US and UK Taxes – Which are higher?

The UK, right? Lots of people make the assumption that the UK is a high tax country, with a generous social safety net funded from those high taxes (some people I know would disagree with how generous – more than the US in a lot of cases, at least, but no Norway!).

I wanted to see if that’s actually a good assumption, because I’ve looked at my own situation and while my UK taxes are a bit higher than my US federal taxes, when you look at other taxes plus health care, it seemed pretty close.

Spoiler: US federal taxes are lower than UK income taxes, but when you put in typical state taxes and health insurance, it gets pretty close. Read on for more!

Background – Tax Brackets

The US and the UK both work on a marginal and progressive tax system: the percentage tax you pay on your highest dollar/pound of income is not the same as on your lowest, and the rate is higher on higher incomes. I know that’s income tax 101, but it’s really important – the first pound that you make over the 40% threshold gets taxed at 40%, but all the others are at 0% or 20%.

I started to type out the US and UK tax brackets here, and then I remembered you guys can read:

  • UK Tax Brackets (there’s a hidden bracket between £100,000 and £125,000 where the personal allowance is reduced by £1 for every £2 extra earned – this results in a small but painful 60% tax bracket).
  • US Federal Tax Brackets

Both countries also have some other taxes that get added on to the income taxes – National Insurance in the UK and FICA (Social Security & Medicare) in the US.

Both systems offer a variety of ways of reducing your taxable income – deductions, credits, pension contributions, etc. For most of us planning for retirement, the biggest one will be those pension contributions, although others can be significant in your particular situation (child tax credit is a big one in the US, and part of it is refundable – can be free money for Americans in the UK!).

Instead of going through a bunch of theoretical math, I thought it might be easier to illustrate in two examples. I picked two examples that aren’t in the extremes of high or low income: Average Andy, who is pretty average, and Prosperous Polly & Pat, who are at the high end of the income scale but before you start getting to really crazy money – probably roughly typical of somebody planning for FIRE. These are just illustrative, and they avoid the complications that creep in at very high and very low levels of income.

Example 1 – Average Andy

Meet Andy – he’s pretty average. He’s 30 years old and makes £40,000 or $56,000 a year, pretty close to the median salary for a full-time employee in the US or UK. He’s single, doesn’t have any income outside his job, and contributes 5% to an employer pension (without salary sacrifice) or 401(k), reducing his taxable income to £38,000 or $53,200. We’ll ignore any employer matches, since those vary tremendously by job in both countries and don’t really impact the tax calculations.

Andy’s UK Taxes

Andy’s £40,000 breaks down like this:

  • Income Tax: £5,098
  • National Insurance: £3,660
  • Pension: £2,000 from Andy, £500 from HMRC as a tax benefit
  • Take Home Pay: £29,242

In total, Andy pays the government £8,758 and gets to keep £31,742 of his total £40,500 effective pay (since HMRC tops up his pension with £500). That’s a 21.6% overall tax rate. That’s also pretty much the end of the story – there’s no state tax and he gets the NHS thrown in for “free”. There are VAT and council tax, but those are based on consumption more than income, so we’ll ignore them.

Andy’s US Taxes

Andy’s $56,000 breaks down like this:

  • Federal Income Tax: $4,766
  • FICA (Medicare & Social Security): $4,284
  • 401(k): $2,800 from Andy – nothing directly from the IRS, but this income is deducted from his taxable income
  • Preliminary Take Home Pay: $46,950

Right now, we’re at Andy having an overall 16% tax rate. But wait! Andy might still need to pay state tax. This varies all over the place, from 0% to over 10%. Let’s split the difference and call it 5% – that just happens to be the actual income tax rate in Massachusetts, after the standard deduction (actually on the lower end if you rank them all out – not so bad for Taxachusetts!)

  • State Income Tax: $2,440

Now we’re at $44,510 (£31,792) – still doing better than UK Andy. But US Andy needs to pay for health insurance! This could be all over the place, depending on what (if anything) his employer offers. I found all kinds of numbers researching this post, but went with the Kaiser Family Foundation’s average employee contribution of $1,489 in 2019 for the employee part of individual health insurance.

  • Health Insurance: $1,489

That doesn’t account for any deductibles or other health spending not covered by his insurance – let’s assume Andy is perfectly healthy and fortunately doesn’t have to use it. That’s good, because average annual deductibles are typically in the thousands!

That leaves US Andy a $43,021 ($30,729) take home, and overall he gets to keep $45,821 (£32,729) of his $56,000 salary, for an overall 18.2% tax + health insurance rate.

Who wins, US or UK Andy?

To me, this is a tossup. US Andy gets to keep an extra £1,063 of his hard earned cash, but if he has any health issues, that’s coming right out of his pocket, at least until he hits his deductible.

However, he’s also contributing to the rather more generous US Social Security scheme, compared to the UK State Pension (I’ll do a post on this in the future, but simple version is that the max Social Security benefit at age 66 is about $3,148 a month, State Pension at age 68 is about £759.20 a month – both of those can increase by delaying, but State Pension isn’t going to catch up).

Either way, this isn’t a clear case of “UK taxes are way higher than the US” – they’re pretty close, especially once you put state taxes and health insurance into the equation.

Example 2 – Prosperous Polly & Pat

Polly is doing well – in the top few percent of the US or UK, earning £100,000 a year ($140,000), all from her job. Her spouse, Pat, mostly stays at home with their two kids, but has a small self-employed business earning £5,000 ($7,000). Polly contributes 5% a year to her pension/401(k).

Polly & Pat’s UK Taxes

Polly & Pat file their UK taxes separately, since there’s no such thing as a joint return:

CategoryPollyPatTotal
Income Tax£25,496£0£25,496
National Insurance£5,860£0£5,860
Pension£5,000 from Polly,
£3,333 from HMRC
£0£8,333
Take Home Pay£63,644£5,000£68,644

Pat & Polly pay the government £31,356 and gets to keep £76,977 of their total £108,333 effective pay (since HMRC tops up Polly’s pension with £3,333). That’s a 28.9% overall tax rate – a chunk more than Andy’s 21.6%. As with Andy, that’s about it – no state taxes, NHS included.

Polly & Pat’s US Taxes

Polly & Pat’s US taxes get lumped together, since they’re filing jointly:

  • Federal Income Tax: $12,053 (including 2 child tax credits at $2,000 each – this would change for 2021 with the recent increases to the child tax credit to $3,000 or $3,600 each, but for now it looks like that’s a COVID one-off for 2021)
  • Polly’s FICA: $10,596
  • Pat’s Self Employment Tax: $706 (half of this is deductible from the federal income tax, already included in the number above)
  • 401(k): $7,000 from Polly
  • Preliminary Take Home Pay: $116,645

So far, US Polly & Pat get to keep $123,645 of their $147,000 income, only a 15.9% tax rate compared to UK Polly & Pat at 28.9% – a big difference! But, let’s add in state tax – again assuming 5% Massachusetts flat tax:

  • State Income Tax: $6,460

And, let’s not forget health insurance – because it’s for a family, the rates go up:

  • Health Insurance: $5,726

And again, we’re assuming no deductibles actually get used – no emergency room visits from accidents with the kids, no health scares, etc.

Take off the state income tax and health insurance, and now we’ve got a take home of $104,459 – with the 401(k), US Polly and Pat get to keep $111,459, for an overall tax + health insurance rate of 24.2%.

Who wins, US or UK Polly & Pat?

This one is a bit further apart – in the UK, Polly & Pat are paying an effective tax rate of 28.9%, while in the US it’s only 24.2% – in the US, they get to keep more than £2,600 ($3,640) more of their hard earned money, about an extra £220 in their pocket every month.

Throw in a few medical expenses and you get pretty close, though – while the US probably comes out slightly cheaper here, I’d say that again it’s not a runaway winner.

Also, Polly’s pension/401(k) contributions are pretty low – she might be able to afford more. She probably won’t get out of the 40% band in the UK or the 22% bracket in the US, but every extra contribution makes a solid difference at those rates.

Implications for Americans in the UK

One thing these examples do reinforce is the common assumption that UK income taxes on any given bit of income are higher than US. That’s a useful simplifying assumption when thinking about your taxes, because it means, for most kinds of income, you’ll get a Foreign Tax Credit that is larger than what you owe the US, so you don’t actually owe anything.

That gets a little dicer for capital gains, dividends, and interest, since the UK has somewhat generous exemptions for these (up to £12,300, £2,000, and £1,000, respectively), where you won’t get FTCs for income that the US taxes.

On the whole, though, if you’re paying attention to how you earn and invest and making sure it’s friendly to both systems, you aren’t likely to owe Uncle Sam much, if anything. Various exceptions apply for specific situations, but it’s typically not far off!

Sources:

US Tax Calculator

UK Tax Calculator

10 thoughts on “US and UK Taxes – Which are higher?

  1. This is a great comparison between effective tax rates between US and UK. I’ve personally had similar results when looking at my situation and that of my dad. My dad still thinks he’s paying much higher taxes in the UK than if he was still living in the US. But he always forgets what he was paying for healthcare, Californian state tax and property taxes. All in all, his income tax works out almost the same, but he gets free NHS healthcare and as you say his social security is double the UK state pension. I’m currently trying to avoid a situation where I might not be able to reduce my US taxes to zero. It could happen if too much of my income is from dividends and at the same time withdrawing from a SIPP with 25% of the withdrawal tax free. One solution is to drag the SIPP withdrawals out over a lifetime, or else (my current plan) withdraw the SIPP quickly such that most of my income is purely from UK shares. This works well in the US (because it’s all qualified dividends and long-term capital gains but no ordinary income – until state pension kicks in) and works well in the UK (because dividends are protected by ISA, or if non-ISA wrapped then there’s the personal allowance, dividend allowance and 7.5% basic dividend tax rate).

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    1. I had one on my 2020 US taxes where I wound up “owing” AMT – that then got offset by the child tax credit, but my girls won’t stay children forever, and without them I would have been paying a few hundred dollars to the US. I’m confident the taxes are calculated correctly, but it’s something I want to explore some more and figure out a) how’d I wind up owing AMT, in a year that was pretty “normal” and b) how to plan around it for the future.

      Withdrawal strategies in general are something I want to look at in the future – I’ve got some vague ideas, but there are a lot of different options to mix and match, all with different tax treatments and eligibility ages (TSP, Roth IRA, UK pension, ISA, and taxable accounts) – it’s good to have options!

      I didn’t even include property tax, that’s all over the place, too. In my case, my Massachusetts property tax was almost exactly the same as my council tax is now, so it’s a wash. But you look at states with high income and property taxes (California, New Jersey, etc.) and it gets nuts, could easily see the total US taxes being more than the UK for the same income.

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      1. Your comment about AMT is interesting. That’s an unknown quantity to me, but I suspect it’s a stealth tax likely to hit more and more people. It looks like the calculation involves adding back foreign tax credits, which isn’t too clever if we’re relying on them to avoid double taxation…

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      2. You don’t fully add back the credits, but there’s some weird math that adjust them (I basically file each form 1116 twice, once with the “normal” calculations and once with “AMT”) – I wind up being able to use much less of the FTC under the AMT calculation method, need to figure out why. AMT makes my brain hurt though, way too much reading of IRS instructions and filling out similar forms using different data. A project for another day.

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  2. I wasn’t sure where it was best to ask this question, but it has to do with Foreign Tax Credits. I understand that you should try to pay any outstanding UK tax before 31 December (instead of 31 January), in addition to any PAYE, so that you can use this to offset US tax owed on the same income in the calendar year. However, HMRC bases it’s calculations on the UK tax year and it may relate to multiples types of income, e.g. dividends, interest, earned, pensions, etc. Also, your PAYE may (temporarily) be out of whack and your Self-Assessment payments on account actually relate to multiple tax years (past and future). So how do you break this tax bill up into the different categories for form 1116.

    Can you just divide the UK tax actually paid in calendar year 2021 (even if some of it may be payments on account or from a prior year) pro-rata across the sources of income (as calculated by the IRS) for the different categories on the 1116? I can’t see any other way of doing it, because each country has a completely different way of calculating tax. You could look at how the HMRC has calculated your tax, but that won’t relate to the same period of time… Perhaps I’m over-thinking it.

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  3. I don’t see any other way, either, and I struggle a bit with the timing part. Definitely agree that paying UK tax before 31 December makes things simpler (I’m in the process of doing a carry-back for a passive category FTC, and while it’s entirely doable, amended returns are a bit of a faff). But I don’t think it solves everything.

    General category is (I think) fairly easy: I report UK taxes actually paid in the calendar year, based on my pay stubs. That lines up nicely with the US tax year – it’s possible that PAYE is slightly off, but close enough I won’t lose any sleep over it, there’s enough UK tax that I’m not paying any US tax on general category even if PAYE is a bit off.

    Passive category is more challenging. The “easy” case is for income (capital gain, interest, dividend) from 01Jan to 05Apr (let’s say 2021, for illustration). After 06Apr, you do your Self Assessment and pay UK tax before the end of 2021. When you do your 2021 US taxes in early 2022, you know exactly how much UK tax was paid, no problem.

    But when the income comes 06Apr to 31Dec 2021, it’s less clear. You won’t do your UK Self Assessment until after April 2022, paying before the end of 2022. But when you do your US taxes in early 2022, you won’t actually have paid any UK tax on that income. Even if you file a US extension to late 2022, you’ll know how much UK tax you’ve paid on it, and have actually paid it, but you’ll have paid the UK tax in 2022, not in 2021. You could file 2021 US taxes without the UK passive income tax, then wait until you file 2022 US taxes to then generate excess FTCs and carry them back to 2021, but this is a pain.

    I’m starting to figure this out for my 06Apr-31Dec21 US & UK taxable dividends now (no capital gains this year), but haven’t come to a final conclusion. I think if you have reasonably consistent income year to year, you can just use the UK tax paid in 2021 (on 06Apr20-05Apr21 income) to the US taxes for 01Jan-31Dec21. And if your UK taxes are consistently higher than US, you’ll build up enough FTCs to cover it anyway. But if there are big inconsistencies/lumpy capital gains and/or if you’re routinely paying more US tax than UK (like if most of your passive category income is in an ISA, but there’s some UK taxable gain generating credits) it’s not entirely clear. Will keep working through it…another one where the form 1116 instructions aren’t super helpful. I’m confident it all comes out in the wash, but the mechanics of getting there aren’t super clear, and the carryback amendment path is just annoying.

    There is a section in IRS pub 514, page 13, about allocating foreign taxes if the foreign taxes aren’t specifically related to one income category. Looking at the examples, I don’t think it really applies to the UK – it’s clear that the UK taxes general category income differently & separately to passive category, and we should be able to figure out how much of our total UK tax applies to which category. But that’s my thinking, I don’t know it for sure!

    There is the wild card option of switching to the accrual basis of foreign taxes instead of cash basis, but I’ve seen David Treitel strongly recommend against this several times. I haven’t quite wrapped my head around why it’s so bad yet – if you made a capital gain on 01 May 21, you would accrue the UK tax at the time of the gain, even though you don’t pay it until after 06 Apr 22, and could apply that accrual to your 2021 US taxes. But I trust David’s opinion more than my own, so not doing that!

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    1. Amen to al that. As you say, I’m working on the basis that if income stays fairly regular then there shouldn’t be any issue if our calculations were ever investigated (unlikely, but theoretically possible). Most importantly I’ll make sure never to claim more FTCs than I actually paid in tax to HMRC in the calendar year. Also, if there is a one-off taxable event, then I’ll make sure to handle this separately (e.g. a property sale, large pension withdrawal, or whatever). Looking at my dad’s last couple years, his effective tax rate has not changed very much. In general, the way the US taxes different types of income is not all that different to the UK. One interesting effect of the treaty is that my dad’s social security can be completed excluded from his US tax return, but is fully taxed in the UK. So I just need to make sure I’m not claiming any FTCs that were in fact paid on the excluded income. Unfortunately, it doesn’t work the other way around. I presume my UK state pension will need to use FTCs, as it will be taxable in both places.

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  4. That all sounds reasonable. It’s the one-off taxable event that I haven’t quite figured out how to do easily – that’s why I’m doing my carryback amendment. It seems like the simplest solution is just planning any one-off taxable events for 01Jan to 05Apr, if you can. Seems bizarre, but nothing surprises me now about US taxes.

    It is good the US and UK tax regimes line up pretty well for passive and general buckets, and the differences don’t really matter for FTCs (no UK equivalent to qualified vs ordinary/short vs long term, different UK tax for capital gains vs dividends, etc.).

    The social security vs state pension one is an odd feature of the tax treaty. I expect I’ll have both social security and state pension, making sure I only apply state pension FTCs to the US tax may get a little interesting, but that’s a problem for future me in 30ish years – who knows how the rules will have changed by then, anyway?

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    1. One thing I’ve figured out is to try and do things the same side of the 5th April each year. So it doesn’t matter when you make an RMD, but always do it before (or after) the 5th. Otherwise you end up having two RMDs in one UK tax year (and none in the another) – doh!

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