US Taxation of US retirement account distributions to NRAs

In my last blog post I discussed how Australia taxes distributions from US retirement accounts. But that’s only half of the picture because the US may also tax these distributions. For US citizens, the US tax treatment is clear and well known. But, what if you’re not a US citizen (or green card holder) when you withdraw your US retirement savings?

These issues were the subject of a series of three podcasts I recorded with John Richardson last week (links below). The purpose of this post is to summarise the key points covered in those podcasts.

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How does Australia tax your US retirement account?

For those who have moved between the US and Australia, access to and tax treatment of retirement accounts is a common issue. We’ve covered the US taxation of superannuation in several posts, but the tax treatment by both countries of 401k and IRA accounts held in the US is also important. Today’s post will cover the Australian side of this equation. My next post will discuss what happens to your US retirement accounts when you renounce US citizenship (or for Australian expats returning from the US).

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FEIE vs FTC – The Basics

This morning I participated in two short podcasts hosted by John Richardson covering the basics of the Foreign Earned Income Exclusion (FEIE) and Foreign Tax Credit (FTC). Keith Redmond, Laura Snyder and Suzanne Herman also participated.

We discussed persistent myth that these two US tax provisions “fix” the problems that arise due to the US practice of taxing the residents of other countries under the fiction that all US citizens are US tax residents.

Each of these podcasts is a short 15-minute introduction to the complexities surrounding US tax compliance for non-resident US citizens.

Edited to add:

Here’s the third podcast we recorded today – it discusses more of the interplay between US tax and your local tax system.

To renounce or retain US citizenship?

Several of us participated in a conversation today about the issues that must be considered when deciding how to deal with the extraterritorial impact of US citizenship based taxation. For those who are just realising that the US requires ALL citizens to comply with US tax obligations, we discussed the various considerations that come into play when deciding how (or whether) to comply. We also discussed the issues that must be considered when deciding whether it is time to renounce US citizenship. As with many momentous life decisions, there is no one-size-fits-all prescription – US citizenship and tax compliance are individual decisions that will depend on personal circumstances, country of residence, future plans, and personal temperament.

The conversation, hosted by John Richardson, included Keith Redmond, Laura Snyder, David Johnstone and Karen Alpert. It is available here:

CARES Act

There has been much speculation among American expat groups about how the recently passed US tax rebates / stimulus will impact Americans living outside of the United States. After all, the US claims the right to tax based on citizenship rather than residence – so shouldn’t the US provide tax rebates based on citizenship as well? As you will see in this post, the complexity introduced by taxing non-residents is not well understood, even by the tax writing committees in Congress. There appear to be some unintended consequences in this bill – though for once, some of these consequences benefit rather than harm non-resident US citizens.  All the more reason for US tax rules to stop at the border – like every other country, the US should tax on the basis of residence and source, not citizenship.

Many Americans abroad have non-American spouses. While most will file their US taxes as “Married Filing Separate”, many find it advantageous to take advantage of the election available under §6013 (g) to file a joint return with their nonresident alien spouse. Making this election means that the spouse agrees to be taxed by the US on their worldwide income. Certainly, that ought to be sufficient to qualify for the $1200 stimulus payment as a US taxpayer? But no, the §6013(g) election treats the spouse as a US tax resident for the purpose of computing tax, but not for the stimulus payment.

Another issue that I haven’t seen any analysis on is the interaction of this credit with the Foreign Earned Income Exclusion (FEIE). My take is that, since the FEIE reduces Adjusted Gross Income (AGI), and the CARES Act rebate is phased out at higher levels of AGI, taking the FEIE would increase the amount of CARES Act rebate. Someone earning more than US$75,000 can exclude foreign earned income, reducing AGI below US$75,0000. I haven’t seen any analysis of this, but if I am correct, then I’m sure this is an unintended consequence – but an example of an unintended consequence that actually favours expats.

US expats will also have to consider how this payment will be treated by the tax authorities where they live. This may vary country to country. Some countries may treat this as a tax credit, reducing any US tax available as a credit against local country income taxes, while others may treat it as taxable income. Best to consult a qualified tax adviser where you live.

The bottom line is that the US government should be taking care of the US economy – not the economies of the countries where US citizens happen to live. US tax rules should stop at the US border – for both tax liability and for tax benefits. And, for those who have been sitting on the fence, worrying about whether they should start complying with US tax law when they are a tax resident of another country, the stimulus payment will barely cover their compliance costs – and certainly won’t cover their losses going forward due to both compliance costs and the cost of opportunities lost.

From my earlier post on Facebook:

President Trump has now signed the CARES Act, and there is much speculation on how this impacts tax-compliant US expats.

I’ve had a quick read of the relevant portion of the legislation and here’s how it works in a nutshell:

The bill creates a new refundable credit for 2020 tax returns with an advance refund of that credit now (or as soon as the IRS can implement it). This means that eligible taxpayers will receive a refund now from the IRS, then on their 2020 tax return they show the credit reduced by the payment they receive now. The credit is available to US citizens and residents with social security numbers and does not appear to be contingent on having any taxable income.

The amount sent out now is based on the numbers in your 2019 tax return (or 2018 if 2019 hasn’t been filed). Those collecting Social Security who do not have a US tax filing obligation will also receive payments based on the amounts shown on Form SSA-1099.

If your income in 2020 qualifies you for a larger credit than what you receive this year, then you get the additional amount when you file the 2020 return. If your income in 2020 qualifies you for a smaller credit than what you receive now, then the net credit you show on the 2020 return is zero (not negative) – that is, you don’t have to pay back the excess.

So – if you’re not currently in the US tax system, what does this mean for you? The amount of the rebate may be just enough to pay for filing under the streamlined program – but once you file, you are in the system and continued compliance will add costs (not just compliance costs, but the opportunity costs of not being able to invest or save in the same ways as other Aussies). If you’re a temporary expat – planning on returning to the US in future – then this may present a good opportunity to come into compliance. If you’re a permanent expat, then you should be very wary of entering into the US tax system, even with the promised tax credit.

Simplified Reporting for “Foreign” Retirement Plans?

As has been widely reported, the IRS has tried to simplify the compliance burden of US taxpayers with non-US retirement plans through Revenue Procedure 20-17. John Richardson’s post on the CitizenshipSolutions blog provides a comprehensive explanation of this revenue procedure.

The Revenue Procedure provides taxpayers with a safe harbour from trust reporting on Form 3520. For plans that meet the requirements, it is no longer necessary to determine whether the plan actually constitutes a trust under US tax rules (see Reg §301.7701-4) because trust status will not change the US tax compliance required. For plans that don’t meet the requirements, nothing has changed – if the plan does not meet the definition of “trust” in the regulations, then form 3520 is not required.

I am concerned that the restrictions placed by Rev Proc 20-17 on what constitutes a “Tax-Favored Foreign Retirement Trust” are too restrictive to be of much use. To qualify, the foreign retirement plan must:

  • Be exempt from tax or otherwise tax-favored in the country where it is organised. (Rev Proc 20-17 Section 5.03(1)).
  • Provide (either directly or via the plan participants) annual information reporting to the relevant tax authority. (Rev Proc 20-17 Section 5.03(2))
  • Permit only contributions with respect to earned (personal service) income. (Rev Proc 20-17 Section 5.03(3))
  • Have contributions limited by either a percentage of earned income, by US$50,000 per year, or by US$1,000,000 over the lifetime of the plan participant. (Rev Proc 20-17 Section 5.03(4))
  • Allow withdrawals only upon reaching a specified age, or on death or disability – or early withdrawal penalties must apply. Withdrawals for certain limited purposes (e.g. education, hardship, home purchase) are allowable. (Rev Proc 20-17 Section 5.03(5))

With regard to Australian superannuation accounts – Australian law allows non-deductible contributions of up to A$100,000 per year that are not conditioned on having earned income (as long as the participant is below age 65). While the vast majority of superannuation members do not make any contributions in excess of the government mandated 9.5% contribution by employers, the ability to make these extra contributions means that a superannuation account will not qualify for the safe harbour provided by Rev Proc 20-17.

Essentially, the IRS is saying that any retirement plan that is similar enough to US retirement plans will qualify as “Tax-Favored.” But, the limits given are actually LOWER than the contribution limits for similar US plans (the limitation for defined contribution plans under §415(c)(1)(A) is $57,000 in 2020). Each country designs its retirement savings rules based on what works best in their own culture, economy and tax system. It is ironic that the US does not recognise Superannuation as a “Tax-Favored Retirement Plan” because the contribution limits are too generous, and Australia does not recognise US retirement plans as “Foreign Superannuation” because the withdrawal provisions are too generous.

So, how many countries have retirement plans that will benefit from Rev Proc 20-17? If you have a foreign retirement account, you can help collate this information by responding to an anonymous informal survey. And please share your stories either in the comments below, or over at CitizenshipSolutions.

Time to ask a good question

Thanks to a follower of this site who has urged their MP to submit Questions in Writing about the Australia/US Tax Treaty and the impact of FATCA on Australian residents claimed by the US as “US Persons.” As I’ve written elsewhere, allowing the US to tax the Australian-source income of Australian residents drains money from the Australian economy. Even if the US tax liability is offset by credits for Australian tax paid, the cost of compliance and the constraints placed on financial planning are real.

Today, Rebekha Sharkie, MP for the electorate of Mayo in South Australia submitted the following question:

312 MS SHARKIE: To ask the Treasurer—

(1) Why was superannuation excluded from the 2001 revision of the USA-Australia tax treaty.

(2) Is it a fact that the 2001 revision of the treaty was focused on businesses rather than on individuals.

(3) Has the Treasurer received any advice on revising the treaty to address issues with taxation of superannuation; if so, can the Treasurer provide any such advice (or if not possible, can a summary of each advice be provided to the House).

(4) Is the Treasurer aware of changes in the past decade in US practices in the enforcement of the Foreign Account Tax Compliance Act as it applies to ‘US persons’ that are also residents of Australia for tax purposes, or Australian citizens that reside in Australia and are subject to Australian taxation.

(5) Has the Government been advised of any such changes by the US Government; if so, could the Treasurer provide the advices (or if not possible, can a summary be provided of each of these advices to the House).

(6) Has any such change in US practice increased the costs to Australian citizens and tax residents that are required to comply with US tax rules; and what is the estimated total cost of treaty and extra-territorial US tax compliance for Australian citizens and Australian tax residents over the forward estimates broken down by financial year.

(7) Under the treaty and related instruments: (a) under what circumstances would Australian citizens and tax residents be paying both US and Australian taxes (however arising); (b) can the Treasurer detail each of these circumstances; and (c) has the Treasurer received any advice concerning any of these circumstances, or concerning the potential or reality of double taxation under current treaty arrangements more generally; if so, can these advices be provided (or if not possible, can a summary of these advices be provided to the House).

(8) What is the number of: (a) Australian citizens; and (b) Australian tax residents; that pay US taxes on Australian income (however arising, including salary, superannuation contributions and distributions, home ownership, business ownership, and any other investments).

(9) Broken down by financial year over the forward estimates, what is the: (a) total cost from the treaty to Government revenue; and (b) total capital removed from Australian superannuation accounts and the Australian economy due to extra-territorial taxation by the US Government (including Australian superannuation contributions and distributions).

(10) What review and monitoring mechanisms does the Government have in place to identify issues arising out of the operation of the treaty.

(11) To date: (a) what concrete steps have been agreed to in order to resolve the issues identified in the US-Australia tax treaty; and (b) what are the deadlines for completing each of these steps.

(12) In tabular form, can a list be provided of the notifications (and a brief description of each individual notification) provided by the US and received by Australia pursuant to Article 2, Paragraph 2 of the treaty.

(13) Will the Government commit to a renegotiation of the treaty; if not, why not; if so, in which year does the Government: (a) expect to commence those negotiations; and (b) intend to conclude negotiations.

Any MP can direct Question in Writing to the appropriate Minister. There is no requirement that the question be answered, but it remains on the list of unanswered questions until it has been answered, withdrawn, or Parliament is dissolved. If a question is left unanswered for 60 days, then the MP who asked the question can ask why there is a delay.

I will be quite interested to hear how the Treasurer answers this question.

Foreign Enrolled Agents on the rise

FATCA – the full employment act for the tax compliance industry…

Increase in Foreign EAs

Bloomberg Tax is reporting a nearly 50% increase in the number of Enrolled Agents with foreign addresses. The article is troubling on many levels, starting with the title: “U.S. Tax-Dodging Crackdown Overseas Brings Foreign-Adviser Surge.” Apparently, the editorial team at Bloomberg has different ideas, because today they published “Stop Treating American Expats Like Tax Cheats.”

FATCA is truly the full-employment act for the tax compliance profession. Below the fold, I’ll examine the following issues raised by the increase in US tax compliance professionals outside of the US:

  • Has the IRS really “gone global”?
  • What support does the IRS provide international taxpayers?
  • Who can prepare tax returns?
  • What is an Enrolled Agent?
  • What to look for in a tax preparer
Continue reading “Foreign Enrolled Agents on the rise”

Revenue Neutrality

When the US Congress considers legislation, one of the standard criteria often applied is that the proposed bill should be revenue neutral – that is, any new costs must be offset by new revenue. But, should this be a consideration for proposals to move to a system of residence based taxation?

No other developed country taxes nonresidents solely on the basis of citizenship. Those who left the US as toddlers to return to their parents’ home country are (under US law) US citizens, but most do not identify as Americans and have few, if any, ties to the US. Taxing the residents of other countries who no longer have substantial ties with the United States is clearly over-reach. While there might be many opinions about exactly where to draw the line, a line must be drawn. It is a question of doing the right thing – and the revenue generated does not alter the immorality of taxing those who are clearly domiciled in other countries.

Furthermore, it is not clear how much revenue is actually generated by the taxation of nonresident citizens – or how much revenue might be generated by taxing nonresidents under the provisions currently applied to nonresident aliens. So any calculation of “revenue neutrality” is only a very rough approximation.

Last Friday, I joined John Richardson and Laura Snyder for a discussion of these issues prompted by a post on John’s website. Here is the resulting podcast:

Reporting of SSNs under FATCA

On 15 October 2019, the IRS amended its FATCA FAQs (aimed at Foreign Financial Institutions – FFIs) by adding Q3 to the questions on Reporting. The new Q3 outlines the procedures that FFIs subject to a Model 1 IGA will be subject to in the event that they report accounts with missing or invalid identification numbers (SSNs). This new question is clearly aimed at easing the anxiety of Accidental Americans at the expiry of Notice 2017-46, which allowed FFIs to report date of birth instead of SSN on existing accounts if the FFI was unable to obtain an SSN.

This is significant because there have been many news outlets reporting that a large number of bank accounts (especially in Europe) would be closed at the end of 2019. The problem arises because there are many US citizens who have always lived outside of the US and may not have a Social Security number. Many of these individuals don’t even identify as Americans and don’t understand why they must go through the bureaucratic hassle of obtaining an SSN (not easy if you’re an adult and living outside the US). In September, the IRS made it possible for these individuals to renounce their US citizenship and follow US tax law without obtaining an SSN. However, the cost of renouncing (USD2,350 per person) is prohibitive for many, and the cost of having US tax returns prepared professionally can also be excessive.

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