Understanding Exchange Traded Funds and Your US Expat Tax Return

Understanding Exchange Traded Funds and Your US Expat Tax Return
November 2, 2016

Americans living abroad are facing an increasing challenge when it comes to financial services due to the regulations surrounding the Foreign Account Tax Compliance Act (FATCA). US mutual fund providers are restricting access to funds and US brokers are closing their accounts. While this can be a frustrating situation for a US expat, one could look at this as an opportunity to evaluate their current investment strategies and advisor relationships for improvement. One such option to consider is investing in Exchange Traded Funds (ETFs), which can provide a multitude of advantages and solve planning and compliance issues that expats typically face.

What are Exchange Traded Funds (ETFs)?

An ETF is similar to a mutual fund, as it allows the US expat investor to hold a diverse selection of stocks or bonds in a single investment. However, unlike mutual funds, ETFs trade on an exchange and the prices change continuously throughout the day. Most commonly, an ETF’s holdings are tied to the composition of an index in the likes of the S&P 500 Index (US large capitalization stocks), the Barclays Aggregate Bond Index (US bonds), or the MSCI Europe Index (European stocks). Mutual funds, on the other hand, hold securities selected by fund managers. Because of this, the structure of ETFs tends to provide many efficiencies in comparison to mutual funds. These efficiencies include:

  • Cost Efficiency: ETFs mimic the holdings of their corresponding index without employing an expensive management team. Unlike mutual funds, ETFs are generally more stable as the underlying index doesn’t change often – thus lowering turnover and decreasing trading expenses.
  • Tax Efficiency: Because ETFs have little annual turnover, taxable distributions are limited to dividends and interest, as capital gains aren’t realized and capital gains tax is deferred. This allows the investor to choose the timing of the realization of capital gains, which allows him or her to manage tax liabilities in the manner that is preferred.
  • Global Tax Efficiency: In addition to being able to control the realization of capital gains, ETFs can typically avoid cross-border investment traps that many Americans abroad face. While mutual funds are subject to punitive taxes as offshore investments, ETFs may be viewed as optimal tax treatment, as they are traded on an exchange.

Why Should a US Expat Choose ETFs?

Most financial advisors encourage diverse investments, but the truth is, most portfolios are not properly balanced and have too much stock (or too many bonds), too much cash or too much in US domestic securities. ETFs can significantly increase diversification, as they provide inexpensive access to many fund categories throughout US markets. ETFs also provide access to international stocks, bonds, and other investments like global commodities and real estate.

It’s not uncommon for a US expat to make frequent career and location moves while abroad, which exposes him or her to a number of countries and currencies. When it comes to cross-border currency planning, some money for future expenses should be held in the same currency as those expenses. However, most Americans abroad are unsure of where they may be living a few years down the road, so they need a globally diverse portfolio with exposure to many currencies. ETFs allow US expat investors to easily diversify their portfolio when it comes to location and currency.

There is immense value in creating a tax-efficient portfolio when it comes to filing your US tax return as a US expat, and ETFs are one way that may help you achieve your investment goals. For more tax tips and ways to save big on expat taxes, download our tax guide for Americans working overseas.

Need Help Understanding How Your Investment Options Could Affect Your US Expat Taxes?

Our team of expat-expert CPAs and IRS Enrolled Agents can help by providing the tax advice you’re looking for, in order to make filing US expat taxes a more hassle-free experience. Contact us today!

The IRS tax code is 7,000 pages. Want the cliff notes version for expats? Let us help.
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