Americans moving and living abroad face a wide range of US expat tax and investment issues. We receive multiple emails from prospective clients inquiring about foreign investments, pensions and US expat tax implications.
This is a summary of key expat tax and investment tips that American expats must take into consideration.
1. Find an Expat Tax Expert.
A competent US tax preparer may not be prepared for the tax complexities that come with living overseas. It is not uncommon for a US tax preparer with no experience in expat taxes to fail to research and successfully execute the special reporting requirements, relevant tax treaties, the application of foreign tax credits and many more necessary steps. A US expat may not feel the effect of that inexperience immediately, but it will certainly come back to haunt them in the future.
2. Report Foreign Financial Assets on US Expat Tax Return.
An American living and working abroad needs to follow all of the reporting requirements that the IRS has laid out for these circumstances. Almost all financial assets held in a foreign country’s banking structure are subject to a number of different reporting requirements. These may include the timely filing of a FinCEN Report 114 (FBAR), IRS Form 8938 (Statement of Specified Foreign Financial Assets), and IRS Form 8621 (Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund). The actual cost of remaining compliant with all of these special regulations may make a seemingly attractive foreign investment counter-productive, or even unsuitable, for a US investor. Plus, now with FACTA an issue, the risk of not complying should compel US investors to maintain their financial assets in a US banking institution, where none of these requirements will apply.
3. Report the ownership interest in Foreign Corporation, Foreign Partnership and Foreign Trust.
Any American who has an ownership stake in a foreign owned entity will have to deal with complex IRS reporting requirements. Any failure to report an ownership interest in a Controlled Foreign Corporation (CFC), foreign partnerships, and foreign trusts can lead to penalties from the IRS. For example, a US tax payer who fails to file a necessary Form 5471 for a CFC can face penalties of over $10,000 for each form. Plus they are now open to having their entire return audited for an indefinite amount of time. It may have been in the past that it was difficult for the IRS to uncover ownership information on a foreign business or corporation, but with FATCA and other agreements between nations, it has become increasingly easier. Expect that active enforcement of these regulations will only increase in the near future. An American entrepreneur that starts a company abroad could be unwittingly digging themselves into a deep financial hole by not dealing with these complex issues immediately upon starting their business.
4. Understand US expat tax treatment of contributions to Non-Qualified Foreign Pension Plan.
It is not unusual for a US expat to participate in a foreign pension plan being sponsored by their employer. These foreign pension plans will usually have beneficial tax treatment under the laws of the country of residence, and employers are known to contribute generously to these funds. This does not necessarily mean that they will be seen in a favorable light to US tax laws. The majority of foreign pension plans do not qualify under double taxation treaties and participating in one could have a negative tax consequence. For example, the local tax benefits may be nulled by the US tax treatment, allowing double taxation to occur. The risk that the expat fails to report this asset can add further complications and interfere with plans on using the foreign pension as a way to supplement retirement. American expats who work abroad should make themselves aware of how tax is treated both in contributions to the pension, and any payments from it. This will save a lot of time and trouble in the future.
5. Understand Roth IRA and Traditional IRA Contributions for American Expats.
American expats often make the error of assuming that they are no longer eligible to contribute to US retirement accounts like IRAs, 401Ks and Roth IRAs for Americans living abroad. Those who do continue to make contributions fail to understand the rules that affect the eligibility of Americans abroad in making those contributions. There is also a third group of eligible contributors who do so without understanding the possible tax implications, setting themselves up to be double taxed on income invested into the account. Avoiding this pitfall takes a special understanding of the local tax obligations and how they relate to the US tax laws.
6. Understand US expat tax treatment of Foreign Insurance.
A non-US registered insurance product will almost never qualify as insurance under US tax rules, even if they can be redeemed immediately for cash. This means that there is no tax advantage to these products for the US tax payer that normally makes these a good long term investment through tax referrals. The foreign insurance policy is seen by the IRS as nothing more than a foreign investment account. Plus, since it is likely a part of a trust that includes PFIC, the taxpayer would be dealing with certain tax requirements that are toxic to their return.
7. Understand the implication of US Estate Plan.
US originated estate plans do not travel to foreign countries well. The laws regarding wills, trusts, and who is able to lawfully inherit wealth after a death could be different in a foreign country. This could make any legacy US estate planning strategy no longer legally valid or trigger taxes that make the strategy counter-productive. When relocating to another country, a US expat should always first consult with an estate plan expert who has vast knowledge of US estate planning, estate planning regulations in the country of residence, and any possible interactions of tax treaties and foreign tax credits on the distribution of wealth.
8. Understanding the Currency Exposures Risks.
One mistake made by American expats abroad is not understanding the currency that their investment broker reports for the value of their investment with the fundamental currency denomination of those investments. An example of this can be found with company’s who list shares in their home country and on the New York Stock Exchange (NYSE). The shares listed on the NYSE trade in US dollars but that does not necessarily make them fundamentally US dollar investments. The shares listed in the US will only track the performance of the shares on their primary exchange. In the same token, the performance of a US listed mutual fund that does invest in foreign currency bonds will be determined by what happens with the underlying currencies. The fact that the fund trades on the NYSE in US dollars is not relevant. A multi-currency investment portfolio can be built by a US brokerage firm that that is listing the value of the investments in US dollars, yet what makes the difference is the currency denomination of the underlying investments, not the “reference currency” that a brokerage firm may use.
9. Avoid High Foreign Investment Management Fees by Utilizing a US broker.
At the retail level, an individual will not find and investment available anywhere in the world that is not available for less through a US discount brokerage firm. Investment expenses like brokerage fees, trade commissions, advisory fees, and mutual fund fees are all typically lower in the US than anywhere else in the world for an investment that is virtually the same. Plus the range and liquidity of investments that US brokers deal in are considerably higher than those found with foreign investment firms.
10. Avoid Buying Foreign Mutual Funds.
American expats may find foreign mutual funds appealing while living abroad, but they are not in the eyes of the IRS. The IRS considers a foreign mutual fund to be a Passive Foreign Investment Company (PFIC), which can be a big headache for US tax payers. A US citizen or permanent resident who has been living and working in a foreign country and making savings investments through non-US financial institutions needs to learn about the ramifications of PFICs immediately. The US tax code treats PFICs with a highly punitive tax treatment. Not only is the tax rate applied considerably higher than the tax rate on similar and identical US registered investments, the necessary accounting and record keeping for reporting the PFIC on IRS Form 8621 could cost thousands of dollars for each investment every year.
11. Diversify the investment portfolio.
Investors have reaped fortunes in all corners of the globe, only to have them disappear the next overnight. It is easy to be lured into new and enticing opportunities when making a profit and having that edge in the market. Yet the laws of diversification extend to everyone, just as the penalties for disobeying them do. An investor taking profits in their local market should re-invest some into more stable markets for when that profitable run finally runs out of steam.
12. Plan for Child’s College Education.
If an American expat anticipates that children will study in the USA, it is essential to review 529 college savings plans for expats and other investment plans.
Do you have other questions about US expat taxes and Investment Options?
If you need additional assistance, US expat tax experts at Artio Partners provide a wide range of services to Americans living abroad, US residents and foreign nationals.