ISAs and US tax: why the UK's favorite tax shelter backfires on Americans

An ISA is tax-free in the UK and fully taxable to the IRS, and putting UK funds in one can make things a lot worse.

The short version

• ISAs are a UK-only tax break. The US-UK tax treaty doesn't cover them, so the IRS taxes interest, dividends and gains inside an ISA every year.
• No UK tax means no foreign tax credit. That's what makes an ISA worse for an American than a plain taxable account in some cases.
• UK funds, ETFs and investment trusts are usually PFICs for US tax purposes, with punitive tax rules and a Form 8621 for each fund in many cases [1].
• ISAs still count for FBAR and possibly Form 8938 [2].
• What Americans do instead: lean on UK workplace pensions, which the treaty does cover, hold individual stocks or cash, and keep US retirement accounts going where they can.

USD conversions in this guide use the Federal Reserve H.10 rate of October 30, 2026 (USD 1.3398 per GBP), rounded. This is general information; a US expat tax preparer can check your situation.

What an ISA is, and why Brits love it

An Individual Savings Account is a UK wrapper that shields savings and investments from UK tax. There are four main types: cash ISAs, stocks and shares ISAs, innovative finance ISAs and Lifetime ISAs [3]. For 2026/27, you can put up to £20,000 (about USD 26,800) a year across all of them [3].

The Lifetime ISA is aimed at first-time buyers and retirement. You can open one if you're 18 or over and under 40, put in up to £4,000 (about USD 5,360) a year until 50, and the government adds a 25% bonus of up to £1,000 (about USD 1,340) a year [4]. Take the money out for other reasons and you face a withdrawal charge.

For a British taxpayer, ISAs are a no-brainer. For you, the picture changes, because of citizenship-based taxation: Uncle Sam taxes your worldwide income no matter where you live, and he only respects a foreign tax shelter when a treaty or IRS rule says so.

Why the IRS ignores the ISA wrapper

The US-UK tax treaty has generous rules for pensions. Article 18 lets income build up inside a UK "pension scheme" without US tax until it's paid out [5]. An ISA isn't a pension scheme, and nothing else in the treaty covers it. So for US purposes:

• Interest in a cash ISA is taxable each year, just like interest on a regular UK savings account.
• Dividends are taxable each year.
• Capital gains are taxable when you sell, even if the money never leaves the ISA.
• The Lifetime ISA bonus is a government payment with no US exclusion, and many preparers treat it as taxable income.

The foreign tax credit problem

Most Americans in London pay more tax to HMRC on their salary than they'd owe the IRS, and foreign tax credits wipe out the US bill. Investment income works the same way: if HMRC taxes your dividends, you can usually credit that UK tax against your US tax.

Inside an ISA, there's no UK tax to credit. So the US tax on ISA income is often a real, out-of-pocket cost, while a regular taxable account might have produced UK tax you could have credited. Your excess credits from salary can sometimes help, depending on the category of income, but don't count on it without running the numbers.

Is an ISA a foreign trust?

Unlike the Canadian TFSA, an ISA is generally treated as an ordinary custodial account rather than a foreign trust, so most practitioners don't file trust forms for it. The IRS hasn't issued ISA-specific guidance, though, so confirm how your preparer reports it.

The real trap: UK funds are PFICs

This is where ISAs go from mildly annoying to genuinely expensive. Most stocks and shares ISAs are filled with UK or Irish-domiciled funds: index funds, ETFs, multi-asset funds and investment trusts. For US tax, almost all of them are passive foreign investment companies (PFICs), meaning foreign corporations that mostly earn passive income.

Under the default PFIC rules, gains and larger distributions are spread back over your holding period, taxed at the top ordinary income rate for each year and hit with an interest charge. Elections can soften this. A qualified electing fund (QEF) election requires an annual statement from the fund, which most UK funds don't provide, and a mark-to-market election taxes paper gains every year. Either way, each fund usually means its own Form 8621 [1], and that means bigger preparer bills.

The ISA wrapper changes none of this. A PFIC inside an ISA is still a PFIC.

What you have to report

What Americans in the UK do instead

There's no perfect answer, but these are the common approaches. Run them past a US expat tax preparer before you commit.

1. Max out the workplace pension first. UK pensions are covered by Article 18 of the treaty, so growth generally isn't taxed by the US until you draw it, and employer contributions can be protected too [5]. Funds held inside a treaty-covered pension are widely treated as sheltered from the worst PFIC pain, though practitioners differ on the details. See our guide to UK pensions and US tax.
2. Hold individual stocks rather than funds. A share in a single UK or US company isn't a PFIC. You can hold them in an ISA (for the UK tax break) or a regular account.
3. Keep cash ISAs small and simple. Interest is taxable to the US, but there's no PFIC risk. It mostly saves you UK tax.
4. Keep US accounts alive. If you still have a 401(k) or IRA, leave it in place. Some US brokerages restrict or close accounts for customers with foreign addresses, so ask before you move.
5. Be careful with US-listed ETFs. They aren't PFICs for you, but UK retail rules have long made them hard to buy through UK platforms. And many don't have UK "reporting fund" status, which means HMRC can tax gains on them as income rather than as capital gains. It's a trade-off between two tax systems.

Already have an ISA full of funds?

Don't panic, and don't sell everything in a rush. Selling triggers the PFIC calculation you were trying to avoid, and the order of events matters. If you haven't been reporting it, the IRS's Streamlined Filing Compliance Procedures exist for people whose mistakes weren't willful. A US expat tax preparer can map out the cleanest fix.

Curious what other Americans in London actually hold? It's a regular topic in our community group for Americans in the UK.

Sources

1. About Form 8621, Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund, IRS
2. Comparison of Form 8938 and FBAR requirements, IRS
3. Individual Savings Accounts (ISAs), GOV.UK
4. Lifetime ISA, GOV.UK
5. Convention between the United States and the United Kingdom for the avoidance of double taxation (2001), schedule to the UK order, legislation.gov.uk

Keep reading

• UK pensions and US tax
• UK taxes for Americans: how they fit with your US return
• PFICs: why foreign funds hurt Americans
• US brokerage accounts while living abroad