Regular readers of my tax blog will not be surprised by the title of this post and the content it hints at delivering. They likely realize by now that the American person abroad is not looked upon favorably by the US tax laws. The tax laws look at anything “foreign” with a jaundiced eye when it comes to the US taxpayer – be it that the taxpayer has a “foreign” spouse, holds “foreign” financial assets (including a “foreign” mutual fund or “foreign” life insurance policy), owns “foreign” real property, runs a “foreign” business, and well… the list goes on. Today’s post provides a rundown of some of the areas in which the US tax law makes it clear that all things “foreign” are not favored.
Before delving into the matter, let me make three points at the outset. First, when tax specialists refer to the word “foreign”, they mean anything that is not in the US, for example, an insurance policy issued by a non-US carrier is a “foreign” policy; a foreign corporation is a corporation formed under the laws of a country that is not the US; a foreign bank account is an account located outside of the United States. For example, an account maintained with a branch of a United States bank when the branch is physically located outside of the United States is a “foreign” bank account. An account maintained with a branch of a foreign bank that is physically located in the United States is not a “foreign” account. It does not matter if the asset in question is “local” to the owner (e.g., a bank account in the UK is “foreign” for US tax purposes, even if the US owner of the account is living and working in the UK and needs that account for his salary and paying bills).
Second, while I realize that the US person living in America may possibly have some or all of these “foreign” touchstones, it is my general experience that the average American residing State-side does not. On the other hand, the American living abroad will have these “foreign” touchstones far more often, since they are a normal and essential part of his everyday life.
Third, if this topic is of interest to you, you can access the vidoes of these discussions that took place on March 18, 2019. They are imbedded in my blog post here.
The two posts giving rise to the video discussions are: John Richardson – “The United States Imposes A Separate And More Punitive Tax on Dual Citizens Who Are Tax Residents Of Other Countries” and Virginia La Torre Jeker – “US Tax Law to American Abroad – “How Do I Hate Thee, Let Me Count the Ways”
Without further ado – here’s the “hate” list:
- US mutual fund versus “foreign” fund investment: A non-US mutual fund investment is treated as a so-called “passive foreign investment company” or “PFIC”. Once treated as a PFIC, harsh US tax consequences result upon the happening of either of two events: 1) when the fund makes a distribution (called an “excess distribution”) to the investor or, 2) when the investor disposes of his PFIC shares (e.g., redeeming or selling them). The amounts on which the PFIC tax is to be calculated are “thrown back” evenly over each of the tax years that the investor held his shares. Tax is then assessed for each prior year at the highest possible tax rate that was in effect at such time (currently 37%; long-term capital gains rates will never apply!). Then, interest is compounded on the deferred tax deemed due for each year, removing the benefit of any tax deferral. If an investor has held his PFIC shares for many years, he can basically say goodbye to that investment. In addition, onerous information reporting is required on special US tax information forms (e.g., Form 8621 and Form 8938; also the notorious FBAR). None of these things happen when the investor sticks to US mutual funds! Learn more about PFICs at my US tax blog post here and here.
- US bank or brokerage accounts versus “foreign” bank or brokerage accounts: The US person is not required to report detailed information about his US bank or brokerage accounts to either the U.S. Internal Revenue Service (IRS) or to the Financial Crimes Enforcement Network (FinCEN). However if a US person has any “foreign” bank or brokerage accounts, significant information about them must be reported to the IRS and to FinCEN. Please read up on our good friend, Mr. FBAR (here, here, and here) and see number 3, below, regarding Form 8938.
- US financial assets versus “foreign” financial assets: The US person is not required to annually report to the IRS about his US financial assets but such reporting is mandatory on Form 8938 for all “foreign” financial assets (e.g., foreign partnership interests, stocks and bonds, mutual funds, life insurance or annuity policies with cash value, bank accounts, brokerage accounts, hedge funds, equity funds). Form 8938 requires detailed information viewed by most as highly intrusive; it is a time-consuming form and can be expensive to have professionally prepared. Everything you need to know about the Form can be found at my tax blog post here.
- US business versus “foreign” business: When compared to the US person running a business in a foreign country, the US person running a business in the US has it easy. The US person living in the US and conducting business there is not treated as running a “foreign” business, but this is not the case for the US person living abroad even though his business is being run in his country of residence (and regardless that he may also be a citizen of that other country). The American with a “foreign” business has numerous special US tax and reporting rules to contend with that harshly discriminate in treatment when compared to his US counterpart with a US business. Buzz words include classification as a “controlled foreign corporation”, the “deemed repatriation tax”, the “GILTI” tax, Form 5471 reporting, Form 926 reporting, an unlimited statute of limitations if reporting is not properly made on the numerous forms that are required for foreign holdings. You can learn more about these issues at my tax blog posts here, here, here, here, and here.
- US citizen spouse versus “foreign” spouse: Under the US tax laws, a US citizen may make unlimited lifetime gifts, or leave an unlimited amount of assets at death to a US citizen spouse. However if the recipient spouse is not a US citizen, the rules change and the transferor can be subject to US Gift or Estate taxes, as the case may be. You can learn more about this discriminatory tax treatment at my US tax blog posts here, here, and here. Furthermore, the entire tax filing exercise will become infinitely more complicated (and expensive) when a non-US spouse is involved in the marriage. More here.
- US pension plan versus “foreign” pension plan at expatriation: A US person who gives up his US status (e.g., US citizenship or certain green card long-term resident status) and qualifies as a so-called “covered expatriate” with a foreign pension plan, will take a very harsh tax hit under US Internal Revenue Code Section 877A’s expatriation provisions. Unless the foreign payor of the pension agrees to be treated as a US person (believe me, it won’t), the foreign pension will be an item of deferred compensation that is considered an “ineligible” deferred compensation plan under Section 877A of the Code. “Ineligible” deferred compensation plans are taxed immediately upon expatriation and they take a very nasty tax hit. Essentially, one must calculate the present value of the covered expatriate’s interest in the deferred compensation plan and include it in taxable income for the year of expatriation. Here’s an example of how this might work in the real world (Warning: Buckle your seat belt): Assume the covered expatriate has a typical foreign pension from his foreign country employer that will pay $6,000 per month for life after the expatriate’s retirement. Under the expatriation regime, the IRS will use some magic formula from actuarial science (life expectancy) and compute the value of that $6,000 per month income stream for life as a large lump sum amount. Let us assume that the lump sum present value of $6,000 per month till the individual’s expected date of death is $800,000. The covered expatriate must include this amount of $800,000 in his income and pay income tax on it in the year he expatriates. This is required even though he might not start receiving those pension payments for another 25 years! All this simply because his pension plan is “foreign” versus a US plan.
- US real property taxes versus “foreign” real property taxes: Under the recently enacted “Tax Cuts and Jobs Act” (“TCJA”) Reform, foreign property taxes are no longer deductible at all, whereas property taxes paid to a US State remain deductible (subject to dollar limitations). So, the American citizen owning his home and paying property taxes on it to the foreign country where he resides cannot deduct those property taxes on his US income tax return at all, whereas his counterpart living in the US may deduct property taxes paid on the State-side principal residence. This TCJA provision has not gotten much press, but it certainly unfairly increases taxable income of the many US taxpayers owning foreign real property.
- 20% deduction under Section 199A for US business versus “foreign” business: A new provision (found in section 199A of the US Internal Revenue Code) was enacted with TCJA. If a taxpayer can utilize the new law, the taxpayer can save a bundle in taxes since the provision provides a 20% deduction for so-called “qualified business income”. The American who runs his business abroad will not be a lucky recipient of this benefit. Why is he so precluded? Simply because the rules narrowly subscribe this windfall in tax savings to income that is effectively connected with the conduct of a trade or business within the United States. Of course, a US person operating a US business has the chance to use the new deduction. Sound fair? You can read all about Section 199A at my blog post here.
- US life, sickness, casualty insurance or US annuity versus “foreign” insurance / annuity: Many US persons living abroad have foreign life, sickness or accident insurance or a foreign annuity. Yet, only a handful have any knowledge of the US Foreign Insurance Excise Tax provisions affecting these policies. Generally, an excise tax of 1% is imposed on premiums paid for foreign life insurance, sickness or accident insurance or for a foreign annuity contract when the same is issued with respect to a US citizen or resident. No such excise tax is imposed for such policies/annuities issued by a US carrier. The fact of the matter is that many US carriers will generally not provide such insurance or an annuity to the US person who is living abroad. So, not only are they denied the essential coverage that such policies can provide for a more secure life without turning to a foreign carrier, they have to pay an excise tax to the US government for making that forced choice.
Small wonder that US persons living and working abroad feel “enough is enough”. While there are surely more examples than those I have set out in today’s post, I think that’s enough “hate” for one day. For Canadian-US dual nationals, other special US tax “hate-you” examples have been carefully and frighteningly enumerated by John Richardson at his excellent blog post here.
Posted: March 14, 2019
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8 thoughts on “US Tax Law to American Abroad – “How Do I Hate Thee, Let Me Count the Ways””
Great analysis, Virginia.
Thanks very much. I will be participating in a TV interview on this topic on Monday. I will update this post soon with those details and I will also tweet same, if you follow me on Twitter.
Very informative posting.
Are there different rules for US citizens working in international organizations (specifically in the UAE) regarding taxation of retirement funds contributions while employed /distributions upon separation?
I have written some blog posts on foreign pensions – and in fact, mention the DEWS Plan in the UAE. Foreign pensions are very complicated and cause all sorts of tax issues and problems for the US person abroad. You can find further information at my blog post category “Pensions and Deferred Compensation (Foreign Plans)”.