As we go through our lives, we work and we save so that we can have a happy, golden retirement. If you are living abroad, this may not be as easy as you might think. When you live in a foreign country, the banking and tax laws do not conform to the US rules and regulations, even though they seem similar in some aspects. Putting your money in an investment account may cause you more harm (time and money) than good when you factor in the US expat taxes and reporting requirements.
Foreign investment accounts can be similar to US based accounts, like a mutual fund, where contributions are made to an investment account and the funds from multiple accounts are pooled together to invest in stocks and bonds. The fund makes dividend and capital gain distributions to its owners periodically. The distributions can either be paid out to the owner, or reinvested back into the fund. Normally, with a US mutual fund, the dividends and capital gains are reported on your US tax return and then taxed at your ordinary tax rate, or a preferred tax rate (depending upon how long the investment was held).
What is a PFIC?
When you are dealing with a foreign investment account, whether it is a mutual fund, hedge fund, insurance product, money market savings account, or even a non-US pension, there are some severe tax treatments that may occur with your US taxes. These types of accounts are generally considered Passive Foreign Investment Company or PFICs for short (commonly called pee-fick). While the PFIC moniker sounds like a fancy or specialized account, many non-US persons own them and don’t even realize it.
The new-ish FATCA (Foreign Account Tax Compliance Act) of 2010 created some hurdles for US taxpayers who own PFICs when filing their US expat taxes. The first is the disclosure of the accounts. If you exceed a certain balance threshold, you will need to report all bank and financial holdings on form 8938, filed with your US tax return. Here are the threshold amounts:
|Form 8938 Reporting Thresholds|
|US Person Living In the USA|
|Filing Status||End of Year Balance||Highest Balance During the Year|
|Single / Head of Household||$ 50,000.00||$ 75,000.00|
|Married Filing Jointly||$ 100,000.00||$ 150,000.00|
|Married Filing Separately||$ 50,000.00||$ 75,000.00|
|US Person Living Outside the USA|
|Filing Status||End of Year Balance||Highest Balance During the Year|
|Single / Head of Household||$ 200,000.00||$ 300,000.00|
|Married Filing Jointly||$ 400,000.00||$ 600,000.00|
|Married Filing Separately||$ 200,000.00||$ 300,000.00|
These account balances are the aggregate total of all your accounts. While this form only lists the account information, it also requires you to check a box indicating whether the account is a PFIC. In addition, you will also need to file a US Treasury FinCen form 114, also known as the FBAR. The FBAR form is filed separately from your US tax return and is required if your bank account/financial account balances exceed $10,000 at any point during the calendar year.
Did You Say As High As a 50% Tax?
While you might think that the foreign accounts are similar in structure to US based accounts, watch out! They hold a much more aggressive tax treatment. While a US mutual fund, which invests in foreign stocks, would have a long-term capital gains tax of 15%, a virtually similar fund in the UK (or anywhere outside the USA) would produce (to the IRS) only ordinary income, which would be taxed at your top individual rate of 39.6%. Now that is quite a difference. In some situations, the total tax on a PFIC investment may be as high as 50%. A PFIC would also lose some advantages when it comes to capital losses, which would not be able to be carried forward or used to lower other capital gains. Now we are talking about doling out some serious money to Uncle Sam when it comes to US expat taxes.
And to add insult to injury, the reporting requirements for a PFIC can be lengthy, arduous, and expensive. Form 8621, which needs to be filled out each year for each separate PFIC, should be filed with your US tax return. Just complying with the IRS regulations generally requires hours of research and preparation on the part of both the taxpayer and the paid preparer (which is HIGHLY recommended in this case). Very often owners fail to divulge the necessary information on their tax returns, and inexperienced tax accountants may not ask the proper questions to get that information. Some accountants may also not want to prepare these forms, as they are complicated and time consuming (the IRS estimates that the form 8621 will take 22 hours to complete!). I’m sure you can think of a few other things you would rather do for 22 hours.
Not only does the form 8621 need to be filled out each year, separate forms need to be filled out for each fund. For example, a single UK ISA account may have 3-4 different funds that make up the investment. This type of reporting equals high tax preparation costs, as almost all tax preparation companies charge big bucks for form 8621. The higher tax rates, plus the added cost of tax preparation will almost always be more than the gain from the account and most certainly will negate any tax benefit derived from owning the account in the foreign country.
So, then why file my US Expat Taxes?
Many people believe that since they are living in a foreign country and bank with foreign banks, they can simply slip by the IRS without being detected. While this may have been the case a few years ago, these times they are a-changin’. The FATCA regulations not only affected the way US persons bank and file personal tax returns, it also affects the way the US and foreign countries interact financially. The US has agreements and/or treaties with over 150 nations to share bank information of US citizens in exchange for agreeable banking regulations. This means that there’s a good chance that your foreign bank will have a reporting requirement to the US regarding your bank account, so it’s better to be fully compliant with your IRS filings. While there are no specific penalties associated with the form 8621, it is associated with form 8938 in regards to PFICs, which carries a $10,000 penalty. Failure to file form 8621 can also suspend the statute of limitations with respect to the tax return, meaning the IRS could have an unlimited amount of time to audit the return.
What are your options?
From the perspective of your US expat taxes, the best option would be to invest in US investment accounts. You would not have any extraneous reporting and you would receive convenient tax reporting forms each year. Unfortunately, this is not the best solution for most people living outside the US. The best option would be to research before you invest. See what kinds of funds/investments carry the least amount of US tax reporting. Taking some time to look before you invest will save you a lot of money and stress when tax time rolls around!
Need Help with Your US Expat Taxes?
Contact us today so that Greenback can help. Greenback makes life better for Americans living abroad by taking away the anxiety and hassle of getting and staying compliant with US taxes. We help people navigate a ridiculously complex system in a way that makes sense for their individual situation.