Introduction: Why Alphabet Shares Work Differently for American Shareholders
Alphabet shares let a UK family company pay different dividends to different shareholders, and for a British owner-manager they are one of the most common planning tools in the country. However, if you hold a US passport, the same structure is judged by two tax systems at once. HMRC tests it against the settlements code, while the IRS applies its own rules on who earns the income, whether the company is a controlled foreign corporation, and which forms you must file each year.
At TaxYork, we regularly meet American founders whose accountant set up alphabet shares without asking about citizenship. The UK paperwork is usually tidy. The US side, by contrast, is often missing entirely: no Form 5471, no controlled foreign corporation analysis and no thought about how a share class issued to a British spouse changes the American return.
Alphabet Shares and the Two Tax Systems You Answer To
The core problem is simple. Alphabet shares are a UK income-splitting device, whereas the United States taxes its citizens on worldwide income wherever they live. Consequently, a structure that saves British tax can leave the US bill untouched, increase it, or create reporting duties that carry a $10,000 penalty per form. Furthermore, the two systems ask different questions. HMRC asks whether the owner has diverted income to a family member. The IRS, meanwhile, asks who owns the votes and the value of the company, and how its earnings would be shared between the classes.
Who This Guide Is For
This guide is written for American citizens and green card holders who own, or are about to own, a UK limited company with more than one class of share. In particular, it speaks to founders married to British spouses, investment bankers and consultants trading through a personal company, and families with adult children on the share register. If you already hold alphabet shares and have never filed a US international information return for the company, the later sections on missed reporting apply directly to you.
How Alphabet Shares Work Under UK Company Law
Alphabet shares are simply separate classes of share, labelled A, B, C and so on, each carrying its own rights to dividends, votes and capital. The company's articles of association set those rights. Therefore, the directors can declare a dividend of £50 per share on the A class and nothing on the B class in the same year, provided the articles allow it.
Class Rights, Articles and Section 629
Under section 629 of the Companies Act 2006, shares form one class only if the rights attached to them are uniform. Accordingly, genuine alphabet shares need genuinely different rights written into the articles. A company that merely renames ordinary shares as A and B, with identical rights, has one class in law. In that case, a board resolution paying different amounts to each letter is open to challenge by the other shareholders and, more importantly for tax, by HMRC.
Declaring Different Dividends on Each Class
In practice, well-drafted articles give the board discretion to declare dividends on any class independently. Additionally, most modern structures give each class full voting and capital rights, so the only difference is dividend flexibility. That design matters on both sides of the Atlantic, as later sections show. By contrast, cheaper "dividend-only" classes with no votes and no share of the sale proceeds are exactly the arrangements that HMRC and the IRS both treat with suspicion.
Distributable Reserves Set the Ceiling
Every dividend must come from distributable profits under Part 23 of the Companies Act. Notably, HMRC's guidance at TSEM4225 treats insufficient reserves as a key warning sign. If the company could not have paid the same rate on every share, HMRC infers that one family member's dividend was really another's income. As a result, you should check reserves before every declaration on alphabet shares, not just at the year end. Profits now face corporation tax at 19% to 25% before any dividend is paid, so reserves are post-tax figures.
HMRC and the Settlements Code
The settlements legislation in Part 5, Chapter 5 of the Income Tax (Trading and Other Income) Act 2005 is HMRC's main weapon against income splitting. Under section 624 of ITTOIA 2005, income arising under a "settlement" from which the settlor or their spouse can benefit is taxed on the settlor. Importantly, "settlement" is defined broadly enough to include any arrangement, so issuing a new share class to your husband or wife is squarely within scope.
The Spouse Exemption and Jones v Garnett
The escape route is section 626 of ITTOIA 2005, which exempts an outright gift between spouses, provided the property is not "wholly or substantially a right to income". In the Arctic Systems case, Jones v Garnett, decided by the House of Lords in 2007, a wife's ordinary shares carried full voting and capital rights. Consequently, the gift was outright and the exemption applied. Therefore, alphabet shares issued to a spouse with votes and a full share of capital on a sale generally sit inside the exemption.
Dividend-Only Shares Fail the Exemption
By contrast, a class that carries dividends but no votes and no capital entitlement is, almost by definition, "wholly or substantially a right to income". In that case, section 626 fails and the dividends are taxed on the founder at their own marginal rate. For 2026/27, UK dividend tax rates are 10.75% at basic rate, 35.75% at higher rate and 39.35% at additional rate, with only a £500 dividend allowance. Hence, a successful HMRC challenge can reclaim years of saved tax, plus late-payment interest and penalties.
Minor Children and Spotlight 62
Dividends on alphabet shares held by your unmarried minor children are taxed on you under section 629 of ITTOIA 2005 once they exceed £100 a year per child. Furthermore, HMRC's Spotlight 62 on dividend diversion to fund school fees targets arrangements where a new class of shares reaches a grandparent or sibling at an undervalue, with dividends then used for the owner's children. HMRC's stated view is that the owner is the real settlor. We therefore advise American clients to steer well clear of these arrangements.
The New Self Assessment Boxes Expose Every Structure
From 2025/26 returns, the Income Tax (Additional Information to be included in Returns) Regulations 2025 require directors of close companies to report the company name, registration number, dividends received and their highest shareholding percentage in the year. Notably, the percentage is measured by nominal value, so a founder holding alphabet shares may report a low percentage while taking most of the dividends. That mismatch is precisely the pattern HMRC's systems can now spot. In addition, a fixed £60 penalty applies where the director information is left out.
How the IRS Sees Alphabet Shares
The IRS does not recognise the settlements code at all. Instead, it taxes the legal and beneficial owner of shares on dividends paid to them, subject to its own assignment-of-income doctrine. Therefore, the US result depends mainly on whether your spouse or child is also a US person. For a deeper look at the related technique of waiving dividends, see our guide to dividend waivers for American shareholders.
Qualified Dividends and the Net Investment Income Tax
Dividends from a UK company generally count as qualified dividends, because the United Kingdom has a comprehensive income tax treaty with the United States. As IRS Topic 404 explains, qualified dividends are taxed at 0%, 15% or 20%. For 2026, the 20% rate starts above $545,500 of taxable income for single filers and $613,700 for joint filers. Additionally, the 3.8% net investment income tax applies above $200,000 (single), $250,000 (joint) or $125,000 (married filing separately). Crucially, following the Federal Circuit's August 2026 decisions, UK tax cannot be credited against that 3.8% charge.
A Non-American Spouse Changes the US Arithmetic
If your spouse is British and not a US person, dividends paid on their alphabet shares are, for US purposes, their foreign-source income. The IRS generally has no claim on it. As a result, moving dividends from your class to theirs reduces your US gross income, your adjusted gross income and, therefore, your net investment income tax. For many high earners filing separately, this is where the real American saving lies, because the UK tax on dividends already exceeds the 15% or 20% US rate and the foreign tax credit clears regular US tax anyway.
When Both Spouses Are American
However, if both spouses are US citizens, splitting dividends between their alphabet shares achieves little in America. Married couples filing jointly are taxed on combined income, so the US bill is the same whichever class receives the money. In that situation, the benefit is purely British. Similarly, if your British spouse has made a section 6013(g) election to be treated as a US resident, their dividends come straight back into the joint US return.
The Foreign Tax Credit Trap When HMRC Wins
The most dangerous outcome arises when HMRC succeeds under section 624 but the IRS still regards your spouse as the owner. HMRC then taxes you on your spouse's dividend, yet that income never appears on your US return. Consequently, the extra UK tax has no matching US income, and it lands in your passive category as an excess credit on Form 1116. Since UK dividend rates already exceed US rates, those excess credits rarely get used before their ten-year carryforward expires. In short, a failed structure costs you twice.
Controlled Foreign Corporation Rules and Share Classes
The biggest US issue with alphabet shares is not the dividend itself. Rather, it is the controlled foreign corporation regime, which can tax an American owner on company profits before any dividend is declared. Therefore, the way you divide votes and value between classes directly shapes your US compliance.
Vote or Value: The 10% and 50% Tests
A US person owning 10% or more of the total vote or total value of a foreign company is a "US shareholder". A foreign company is a controlled foreign corporation (CFC) when US shareholders together own more than 50% of the vote or the value. Notably, the test is vote OR value, so a founder cannot escape it by holding voting A shares while giving the value to someone else, or vice versa. Moreover, the value of alphabet shares is judged economically, not by nominal value, which is the opposite of the new UK tax return box.
Why a British Spouse's Shares Are Not Attributed to You
US constructive ownership rules normally treat you as owning your spouse's shares. However, section 958(b)(1) of the Internal Revenue Code switches that off for stock owned by a nonresident alien. Accordingly, shares held by a British spouse who is not a US person are not counted as yours when testing CFC status. This is a powerful and widely missed point. A genuine 50/50 split of votes and value between an American founder and a British spouse means US shareholders own exactly 50%, not more than 50%, so the company is not a CFC. By contrast, if your spouse is American, family attribution applies in full and the split changes nothing.
How the IRS Allocates Income Between Classes
Where the company is a CFC with more than one class, Treasury Regulation 1.951-1(e) allocates its earnings by a hypothetical distribution on the last day of the year. Specifically, each class receives what its distribution rights would give it, judged on all the facts, including the class terms, any shareholder agreement and, where appropriate, relative market values. Actual dividends paid during the year are ignored. Furthermore, paragraph (e)(6) disregards any arrangement with a principal purpose of shifting earnings between classes to avoid US tax. Therefore, board discretion over alphabet shares does not let you steer the US inclusion towards a non-American family member.
NCTI, the High-Tax Exclusion and Form 8992
From 2026, the old GILTI regime is called net CFC tested income (NCTI). An individual owner of a UK trading company can often exclude the income entirely through the high-tax exclusion election, because UK corporation tax at 25% exceeds the 18.9% threshold. Alternatively, a section 962 election gives access to the 40% deduction and a 90% deemed-paid credit. Either way, the calculation still has to be reported annually on Form 8992. As a result, a CFC with alphabet shares creates a recurring filing burden even when no US tax is due.
Alphabet Shares for Employees and Adult Children
Beyond spouses, founders often issue alphabet shares to key staff or grown-up children. Each group raises its own US and UK issues, and the rules for staff are particularly unforgiving.
Employment-Related Securities and Section 83
When shares go to an employee or director because of their job, the UK employment-related securities rules apply. In PA Holdings, the Court of Appeal held that dividends on a special class issued to staff were really earnings, taxable with national insurance. For an American employee, section 83 of the Internal Revenue Code adds a parallel charge on shares received for services. Importantly, the UK section 431 election has a 14-day window, whereas the US section 83(b) election has 30 days. Our guide to growth shares for American founders explains how to meet both deadlines.
Adult Children With US Passports
Adult children fall outside section 629, so dividends on their alphabet shares are usually their own income in the UK, provided the shares are a genuine outright gift. However, a child born to an American parent is often a US citizen too. In that case, the child must file a US return, report the dividends and possibly Form 5471 if their holding reaches 10%. Moreover, their shares are attributed to you under the family rules, so they can push the company into CFC status rather than out of it.
Missed Reporting on Alphabet Shares
Many American owners have run alphabet shares for years without a single US information return. This is common, it is fixable and, crucially, it keeps your US tax assessment period open until you file.
Form 5471, Form 8938 and FBAR
Form 5471 is due every year you are a 10% US shareholder of a CFC, and in the year you acquire a 10% stake in any foreign company. The penalty is $10,000 per form per year, and the statute of limitations on your whole return stays open until the form is filed. In addition, the shares are specified foreign financial assets for Form 8938 once thresholds are met, which for Americans living abroad start at $200,000 at year end for single filers. The IRS's comparison of Form 8938 and FBAR requirements sets out the overlap. Furthermore, if you own more than 50% of the company, you have a financial interest in its bank accounts and must include them on your FBAR filed with FinCEN.
Putting Missed Returns Right
If you have missed these filings through ignorance rather than intent, you can generally catch up without the heaviest penalties. For individual returns, our IRS Streamlined Filing service handles the three years of returns and six years of FBARs required. Where only information returns are missing, the delinquent international information return route may be more suitable. Either way, we prepare the Form 5471s, rebuild the company's earnings and profits in US terms, and make any high-tax exclusion elections needed. Our FBAR and FATCA reporting team then brings the account reporting up to date.
Case Study: Rachel's London Consultancy
This illustrative example shows how alphabet shares play out for an American founder married to a British spouse. The figures use 2026/27 UK rates and an assumed exchange rate of $1.35 to the pound.
The Structure Rachel Was Sold
Rachel is a US citizen living in London. She owned all 100 ordinary shares in her consultancy, which makes pre-tax profits of £420,000 and pays £105,000 of corporation tax. She takes a £12,570 salary and needs £200,000 of dividends a year. Her husband, Daniel, is British only and has no other income. In 2026, a UK adviser created alphabet shares: Rachel kept 100 A shares with all the votes and capital, and the company issued 100 B shares to Daniel with dividend rights only.
The UK and US Numbers
If Rachel took the full £200,000, her UK income tax would be about £70,825. Split evenly, Rachel's bill falls to about £29,100 and Daniel's is about £21,777, a combined £50,877. On paper, the family saves roughly £19,950 a year. On the US side, Rachel's dividends fall from $270,000 to $135,000. Since she files separately, her 3.8% net investment income tax drops from about $6,155 to about $1,025. However, Daniel's B shares carried no votes and no capital, so section 626 could not apply. Consequently, HMRC could tax the whole £200,000 on Rachel, removing the UK saving and adding interest. Meanwhile, the extra UK tax would sit on income the IRS still treats as Daniel's, so it would strand as unusable foreign tax credit. Moreover, Rachel still held 100% of the votes, so the company remained a CFC and she had missed two years of Form 5471 and Form 8992.
The Restructure That Worked
We worked with Rachel's UK accountant to convert the structure so that Daniel's B shares carried full voting rights and half of the capital on any sale. Therefore, the shares became an outright gift of real ownership, placing them within the section 626 exemption. On the US side, Rachel now owns exactly 50% of the vote and value, and Daniel's shares are not attributed to her. As a result, the company stopped being a CFC, and her annual Form 8992 fell away once the final CFC year was filed. We also filed her missed returns through the non-wilful route. Overall, the family keeps the £19,950 UK saving and the $5,130 US saving, with the risk removed. Before making such a change, we review the separate US reporting that can follow any transfer of value to a spouse.
How TaxYork Can Help
TaxYork provides comprehensive US and UK tax return preparation for American owners of UK companies. We model alphabet shares on both sides before any class is issued, test votes and value under the CFC rules, and prepare your Form 1040, Form 5471, Form 8992, Form 8938 and FBAR each year. Additionally, our US tax returns for expats service coordinates the UK dividend tax with your foreign tax credit, while our US-UK treaty and double tax relief team makes sure every pound of UK tax works as hard as possible. If you are planning an exit, our guide to UK share buybacks for American owners explains how share classes affect the US result on sale.
Conclusion
Alphabet shares can save a British family meaningful tax, but for an American shareholder they are never a purely UK decision. The settlements code decides whether HMRC respects the split. Meanwhile, the IRS applies separate tests on who owns the income, whether the company is a CFC and how earnings are allocated between classes. In our experience, the best structures give every class real votes and real capital, keep a non-American spouse's holding at a level that avoids CFC status, and are reported fully in both countries from day one. Above all, if you already hold alphabet shares without US filings, act now, because the assessment window stays open until you do.
Contact Us
If you own a UK company with alphabet shares, or are about to create them, speak to specialists who prepare both sides of the return. Please book a consultation with the TaxYork team today. You can also email hello@taxyork.com or call 020 3488 8606.
Disclaimer
This article provides general information about the US and UK tax treatment of alphabet shares as at September 2026 and does not constitute tax, legal or financial advice. Tax rules change frequently, and the right answer depends on your personal circumstances. The case study is illustrative, uses assumed figures and simplified calculations, and does not describe a real client. Please obtain professional advice tailored to your situation before acting on any information in this article.