Navigating U.S. and UK Tax Systems as an Expat
When a U.S. citizen or Green Card holder lives and works in the UK, they are caught between two tax systems that both claim the right to tax their worldwide income. For these individuals, the Foreign Tax Credit (FTC) and the U.S.-UK Tax Treaty are the primary tools used to avoid double taxation.
However, the IRS often issues a Notice of Deficiency (Letter 531 and/or CP2319A) when there is a technical disagreement over how these tools were applied. This article explains the technical landscape for expats facing these audits and provides guidance on steps to respond appropriately.
Who Is at Risk for a "Sourcing" Audit?
U.S. taxes are based on citizenship, while the UK taxes are based on residency. This conflict is most relevant to U.S. expats in the UK, digital nomads and business travelers working across multiple countries, and investors with U.S. assets. These individuals may pay foreign taxes while still being required to report their global income or U.S.-sourced earnings to the IRS.
Sourcing vs. Residency
The IRS frequently audits the Foreign Tax Credit when it suspects income has been mis-sourced. U.S. law generally sources wages based on where the work is physically performed, yet a paycheck from a U.S. company may trigger an assumption of U.S.-sourced income. This can lead the IRS to disallow UK tax credits if no proper treaty election is made.
Re-Sourcing via Treaty (Article 24)
The U.S.-UK Tax Treaty (Article 24) provides a mechanism called "Re-Sourcing" that allows a UK resident to treat what would normally be U.S.-source income as foreign-source for the purposes of the Foreign Tax Credit. To claim this, Form 8833 (Treaty-Based Return Position Disclosure) must be filed. Failing to include this form is a major audit trigger.
The "150-Day Rule" for Expats
If the IRS disagrees with your filing, they will send a Notice of Deficiency. While often called a "90-day letter," U.S. expats have 150 days from the date of the notice to file a petition with the U.S. Tax Court. This deadline is set by law and cannot be extended by the IRS or the Taxpayer Advocate Service.
Missing this window means the IRS will automatically assess the tax, leaving you with only the option to pay the full amount and sue for a refund later. Timely action is therefore critical to protect your rights and avoid unnecessary penalties.
Key Evidence for Appeals
Physical Presence Logs
Maintain a day-by-day calendar showing exactly where you were (UK, U.S., or elsewhere) when each dollar was earned. This is the foundation for establishing the "place of performance" for income sourcing purposes.
HMRC Substantiation
Include official SA302 tax calculations and proof of payment from the Government Gateway to verify that foreign taxes were actually paid.
Travel Records
Flight itineraries, hotel receipts, and other travel documents should back up the physical presence log, proving your location on relevant dates.
Employment Contracts or Consulting Agreements
Provide copies of contracts that explicitly state the work location is outside the UK. This supports your claim that the income should be treated as foreign-sourced.
Employer/Client Verification Letters
Obtain signed letters from employers or clients confirming that services for specific projects were performed while physically present abroad.
Digital Footprints & Meeting Logs
Timesheets, calendar events, and other logs showing detailed hours worked on specific dates from a foreign office can help substantiate the work location.
Proof of Foreign "Tax Home"
Provide tenancy agreements, utility bills, and evidence of registration with local authorities or healthcare providers to substantiate bona fide residence outside the U.S.
Form 12661 (Disputed Issue Verification)
If requesting an audit reconsideration, this form allows you to formally explain each disputed item and attach supporting evidence.
Correspondence with Foreign Tax Authorities
Include any letters from foreign tax authorities confirming your residency status or tax liability for the relevant year.
Currency Conversion Records
Maintain a spreadsheet showing the exchange rates used for each income payment, backed by a recognised source such as the Bank of England, OANDA, or other financial institutions.
The "Nexus" Argument
Demonstrate the connection between the income and the foreign location, especially if working for a U.S. company, by showing the individual was genuinely working and integrated into the local environment abroad, not merely on vacation.
The "Small Tax Case" Procedure
For deficiencies of $50,000 or less (including the common $15,000–$20,000 range), taxpayers can choose the Small Tax Case (S Case) procedure. This is less formal, faster, and designed for taxpayers to represent themselves without needing a high-priced attorney. However, the decision rendered in an S Case is final and cannot be appealed to a higher court.
The Small Tax Case procedure is conducted before a single Tax Court judge, with simplified rules of evidence and procedure compared to a regular Tax Court trial. Taxpayers are encouraged to submit clear documentation and a concise explanation of their position. While representation by an attorney or enrolled agent is allowed, many expats use the procedure to present their case personally, which can save time and legal costs. This approach is particularly useful for disputes involving foreign tax credits or sourcing issues, where the evidence is mostly documentary rather than testimonial.
Need help with your IRS Notice of Defiance?
If you need more help after recieving an IRS notice of defiance it is always best to speak to a Tax Professional. Do not heistate to Contact Us, we have over 20 years experience in helping U.S. expats with any issue related to dual tax filings.