This article was first published on January 4, 2012. It was updated on June 16, 2014, with information relevant to the 2013 and 2014 tax years.
US Expat Taxes for the Wealthy
In recent years, there has an increase in the renunciation of US citizenship by wealthy citizens living abroad. This is undoubtedly the result of dual taxation and excessive US expat taxes assessed on US citizens’ worldwide income. Although there are many tax planning strategies to help reduce the year-end tax bill, incentives for foreign residents are limited. This article will discuss some of the various tax issues surrounding high net worth US citizens living abroad.
The largest tax issue facing wealthy US citizens living abroad is that of dual taxation. Some foreign countries have tax systems that assess tax based on residency, rather than citizenship. However, the US government assesses tax based on citizenship. Therefore, US citizens living abroad run the risk of being subject to taxation by two countries.
In an attempt to reduce the impact of dual taxation, the US offers the following:
- Tax treaties: The US has tax treaties with numerous countries. These treaties provide reduced tax rates and exemptions for US taxpayers living in foreign countries.
- Totalization agreements: The US Social Security Administration has entered into Totalization agreements with 24 foreign countries in an effort to preclude a US citizen from paying into two social security systems.
- Foreign Tax Credit: US citizens who are required to pay taxes in foreign countries are eligible to take a credit for those taxes on their US expat taxes. This credit reduces the US expat tax liability dollar for dollar.
- Foreign Earned Income Exclusion: US citizens living abroad are eligible to exclude up to $97,600 for 2013 (and $99,200 for 2014) of their foreign earned income on their US expat taxes.
- Foreign Housing Exclusion/Deduction: US citizens residing abroad can take an exclusion or deduction (depending on their employment status) for foreign housing expenses, including rent, utilities and property insurance (among others).
Alternative Minimum Tax
The alternative minimum tax (AMT) is designed to prevent wealthy individuals (as well as corporations and trusts) from eliminating their US expat tax liability through various shelters and clever tax planning strategies. Wealthy US citizens living abroad will likely be subject to AMT. The good news is that the foreign tax credit is allowed under the complex AMT calculation, even though the application is slightly different.
The calculation for AMT is multifaceted, and cannot be explained in a short brief. However, it’s important for high net worth individuals living abroad to consider the AMT in their tax planning strategies. The IRS website provides an Alternative Minimum Tax Assistant to help taxpayers determine whether they will have to pay AMT on their US expat taxes. If you are subject to the AMT, it is highly recommended that you enlist professional help in the preparation of your US expat taxes.
Foreign Financial Accounts
US citizens living abroad who have foreign financial accounts whose cumulative balances totaled $10,000 at any one point during the year are required to report these accounts on Form FinCEN 114, Report of Foreign Bank and Financial Accounts (FBAR) each year. This requirement is frequently overlooked, but failure to file can cause stiff penalties. The IRS also requires that Form 8938 be filed in the event that a taxpayer has values over the threshold for their respective filing status.
Because US citizens living abroad are required to report and pay taxes on their worldwide income, they will want to be sure to include interest earned in these foreign financial accounts on their US expat taxes as well.
US HIRE Act
Beginning January 1, 2013, the US Hiring Incentives to Restore Employment (HIRE) Act took effect. This Act was originally designed to help reduce the US unemployment rate, but side effects have included increased reporting requirements for US citizens with ownership interest in foreign financial accounts. Historically, this reporting requirement was limited to the FBAR discussed above. However, beginning with the 2013 tax year, US citizens who have more than $50,000 in foreign bank accounts are be required to report this information directly on their US expat taxes. In addition, foreign banks will be required to report information to the US government annually regarding their US account holders. This follows the trend seen in recent years with the IRS cracking down on foreign investments. The ultimate fear for US citizens living abroad is that foreign banks may be (even more) reluctant to open bank accounts for them.
Wealthy individuals often take advantage of profitable investment opportunities in multiple foreign countries. Transferring money between these countries can sometimes prove to be a challenge, and costly when currency exchange and transfer fees are factored into the equation. Furthermore, gains or losses resulting from exchanging US currency to/from non-US currency are taxable under the US expat tax system. Depending on the reason for the currency exchange, the gain/loss will either be taxed as an ordinary or capital gain/loss. Currency gains obtained for personal reasons of $200 or less (not investment or businesses) are not taxable.
Speaking of offshore investments, the US has many special rules for citizens regarding income and/or ownership related to foreign investments. US taxpayers who have ownership interests in foreign mutual funds, trusts, corporations or partnerships have additional reporting requirements beyond their annual US expat taxes. Moreover, investments in certain foreign organizations (such as mutual funds) require US shareholders to pay tax on gains or increases in value each year rather than waiting until the funds are distributed.
Because of SEC restrictions, investing in the stock of foreign corporations can be a challenge for US citizens. However, US citizens living abroad have a greater opportunity to be successful in this task by having greater access to foreign exchanges. Some wealthy individuals living abroad have even gone so far as to set up foreign investment mediums, such as corporations or partnerships, to assist with investments in foreign corporations. It is important for US citizens engaging in this type of activity to be aware that there are additional reporting requirements for US citizens with ownership in foreign businesses. Resulting dividends and gains or losses on the sale of the stock are taxable on US expat taxes.
The above list is not comprehensive with regards to US expat taxes for wealthy US citizens living abroad. Additionally, many of the above situations can be avoided or minimized by enlisting an experienced tax professional to assist with tax strategizing. Other issues to consider include ownership in foreign businesses, foreign retirement vehicles, and gain and losses associated with investments in foreign stocks. Any wealthy expats should keep all of these in mind when it comes to their US expat taxes.
Need to Know More About US Expat Taxes?
If you are a high income earner, have a look at this post on how this affects your US expat taxes. If you have any other questions or would like to learn about our expat tax services, please contact us.