Do I have to file a US tax return for a year I spent on garden leave in London?

Yes. US citizens and green card holders must file on worldwide income, and garden leave salary is wages even though you did no work. HMRC treats it as ordinary earnings taxed through PAYE, and the IRS expects it on Form 1040 for the calendar year of payment. UK tax paid can usually be claimed as a foreign tax credit, so filing is often required even where no US tax is ultimately owed.

Is garden leave pay treated differently from PILON by HMRC?

Garden leave pay is salary for the notice period and is taxable as earnings under section 62 ITEPA 2003 because the employment continues. PILON ends the employment early. Since 6 April 2018, the post-employment notice pay rules treat the basic pay element of any termination payment as fully taxable earnings, with no access to the 30,000 pound exemption. Only a genuine termination award above that element can use the threshold.

How is garden leave pay sourced if I move to the US during my notice period?

US regulations source employee pay on a time basis by days of services performed inside and outside the United States, but garden leave involves no services, and there is no IRS guidance specific to it. The position must be reasoned from the contract, settlement terms and travel records. If part is treated as US source, the UK tax on that part may not be fully creditable, creating a risk of double taxation.

Which catch-up route is best for missed US tax returns from a garden leave year?

If you lived abroad, meet the 330-day non-residency test and your failure was non-willful, the Streamlined Foreign Offshore Procedures let you file three years of returns, six years of FBARs and Form 14653 without failure-to-file, failure-to-pay or FBAR penalties. If only one year is missing, FBARs are current and no tax is due, a late return with a reasonable-cause statement may be enough.

What penalties apply if I owe US tax for the missed garden leave year?

The IRS failure-to-file penalty is 5 percent of unpaid tax per month or part month, capped at 25 percent, with a minimum penalty for returns more than 60 days late. The failure-to-pay penalty is 0.5 percent per month and interest runs from the original due date. Reasonable-cause relief or first-time abatement may reduce penalties. Where UK tax fully offsets US tax, penalties based on unpaid tax are usually nil.

Missed US Tax Returns: Garden Leave Pay for UK Bankers

Q: Can I use the Foreign Earned Income Exclusion on garden leave pay?

Potentially, if the pay is foreign-source earned income and you meet the bona fide residence or 330-day physical presence test with a foreign tax home. For most London bankers, the foreign tax credit on Form 1116 works better because UK tax is typically higher than the US tax on the same wages and the exclusion is capped. You cannot claim a credit for UK tax on income you have excluded.

Missed US tax returns are common among American investment bankers and fund managers in London who spend three to twelve months on garden leave between firms. The short answer is that garden leave pay is employment income in both countries: HMRC taxes it through PAYE as ordinary salary, and the IRS expects it on your Form 1040 for the calendar year in which you received it, whether or not you did any work. If you skipped the US return for a garden leave year, you can usually catch up through the Streamlined Foreign Offshore Procedures or a late filing with a reasonable-cause statement, and in most London cases the UK tax already paid means little or no US tax is actually due.

In the returns we prepare for senior City professionals, the garden leave year is one of the most frequent triggers for a lapse in US filing. The reasoning we hear is always a variation of the same two assumptions: "I was not working, so I had no income", or "PAYE took care of it". Both are wrong for US purposes. This guide explains how garden leave pay is taxed on each side of the Atlantic, how it interacts with the Foreign Earned Income Exclusion and the foreign tax credit, why sourcing becomes difficult when you relocate mid-notice, what happens to forfeited deferred bonuses and buy-out awards, and exactly how to put missed returns right.

What is garden leave, and how is it different from PILON?

Garden leave is a period during which an employee has resigned or been given notice, remains employed and on full contractual pay, but is instructed not to attend work, contact clients or start with a competitor. In financial services, notice periods of three, six or even twelve months are routine for managing directors, portfolio managers and senior traders, and firms frequently place departing staff on garden leave for all or most of that period to protect client relationships and market-sensitive information.

Payment in lieu of notice (PILON) is different. With PILON, the employment ends immediately and the employer pays a sum representing the notice period that will not be worked. The legal distinction matters for UK tax treatment, and it can matter for US sourcing, so the first document we ask for when preparing a garden leave year is the settlement agreement or resignation acceptance letter showing which mechanism was used.

Garden leave: employment continues until the termination date; you are paid your normal salary on the normal payroll dates; you remain bound by your contract.
PILON: employment ends on an earlier date; you receive a payment covering some or all of the unworked notice; post-employment restrictions may still apply.
Hybrid: many City exits combine a period of garden leave followed by an early release with a PILON for the remainder, which means two different UK tax treatments inside one notice period.

How does HMRC tax garden leave pay and PILON?

HMRC is clear that garden leave pay is simply salary. Its Employment Income Manual at https://www.gov.uk/hmrc-internal-manuals/employment-income-manual/eim12975 explains that where proper notice is given and the employee is told not to attend work, the payment is the salary due for the period of notice and is taxable as earnings under section 62 of the Income Tax (Earnings and Pensions) Act 2003. Because the employment continues, the employer operates PAYE and Class 1 National Insurance in the usual way, and the pay appears on your payslips and your P60 for the relevant UK tax year.

PILON used to be more nuanced, because a non-contractual PILON could sometimes fall within the 30,000 pound exemption for termination payments. That route was closed from 6 April 2018. HMRC guidance at https://www.gov.uk/hmrc-internal-manuals/employment-income-manual/eim13880 sets out the post-employment notice pay (PENP) rules: the portion of a termination payment that represents basic pay for the unworked notice period is calculated by formula and is chargeable to income tax as general earnings. It does not benefit from the 30,000 pound threshold. Only the excess of a genuine termination award over PENP can qualify for the exemption.

For a London banker, the practical upshot is that almost everything received during a notice period, whether labelled garden leave or PILON, will have borne full UK income tax at marginal rates through payroll. That UK tax is exactly what makes a US catch-up manageable, provided it is claimed correctly on the US side.

Is garden leave pay taxable income on your US return?

Yes. A US citizen or green card holder is taxed on worldwide income, and wages remain wages whether or not you were at your desk. The IRS reminds Americans abroad at https://www.irs.gov/individuals/international-taxpayers/us-citizens-and-resident-aliens-abroad that the filing requirement applies even when income is earned overseas and even if no US tax is ultimately due. There is no US provision that exempts pay for a period of inactivity. Garden leave salary, PILON, holiday pay settled on exit and any bonus paid during the notice period all belong on Form 1040 as wages for the calendar year in which they were paid.

The failure mode we see most often is not an attempt to hide income. It is a banker who has filed every year while employed, sometimes through a firm-sponsored provider, and then loses that support when they give notice. The new employer's provider does not pick up the gap year, the old employer's provider has stopped, and nobody files for the year in which the garden leave fell. A year later the same person realises the omission when opening a US brokerage account or applying for a US mortgage.

Can you use the Foreign Earned Income Exclusion on garden leave pay?

The Foreign Earned Income Exclusion (FEIE), claimed on Form 2555, lets a qualifying individual exclude foreign earned income up to an annual inflation-adjusted limit published at https://www.irs.gov/inflationadjustment. The IRS defines foreign earned income at https://www.irs.gov/individuals/international-taxpayers/foreign-earned-income-exclusion as wages, salaries, professional fees or other amounts paid to you for personal services rendered by you. To qualify, your tax home must be in a foreign country and you must pass one of two tests.

Bona fide residence test: you are a bona fide resident of a foreign country for an uninterrupted period that includes an entire tax year. A London banker with a UK home, family and employment will usually meet this for full calendar years spent in the UK.
Physical presence test: you are physically present in a foreign country or countries for at least 330 full days during any period of 12 consecutive months. This is purely a day count and is the test most often used in a year of relocation.
Tax home: separately from either test, your regular place of business must be outside the United States. A move to a US-based role can end your foreign tax home before your garden leave pay has finished.

Garden leave pay is compensation from your employment, so in principle it can be foreign earned income. The harder questions are whether it is attributable to personal services, where those services are treated as performed, and whether you still met a residence or presence test for the relevant part of the year. For a banker who stays in London throughout the notice period, garden leave pay is generally treated as foreign-source earned income from the London employment. For a banker who relocates to New York mid-notice, the answer needs careful analysis.

Where is garden leave pay sourced if you move during your notice period?

This is the gap that almost no published guidance addresses. The US sourcing rules for employee compensation are in Treasury Regulation section 1.861-4, available at https://www.law.cornell.edu/cfr/text/26/1.861-4. As a general rule, compensation for services performed partly inside and partly outside the United States is apportioned on a time basis: the US-source portion bears the same relation to total compensation as the number of days of performance of services in the United States bears to the total number of days of performance of services. The period is presumed to be the calendar year unless another distinct, separate and continuous period is more appropriate, and the regulation allows an alternative basis where the taxpayer can show it more properly determines the source.

Garden leave creates an obvious problem: during the notice period you are, by definition, not performing services. There is no IRS guidance written specifically for garden leave, so the position taken on the return must be reasoned from the facts. In practice we see three broad approaches, and the right one depends on the contract wording and the documented facts.

Attribution to the employment period: the pay is treated as compensation for the London employment as a whole, so it follows the source of the services actually performed in that role, which for a London-based banker is overwhelmingly foreign.
Location during the notice period: the pay is treated as attributable to the notice period itself and sourced by where you were while on garden leave, which can produce a US-source slice once you have moved to the United States.
A distinct period under the regulation: the contract, settlement agreement and payroll records are used to show that a specific period, such as the final months of London employment, is the more appropriate measuring period.

The source matters for two reasons. First, only foreign-source earned income can be excluded under the FEIE. Second, the foreign tax credit is limited to the US tax on foreign-source income, so if part of the garden leave pay is treated as US source, the UK tax on that slice may not be fully creditable against US tax. The UK, meanwhile, will usually have taxed the entire amount through PAYE as earnings of a UK employment. That mismatch is where real double taxation can arise, and it is the point at which the treaty's relief provisions and the choice of sourcing position need to be worked through on the return itself, with a written explanation retained in the file.

FEIE or foreign tax credit: which works better for a London banker?

For most senior bankers, the foreign tax credit on Form 1116 produces a better result than the FEIE. UK marginal rates on high earnings are generally higher than the equivalent US federal rates, so UK tax paid through PAYE will usually be enough to offset the US tax on the same wages, and excess credits can be carried to other years under the Form 1116 rules. The exclusion, by contrast, caps out at the annual limit, which a City compensation package will exceed many times over.

There is also a strict rule against double-dipping. IRS Publication 54 at https://www.irs.gov/publications/p54 states that you cannot deduct, exclude or take a credit for any item related to amounts you exclude as foreign earned income. If you exclude part of your garden leave pay, the UK tax attributable to that excluded slice cannot be credited. Once you elect the FEIE and later revoke it, you generally cannot re-elect it for several years without IRS consent, which matters for a banker who may relocate again. In our experience, the FEIE is most useful in narrow cases, for example a year with low total income, or where the banker wants to exclude a modest amount while crediting UK tax on the remainder.

How do the UK and US tax years collide during garden leave?

The UK tax year runs from 6 April to 5 April. The US tax year for individuals is the calendar year. A six-month garden leave from October to March sits entirely within one UK tax year but straddles two US tax years. That means one P60 and one UK Self Assessment return, but two Forms 1040, two Forms 1116 and potentially two FBARs, each capturing a different share of the same income and the same UK tax.

When preparing these returns we reconstruct month-by-month payroll data rather than relying on P60 totals. Each month's gross pay, PAYE deducted and National Insurance is mapped to the correct US calendar year, converted at an appropriate exchange rate and matched to the foreign tax credit claimed. If the UK tax liability for the year is later adjusted through Self Assessment, for example because a bonus or buy-out award lands in the same UK tax year, the foreign tax credit may need to be revisited on both US returns. Mismatches here are one of the most common reasons we see IRS notices on otherwise straightforward expat returns.

What happens to forfeited deferred bonuses and buy-out awards?

Senior bankers typically hold several years of deferred bonus in cash or shares, which is forfeited on resignation to join a competitor. A hiring firm will often grant a buy-out award designed to replace the value lost. The tax consequences on each side are frequently misunderstood.

Forfeited unvested awards: where shares or units never vested and were never delivered, there is generally nothing to report as income in either country for the forfeited amount. You cannot claim a deduction for value you never received.
Cash buy-outs: a cash payment from the new employer is employment income when paid. It is taxed through PAYE in the UK if you are on a UK payroll, and it is wages on your US return for the calendar year of payment.
Share buy-outs: replacement restricted stock units are typically taxed on vesting or delivery in both countries. For US sourcing, the regulation treats multi-year compensation as sourced on a time basis over the period to which it is attributable, so if you move countries during the vesting period, part of each vest may be US source and part foreign.
UK apportionment: HMRC applies its own apportionment rules to employment-related securities for internationally mobile employees, which may not match the US apportionment. The two calculations must be reconciled to avoid claiming credits for UK tax on income the US treats as US source.

Buy-out awards also create a practical trap for missed filings. The award letter usually arrives during garden leave, and the first cash tranche may be paid before you start. If the garden leave year was never filed, that cash tranche is also missing from the US record, and it may be the single largest item on the return.

Worked scenario: an MD with six months of garden leave straddling a calendar year

This illustration uses assumed figures only, to show the mechanics. Assume a US citizen managing director at a London bank earning basic salary of 40,000 pounds per month resigns and is placed on six months' garden leave from 1 October 2025 to 31 March 2026. She remains in London until 14 February 2026, then relocates to New York, where her new employer's role starts on 1 April 2026. Assume an illustrative exchange rate of 1.30 US dollars to the pound for every month. She did not file a 2025 US return because she believed she had no active work income after September.

UK side: all six months of salary, 240,000 pounds, fall in the 2025-26 UK tax year and are taxed through PAYE as earnings. Her P60 shows the full year's pay, including the garden leave months, and UK tax at the additional rate on most of it.

US 2025 return: the October to December garden leave salary of 120,000 pounds, about 156,000 dollars at the assumed rate, plus her January to September pay, is reportable as wages. She was a bona fide UK resident for all of 2025 and her tax home was London, so the income is foreign earned income from a London employment. Using the foreign tax credit on Form 1116 in the general category, the UK PAYE attributable to 2025 pay would typically exceed the US tax on the same wages, leaving no US federal tax due on that income. The return is still required, as are FBARs for her UK accounts.

US 2026 return: the January to March garden leave salary of 120,000 pounds is reportable, together with her New York salary from April. Her tax home moved to the United States when she relocated, and she cannot be a bona fide resident abroad for 2026 as a whole. She may still pass the physical presence test using a 12-month window ending on 14 February 2026, which would allow a prorated exclusion for the foreign-source part of early 2026 pay if that proved beneficial. The key judgement is sourcing of the salary paid for 15 February to 31 March, when she was physically in New York but still employed by the London bank and performing no services. If that slice is treated as US source, the UK tax on it may not be fully creditable and a double tax cost can arise; if it is attributed to her London employment, it remains foreign source. We document the chosen position, reconcile it to the UK payroll records and apply the treaty relief provisions where relevant.

Result: the 2025 return that was missed is essentially a compliance exercise with minimal US tax, and the risk is concentrated in penalties for non-filing, the missing FBAR and the 2026 sourcing question. This is typical of the garden leave cases we see.

How do you catch up missed US tax returns after a garden leave year?

The right route depends on whether you owe US tax, how many years are missing and whether FBARs were also missed. For London-based bankers with a single lapsed year, the choice is usually between the Streamlined Foreign Offshore Procedures and a simple late filing.

The Streamlined Foreign Offshore Procedures, described at https://www.irs.gov/individuals/international-taxpayers/us-taxpayers-residing-outside-the-united-states, are designed for US persons living abroad whose failures were non-willful. Eligibility requires that, in at least one of the most recent three years for which the US return due date has passed, you had no US abode and were physically outside the United States for at least 330 full days. You file the three most recent years of delinquent or amended returns with all required information returns, the six most recent years of FBARs, and Form 14653, the certification by a US person residing outside the United States. The IRS defines non-willful conduct as conduct due to negligence, inadvertence or mistake, or a good faith misunderstanding of the law. Qualifying taxpayers are not subject to failure-to-file, failure-to-pay, accuracy-related, information return or FBAR penalties.

The Streamlined route is particularly relevant where the garden leave year revealed a wider pattern, for example unreported UK ISAs, a UK pension or a foreign company interest requiring Form 5471, or where FBARs were also missed. The certification narrative must be specific and truthful. A banker who assumed garden leave pay was not reportable, or that PAYE discharged US obligations, is describing a misunderstanding of the law, but the narrative has to be built from the actual facts of the case.

If the only lapse is one garden leave year, all FBARs are in order and the foreign tax credit wipes out US tax, a late-filed return may be sufficient. The failure-to-file penalty is a percentage of unpaid tax, so where no tax is due the monetary exposure is typically limited, although the minimum penalty rules for returns more than 60 days late can apply where tax is due. Late FBARs are filed electronically through FinCEN's BSA E-Filing System at https://bsaefiling.fincen.treas.gov with an explanation for late filing. Note that the IRS withdrew its separate Delinquent FBAR Submission Procedures page in mid-2026, so that route should not be relied on as a named IRS programme.

What penalties apply to missed US tax returns?

Penalties are driven by tax actually due, not by gross income. The IRS explains at https://www.irs.gov/payments/failure-to-file-penalty that the failure-to-file penalty is 5 percent of the unpaid tax for each month or part of a month the return is late, up to a maximum of 25 percent, and that a minimum penalty applies to returns more than 60 days late where tax is owed. Where both penalties apply, the failure-to-file penalty is reduced by the failure-to-pay penalty of 0.5 percent per month, which continues after the failure-to-file penalty has reached its cap; see https://www.irs.gov/payments/failure-to-pay-penalty. Interest also runs on unpaid tax from the original due date.

Reasonable cause: penalties may be abated where you exercised ordinary business care and prudence but could not comply, as explained at https://www.irs.gov/payments/penalty-relief-for-reasonable-cause. A written statement explaining the facts is essential.
First-time abatement: an administrative waiver may be available where you have a clean compliance history for the prior three years, as described at https://www.irs.gov/payments/penalty-relief-due-to-first-time-abate-or-other-administrative-waiver.
Information return penalties: separate penalties can apply to missing forms such as Form 5471 or Form 8938, which is one reason the Streamlined procedures are attractive where those forms were also missed.

What US deadlines apply to citizens in London?

The regular due date for a calendar-year Form 1040 is 15 April. US citizens whose tax home and abode are outside the United States qualify for an automatic two-month extension to 15 June, as the IRS explains at https://www.irs.gov/individuals/international-taxpayers/us-citizens-and-resident-aliens-abroad-automatic-2-month-extension-of-time-to-file. You must attach a statement to the return explaining that you qualify, and interest still runs on any tax unpaid after 15 April. A further extension to 15 October is available by filing Form 4868 by the June date. FBARs are due on 15 April with an automatic extension to 15 October, and are required where the aggregate value of your foreign financial accounts exceeded 10,000 dollars at any time in the year, as FinCEN explains at https://www.fincen.gov/report-foreign-bank-and-financial-accounts.

A banker who relocates to the United States during garden leave loses the automatic June extension for the year in which their tax home and abode are no longer abroad on the regular due date, so the 15 April deadline and a Form 4868 extension become the relevant dates. UK residence status for the year of departure is governed by the statutory residence test and the split-year rules summarised by HMRC at https://www.gov.uk/government/publications/rdr3-statutory-residence-test-srt, which will determine how the UK taxes income after you leave.

What records do you need to prepare a garden leave year?

Resignation letter, acceptance and any settlement agreement showing garden leave dates, any early release and any PILON.
Monthly payslips for the whole calendar year, not just the P60, so pay and PAYE can be split between US tax years.
P60, P45 and any P11D for benefits such as private medical insurance or car allowance during the notice period.
Deferred bonus statements showing forfeited awards, and the new employer's buy-out award letter and vesting schedule.
A day-by-day travel log for the year, including exact relocation dates, to support the physical presence test and any sourcing position.
Year-end and maximum balances for every UK bank, ISA, brokerage and pension account for FBAR and Form 8938 purposes.
UK Self Assessment returns and HMRC calculations for the relevant UK tax years to support the foreign tax credit.

How we prepare these returns

Our work on garden leave years is tax preparation and compliance: reconstructing payroll by month, mapping UK tax to the correct US calendar year, documenting a sourcing position that matches the contract and the travel records, choosing between the foreign tax credit and the exclusion, and filing any missed FBARs and information returns. Where more than one year is missing, we assess eligibility for the Streamlined Foreign Offshore Procedures and prepare the Form 14653 narrative from your facts. For most London bankers, the result is a full set of compliant US filings with little or no additional US tax, and the peace of mind that the next firm move will not reopen the same problem.