Important: What expats and Americans who invest offshore need to know about US based tax advisors
If you are an American expat or an American who invests offshore, here are some things you absolutely need to know and consider.
A number of our clients moving to or from the United States have a US based tax compliance firm prepare their income tax returns. We also have a number of clients who live in the United States but have offshore investments for all the right reasons: asset diversification and security.
We work with a number of US based compliance firms, and we have the greatest of respect for these firms, but our experience is that they are usually not familiar with the international aspects of the US system. This often means they are not actually aware of the questions to ask, with respect to your international affairs, or of the compliance requirements relating to your international assets and income.
The international aspects of the US tax system are extremely complex; not only are the statutes and regulations alien (no pun intended) to the domestic compliance firms, but the additional informational returns relating to almost all aspects of an expat’s international lifestyle are complicated and carry stiff penalties if not filed or not filed correctly.
The expat’s lifestyle decisions primarily relate to the fact they live and work in another country and often for a non-US employer. For example, their investments will often be investments that “make sense” in the country where they live. These investments may be “tax favored” in the local country or, foreign mutual funds for example, which offer good returns plus a means of diversifying their investments.
Local country tax favored investments almost never offer the US taxpayer the expected benefits. This is because such investments are virtually never tax favored by the US system. As a result, for each dollar of local tax savings the expat receives there is a corresponding increase in the US tax they owe.
Foreign mutual funds can also result in unexpected US tax. These funds fall within the definition of a Passive Foreign Investment Company (often referred to as PFICs). Such investments are highly taxed by the US and often result in double taxation. Further a separate return must be filed for EACH PFIC!!!! The compliance costs alone can be substantial.
Working for a non-US employer can also raise unexpected US tax implications. Most employees will elect to participate in their company’s pension plan if one is offered. Most jurisdictions allow favorable tax treatment for such plans. In particular, employer contributions are not taxed; earnings in the plan are not taxed; and employees may often make tax deductible contributions to the plan. There arrangements are similar to plans offered by employers in the US—in essence all tax is deferred until the employee retires or takes a distribution from the plan. Unfortunately, for US taxpayers these tax deferral benefits are not available when the expat participates in a non-US pension plan. Employer contributions are taxed to the employee; earnings in the plan are taxed to the employee; and no deduction is allowed to the employee for contributions to the plan.
Many countries have tax treaties with the US. Under these treaties the impact of these pension rules can be reduced, but a proper treaty claim must be made. Also, in high tax countries the expat may have sufficient foreign tax credits to offset the US tax resulting from their participation in such plans. But this requires a tax preparer that understands these rules and knows how to use the international treaty system.
Finally, many long-term expats have established non-US trusts or are beneficiaries of non-US trusts. Like other non-US structures the US tax on such structures is often extremely unfavorable. This treatment can often be addressed with proper planning. But, as with other foreign structures, there are substantial informational returns that must be completed with respect to foreign trusts. Failure to file these forms can result in substantial penalties.
The international related forms that may be required include:
- Forms 3520/3520A—with respect to foreign trusts—including your foreign pension plans.
- Form 5471—with respect to your interest in foreign business enterprises.
- Form 8938—relating to your interest in foreign financial assets
- Form 8865—with respect to your interest in a foreign partnership
- Form 8621—relating to foreign collective investments (Passive Foreign Investment Companies—PFICs)
- Form TD F 90-22.1 – The FBAR—relating to your interest in foreign financial accounts.
As noted above, the penalties for failure to file these forms are substantial. For example, the failure to file Form 3520 has a minimum fine of $10,000. Failure to file Form 5471 is $10,000. And the failure to file the FBAR can have a penalty of $10,000 per account.
While we appreciate the desire to use a US based accountant while living in the US, and in fact we often encourage such use, you must make sure your accountant understands the importance of these forms and the consequences for failure to file.
We are more than happy to work with your US based accountant to ensure these compliance requirements are properly met. Please get in touch if you have any questions about the foreign side of US tax compliance.