If you’ve got a UK ISA and you’re living in the U.S., or you’re an American who inherited one, you’re probably wondering: Are ISAs taxable in the USA? The short answer is yes - and that’s not just a little yes. It’s a full, complicated, IRS-level yes. The IRS doesn’t recognize ISAs as tax-advantaged accounts. To them, it’s just another investment account. That means every bit of growth, every dividend, every interest payment inside your ISA could be taxable income - even if you never touched the money.

How the IRS Sees Your ISA

The UK government treats ISAs (Individual Savings Accounts) as tax-free wrappers. You put money in, it grows, you take it out - no tax. But the U.S. tax system doesn’t care about UK labels. It looks at substance, not names. So if your ISA holds stocks, bonds, mutual funds, or cash that earns interest, the IRS treats it like any other foreign brokerage account. And that’s where things get messy.

Here’s how it breaks down:

• Interest income from cash ISAs is taxed as ordinary income, just like a U.S. savings account.
• Dividends from stocks inside a Stocks and Shares ISA are taxed as ordinary income - not at the lower qualified dividend rate.
• Capital gains from selling investments inside your ISA are taxed in the year they happen, not when you withdraw. There’s no step-up in basis at death for U.S. tax purposes.
• Foreign financial accounts over $10,000 at any point in the year trigger FBAR reporting requirements.
• Passive Foreign Investment Companies (PFICs) - which include most UK mutual funds and ETFs - are a nightmare. They’re taxed at punitive rates with interest charges on deferred taxes.

Let’s say you opened a Stocks and Shares ISA in 2020 with £20,000. By 2025, it’s worth £30,000. You didn’t sell anything - you just let it grow. The IRS still wants you to report and pay tax on the $10,000 gain. And if any of those holdings are UK-based funds, you might owe even more because of PFIC rules. Most people don’t realize this until they file their taxes and get hit with a surprise bill.

PFICs: The Silent Tax Trap

One of the most dangerous parts of holding a UK ISA in the U.S. is PFICs. A Passive Foreign Investment Company is any foreign corporation where 75% or more of its income is passive (like dividends or interest) or 50% or more of its assets produce passive income. Most UK mutual funds, index trackers, and ETFs fall into this category.

The IRS treats PFICs like a tax trap. If you own shares in one, you have two bad choices:

1. Mark-to-Market election: You report annual gains as ordinary income, even if you didn’t sell. This can create phantom income - you owe tax on paper gains you never cashed out.
2. Qualified Electing Fund (QEF) election: You get annual statements from the fund showing your share of income and gains. But most UK funds don’t provide these. If they don’t, you’re stuck with the worst option.
3. Default treatment: When you sell, you pay tax on the entire gain at the highest ordinary income rate - plus interest charges for every year the tax was deferred. This can turn a 20% capital gain into a 40%+ effective tax rate.

Real example: A U.S. taxpayer held a UK Vanguard Equity Index Fund inside their ISA. The fund grew 50% over five years. When they sold it, they owed $12,000 in back taxes and interest - even though they’d paid zero tax in the UK. The fund didn’t provide QEF statements. No one warned them.

FBAR and FATCA: The Reporting Nightmare

It’s not just about taxes. You also have to report your ISA to the U.S. government. If the total value of all your foreign financial accounts - including your ISA - exceeds $10,000 at any time during the year, you must file an FBAR (FinCEN Form 114). This is separate from your tax return. Failing to file can cost you $10,000 per violation.

Then there’s FATCA. Your ISA provider might be required to report your account balance and transactions to the IRS under the U.S.-UK intergovernmental agreement. That means the IRS already has your data. If you didn’t report it, you’re not hiding - you’re just making a mistake that looks like fraud.

What About ISA Contributions?

When you put money into your ISA from a U.S. bank account, the IRS doesn’t care where the money came from. It’s not deductible. It’s not a gift. It’s just a transfer. You’ve already paid U.S. tax on that income when you earned it. But the growth? That’s new income. And the IRS wants its cut.

There’s no way to “pre-pay” U.S. tax on ISA contributions. No special form. No exemption. No treaty override. The U.S.-UK tax treaty doesn’t cover ISAs. It covers pensions, social security, and a few other things - but not these.

What Should You Do?

If you’re already holding an ISA and you’re a U.S. taxpayer, here’s what you need to do:

1. Stop adding new money. Every dollar you add now creates more future tax liability.
2. Review your holdings. If you own any UK mutual funds or ETFs, they’re likely PFICs. Talk to a cross-border tax specialist - not your regular accountant.
3. File past FBARs if you missed them. The IRS has amnesty programs for people who didn’t know they had to file.
4. Consider closing the ISA. If you’re not planning to return to the UK, liquidating and moving the money to a U.S.-based brokerage might save you thousands in penalties and interest down the road.

Some people think they can ignore it. They assume the UK tax-free status protects them. It doesn’t. The IRS doesn’t care what the UK says. It only cares what U.S. law says. And U.S. law says: foreign investment growth = taxable.

Alternatives for Americans Living in the UK

If you’re an American living in the UK and want to save tax-efficiently, here’s what actually works:

• U.S.-based Roth IRA: Contributions are made with after-tax dollars. Growth and withdrawals are tax-free. You can contribute up to $7,000 in 2025 if you’re under 50.
• U.S. 401(k) or employer plan: Even if you work for a UK company, you might still be eligible if they offer a U.S.-compliant plan.
• U.S. brokerage accounts with U.S. ETFs: Avoid UK funds. Stick to Vanguard, iShares, or Schwab ETFs listed on U.S. exchanges. These aren’t PFICs.

You can still use a UK ISA if you want - but treat it like a regular investment account. Don’t assume it’s tax-free. Track every transaction. Keep records. And get professional help before you file.

Bottom Line

ISAs are not tax-free in the USA. They’re a tax liability waiting to happen. The UK treats them like a gift. The IRS treats them like a surprise audit. If you’ve got one, you’re not alone - but you’re also not protected. The longer you wait to fix this, the worse it gets. Start with your tax records. Talk to a CPA who understands cross-border rules. Don’t let a UK savings account turn into a U.S. tax disaster.