- Operations: overhead scales nonlinearly with clients: When you start harvesting loses at the account level, you inevitably end up selling different tax lots, buying different replacement securities, and even having slightly off-target portfolios between clients. This just creates more operational overhead for monitoring, governance, etc.
- Account-specific harvesting replaces holdings that may not fit your “model”: Proper tax-loss harvesting requires you to find “similar enough” securities to replace the old holding (e.g. not trigger US wash sale rules) and often offsets those purchases by days or weeks in either direction. Your harvested portfolios will invariably drift from your defined “model” portfolio.
Having discretion at the model level, as opposed to the account level, is fantastic for governance and ensuring that all clients follow the same process. However, it’s akin to using a sledgehammer to trim your hedge bushes — everything gets cut, even if portions of the bush don’t need trimming (tax-wise).
Simplify Tax Reporting Pain
We know that one of the administration as a US person abroad is filing taxes. We help by providing you (or your CPA) with the technical information you’ll need to satisfy requirements in BOTH countries with minimal legwork. PFIC-free investing and bilingual tax reporting are just two ways Edale saves Americans in the UK from unnecessary stress.
- Transaction Reports for both the US Tax Year (Jan 1 – Dec 31) and UK Tax Year (April 6 – April 5): we can provide, and also from the platforms we use, you can get reports that show:
- Income received (e.g., dividends/interest where applicable)
- Realised gains/losses (sales, switches, rebalances)
- Dates and amounts
We are not replacing a US tax preparer — but we do help clients and their accountants by making sure the information required for US filings is available, readable, and consistent.
Dividends are capital in the USA and Income in the UK
When it comes to cross-border US/UK planning, one of the most confusing areas to understand is the difference in how dividend income is characterised. The short version is – they both TAX dividends but they view the “nature” of that income VERY differently:
- UK Tax Treatment:
- The UK taxes pay Income Tax on your “Dividend Income” at graduated rates (8.75%, 33.75%, 39.35%).
- Within the UK, taxing Dividends as Income (higher rates) occurs within a special dividend income band that differs from other forms of income.
- Capital gains arise when you dispose of an asset (sell/switch) for more than its base cost.
- US Tax Treatment
- Dividends are generally included in gross income. However, certain dividends can be treated as qualified dividends, meaning they are still dividend income but are taxed at the preferential long-term capital gains tax rates
- The IRS consider Dividends from US or “Qualifying” foreign companies to be Capital Gains
- You didn’t get a “yield” on your investment. You received a return of capital/profit that directly mirrors the asset’s appreciation.
- The IRS rewards investors who hold for longer periods with these lower rates.