FATCA Solutions For American Expats
FATCA is something every American Expat should be concerned with. FATCA is said to stop Americans avoiding tax. The truth is the Americans that want to hide money will find a way to do so. The Americans that are sensible will find a legal tax compliant way of reducing their tax. FATCA in terms of tax revenue will achieve little. It is however vital that American Expats recieve good advice from an International Financial Planning company like deVere so that can stay within the law and also reduce some of their tax liabilites.
First some history, then for those interested an explanation of one way to mitigate some potential tax.
In 1986 in a clear act by Congress to dissuade investments being made into non US companies and mutual funds, legislation was passed penalising US taxpayers who invest into these asset classes with penal tax charges and heightened filing responsibilities.
It is commonly understood (although widely ignored) that US Citizens and Green Card holders remain subject to US tax on their worldwide income, which includes income generated by employment or self employment AND any underlying investments, even when they are no longer resident in the US. Whilst there is general exemption for non resident US taxpayers earning less than $99,200 this tax year from US income tax – any return generated by an investment portfolio must be reported to the IRS and tax will be payable. The income tax exemption only covers earnings from employment or self-employment not investment income.
To set the scene, if a US taxpayer invests into a US mutual fund or company the growth generated will be subject to tax currently as either ‘income’ or ‘capital gains’. If the return is deemed to be income this is added onto the investor’s income for that year and taxed at their highest marginal rate (currently up to 39.6%). However if the investment return is a ‘capital gain’ this is taxed at different rates depending on how long the asset has been held for. If the asset was held for less than 12 months the top rate of tax is 39.6% – however if the asset is held for more than 12 months the tax is reduced to 20%.
Over and above these taxes, President Obama introduced additional charges on individuals with high levels of investment income on top of regular earnings under Medicare (often referred to as “Obamacare”). This essentially levies a surcharge on top of existing taxes at 3.8%. This note is not focused on this area – however it is worth consulting a US tax attorney to ascertain if this surcharge is payable.
Globally aware and sophisticated Americans may well wish to invest into non US markets to benefit from emerging markets or more traditionally based strategies giving, potentially, higher levels of return and a more balanced and risk equalised portfolio. This is where the concept of a Passive Foreign Investment Company (“PFIC”) come into consideration.
The IRS define a PFIC as “… any foreign corporation if 75 percent or more of its gross income is passive income or if 50 percent or more of its assets are assets that produce, or are held to produce, passive income”. What that means is generally any non US mutual fund, bond or company will be treated as a PFIC. A non-US fund can elect to provide the IRS detailed information such that the US investors can treat the investment return as currently taxable in the US, however most non US funds are not willing to take on this additional compliance and reporting burden so around 95% of all non US mutual funds are classified as a PFIC.
The exact taxing profile of investments made into a PFIC are highly complex and often the cost of merely filing these investments can outweigh the investment return. It is imperative that advice is taken from a competent US attorney if you believe you have any PFIC investments – however to give a very simple overview, every individual investment made into a PFIC should be reported on a separate form to the IRS (Form 8621) which shows the amount of the investment return and the length of time that the asset has been held. Irrespective of whether the return is classified as income or capital gain, the return will be taxed as income, often at the highest marginal rates, broken down on a proportionate basis over the total number of years during which the asset was held. An additional interest charge is also levied to compensate the US Government for the perceived impermissible deferral of tax payments.
Whilst this isn’t a major issue for those who have held these investments for 1-2 years – it can cause havoc for individuals who have held these assets for many years with severe tax penalties.
It is also worth noting that the IRS have the ability to ‘look through’ traditional investment schemes and trusts that have US participants. Trusts should be fully reported to the IRS as a matter of general compliance (Forms 3520 and 3520-a) and the US will seek to tax the underlying beneficiary as if they were holding the investments personally. Therefore most of these arrangements offer no protection from PFIC charges what so ever.
As the US supports an equalised tax system whereby residents and non residents are treated alike, PFIC charges also apply to US physical residents too. So returning to the US with these investments does not solve the issue!
It’s hard enough in life to work and save money without paying unnecessary taxes. One solution is to use a tax qualifying pension contract. This can potentially enable an American expat to save money and not pay tax each and ever year on the investments within the pension . Depending on the Americans resisdence it also enables him to have reduced tax on proceeds.
More information on this and other poignant issues relating to US taxpayers is available within Group and tax efficient investment advice can be offered supported by full opinion by US Tax Attorneys.
Nigel Green deVere Group
Blog written 21st Feb
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