Investment Constraints 4: Structures

An entrepreneur starting a new business has a choice to make – how should she structure the business legally. In Australia, there are actually four alternatives to choose from: sole proprietorship, partnership, company or trust. The reasons for choosing a company or trust often include limiting legal liability, protecting personal assets, or ease of sharing or transferring ownership. And, in the wake of recent caps on superannuation contributions, more financial planners are recommending family trusts to hold savings that cannot be put into the superannuation system. What are these structures? How do they work in a purely Australian context? And what problems or challenges might arise when a US taxpayer tries to do exactly what her Australian neighbour would find optimal?

This is the fourth instalment in our series of posts discussing the ways US tax laws constrain the investment choices of US taxpayers living in Australia. These are the areas we will be covering:

  1. Superannuation
  2. Homeownership
  3. Real Estate
  4. Australian Managed Funds
  5. Australian Shares
  6. Business Ownership Structures
  7. Investing in the US
  8. Record keeping

This series (and everything on this website) is general information only. I am not a lawyer, tax professional, or financial planner, just someone who has learned about US tax and wants to pass on general knowledge. Many areas of tax law are interdependent, so changes in one area may have unintended consequences in another. You should consult a professional who can consider your own personal circumstances before taking any action. Continue reading “Investment Constraints 4: Structures”

Citizenship matters – Take 2

Here we go again… another Australian politician, Deputy PM Barnaby Joycehas had his eligibility to sit in Parliament challenged based on claims he is a dual citizen!

John Richardson explains why the Australia should NOT allow foreign laws to dictate who can or cannot be a member of Australia’s Parliament. Where an individual has made no claim to citizenship and has not consented to become a citizen, must Australia recognise citizenship granted by a foreign country?

The Australian constitution was written in an era when dual citizenship was rare. Over the past few decades, dual citizenship has become almost common. With many countries granting citizenship by descent, it has become possible to be a citizen without any knowledge of that fact. In the past few weeks, it appears that Australian politicians have virtually weaponised citizenship.

Today’s Australian includes a list of MPs who may have citizenship problems, with leaders of both major parties threatening to refer members from the other side of the aisle to the High Court on this issue.

Citizenship was weaponised in another context when the Australian government agreed to sign an Intergovernmental Agreement (IGA) with the US over FATCA. There will be many Australians, born in Australia (or elsewhere outside the US) with a qualifying US-citizen parent, who may never have been registered as a US citizen, or who were registered as a minor without their consent. The US government considers them citizens, but, if they have never consented to that citizenship, should they be considered US citizens by their Australian bank? A High Court ruling that Barnaby Joyce or Matthew Canavan need not be considered dual citizens under Australian law could be useful for those that the US considers citizens who either have not consented to that citizenship or who believe they relinquished their US citizenship long ago, but do not have a US Certificate of Loss of Nationality.

Investment Constraints 3: Equity

60% of Australians own equity based investments (listed or non-listed) outside of institutional superannuation accounts, and 37% of Australians own listed shares (2017 ASX Australian Investor Study). There are two main ways to invest in equity – purchase shares directly on the share market or purchase a slice of a portfolio managed by a professional portfolio manager. For Australian investors who are claimed by the US, the US tax implications of these two choices are quite different.

This is the third instalment in our series of posts discussing the ways US tax laws constrain the investment choices of US taxpayers living in Australia. These are the areas we will be covering:

  1. Superannuation
  2. Homeownership
  3. Real Estate
  4. Australian Managed Funds
  5. Australian Shares
  6. Business Ownership Structures
  7. Investing in the US
  8. Record keeping

This series (and everything on this website) is general information only. I am not a lawyer, tax professional, or financial planner, just someone who has learned about US tax and wants to pass on general knowledge. Many areas of tax law are interdependent, so changes in one area may have unintended consequences in another. You should consult a professional who can consider your own personal circumstances before taking any action. Continue reading “Investment Constraints 3: Equity”

Investment Constraints 2: Real Property

Last week we started a series of posts discussing the ways US tax laws constrain the investment choices of US taxpayers living in Australia. These are the areas we will be covering:

  1. Superannuation
  2. Homeownership
  3. Real Estate
  4. Australian Managed Funds
  5. Australian Shares
  6. Business Ownership Structures
  7. Investing in the US
  8. Record keeping

This series (and everything on this website) is general information only. I am not a lawyer, tax professional, or financial planner, just someone who has learned about US tax and wants to pass on general knowledge. Many areas of tax law are interdependent, so changes in one area may have unintended consequences in another. You should consult a professional who can consider your own personal circumstances before taking any action.

2. Homeownership

In both Australia and the US, homeownership is a major savings vehicle for many households. Each country provides tax incentives for homeowners, but not the same tax incentives. In the US, home mortgage interest is tax-deductible and when the home is sold the first US$250,000 (per taxpayer) is excluded from taxable income. In Australia, all of the gain on a personal residence is excluded from taxable income. Australian-resident US taxpayers can be caught out by the differences. The US mortgage interest deduction is unlikely to reduce US taxes, as most expats will have sufficient FTC to reduce US tax to zero. Claiming the deduction, however, could help increase FTC carryovers, which could help reduce the US tax bill when the home is sold. Of course, for that to work, the house must be sold before the FTC carryover expires (carryovers last 10 years).Residential Property Index

Over the last decade, house prices in Sydney and Melbourne have more than doubled, and the average price of residential real estate in the capital cities has grown at an average rate of 5.8% per year. In Sydney and Melbourne, in particular, it is important to consider the US tax consequences of any capital gain realised. If a principal residence is owned jointly with a non-US partner, then only half of the total gain will show up on the US tax return. When computing the gain, you can add the cost of renovations (not repairs) to the original cost of the house, so be sure to keep records of the cost of renovations. Also, remember that all US tax computations are done in US dollars, so buying a home is a foreign exchange transaction. When computing the gain on the sale of any asset, the cost base and sales proceeds are converted to USD at the exchange rate from the date of each transaction. This can lead to phantom gains if the AUD appreciates over the period the house is owned. As stated above, the first US$250,000 per owner is excluded from US taxable income. If the gain is more than this threshold, then it is taxed as a capital gain and any US tax can be offset by FTC.

The sale of any real estate may also involve the repayment of an outstanding mortgage. This is another danger area for US taxpayers, because US tax is computed using the fiction that all transactions are in US dollars. If the Australian dollar depreciates between the time the mortgage loan is initiated (when the home is purchased), and the time the loan is extinguished (when the home is sold), the US tax code will treat this as a gain. In effect, the IRS thinks you’ve borrowed US$100,000 (when the exchange rate was USD1=AUD1) and paid back US$75,000 (when the exchange rate was USD1=AUD0.75) for a gain of US$25,000. Of course, since the loan is in AUD, you’ve really borrowed A$100,000 and repaid A$100,000 – no real gain or loss. And, since a principal residence is a personal use asset, the US tax code will only recognise gains on mortgage discharge; losses will be disallowed. For more background on this topic (and how Congress could have fixed the problem in 1986) see this post on The Isaac Brock Society.

3. Real Estate

Buying investment property is very popular in Australia. One of the big attractions is “negative gearing”. Essentially, this means that the Australian tax rules allow interest deductions on loans to purchase an investment property, even if the property is not making a profit. With depreciation deductions, it is possible for a rental property to have a positive cash flow, but generate a taxable loss that will offset other taxable income, including salary.

The rules are different on the US side. Unless substantial time is spent managing a rental real estate portfolio, rental real estate is considered a “passive activity”.  Under US tax rules, passive activity losses can only be deducted to the extent of passive activity income; that is, losses from rental real estate cannot be used to offset salary and other active income. Any losses that are disallowed are carried forward and used to offset future passive activity income. There is a special exception from the passive activity loss rules for rental real estate when you actively participate – this is defined as owning more than 10% of the property and making management decisions or arranging for others to provide services such as repairs. Under this exception, you can deduct as much as US$25,000 of rental losses against ordinary income UNLESS your filing status is Married Filing Separate. For those US taxpayers married to non-resident aliens, this exception is not available.

For US tax purposes, all transactions are converted to US dollars. This can generate phantom currency gains and losses when the property is sold and the mortgage is repaid. Since an investment property is not a personal use asset, unlike a personal residence, currency losses on a mortgage should be available to offset gains on the sale of the property.

 

These are just the broad outlines of US tax treatment of real estate owned either personally or for investment. As always, you should consult a professional advisor before entering into any significant transaction. Next week we will continue this series with an article on investing in shares, either directly or indirectly, and the consequences of the dreaded PFIC rules.

How do US Tax Rules Constrain the Investment Choices of US Taxpayers Living in Australia?

In the Facebook group last week, someone claimed that only the very wealthy are disadvantaged by the dual tax obligations imposed on US citizens and green card holders living in Australia. Certainly, for an Australian resident with only salary income, it is likely that foreign tax credits (FTC) or the Foreign Earned Income Exclusion (FEIE) will completely eliminate any US tax liability. However, for anyone who is considering investing for the future or running their own business, there are many pitfalls and traps in US tax law that need to be carefully considered. It seems like almost anything “foreign” is treated punitively by US tax law, and these xenophobic rules make it difficult for middle class US taxpayers to save effectively while living outside the US.

Over the next few weeks, I will be covering the following areas where US taxpayers living in Australia need to be particularly careful:

  1. Superannuation
  2. Homeownership
  3. Real Estate
  4. Australian Managed Funds
  5. Australian Shares
  6. Business Ownership Structures
  7. Investing in the US
  8. Record keeping

This series (and everything on this website) is general information only. I am not a lawyer, tax professional, or financial planner, just someone who has learned about US tax and wants to pass on general knowledge. Many areas of tax law are interdependent, so changes in one area may have unintended consequences in another. You should consult a professional who can consider your own personal circumstances before taking any action. Continue reading “How do US Tax Rules Constrain the Investment Choices of US Taxpayers Living in Australia?”

CRS – Coming soon to a bank near you…

From 1 July 2017, Australian financial institutions will be required to report account information of anyone with a tax residence outside of Australia to the ATO under the OECD’s Common Reporting Standard (CRS). Once the United States rolled out FATCA, countries in the OECD decided that cross-border reporting of financial accounts might be a good way to rein in use of tax havens for tax evasion. However, while the two are similar, there are some differences.  The key features of CRS are a common standard for: the scope of reporting (type of information, which account holders and which institutions), the due diligence required, format of the data to be exchanged.

With the current push for FATCA repeal, and the recent Hearing on The Unintended Consequences of FATCA, CRS is mentioned by some as a possible substitute for FATCA. Unfortunately, there seem to be a few misconceptions about the differences between the two Automated Exchange of Information (AEOI) schemes. As implemented in Australia, CRS is perfectly compatible with Citizenship Based Taxation.

While it is exceedingly unlikely that the U.S. Congress will ever sign on to CRS, it is important for those who advocate CRS as a more “benign” alternative to be clear on exactly what CRS entails.

This article covers:

  1. How is CRS being implemented in Australia?
  2. Who must report?
  3. Who and what must be reported?
  4. Reciprocity – FATCA vs CRS
  5. Penalties – FATCA vs CRS
  6. Implications for US Persons

Continue reading “CRS – Coming soon to a bank near you…”

Australia’s best investment pal?

The US Study Centre at the University of Sydney, with assistance from AmCham Australia, is producing a study on Australian investment in the US (and vice versa). While there are many factors that determine whether an Australian company will locate operations or marketing efforts in the US, the tax treatment of any Australian managers sent over to the US must be part of the equation. Unfortunately, I think most Aussies moving to the US for business are completely unaware of how the US tax system will see their existing Australian financial assets — until they’re already in the US tax system and it’s too late.
 
It would be great if USSC would include even just a page or paragraph on the way both the tax treaty and the xenophobic US tax code discourage movement of managers between the two countries.
 
AmCham has a blog post that reproduces the article from the Australian (and is not behind a paywall). At the bottom of the blog post (just above the comment box) is an email link. If you’re an Aussie who has relocated to the US for business and had to deal with these issues, please email AmCham and encourage them to include individual tax issues in their study.

How can they do that?

Have you opened a bank or investment account lately? Were you asked about other citizenships? Place of birth? Since mid-2014 Australian financial institutions have been ferreting out US Persons. At most institutions, every new account holder is asked these questions. And, if you are found to be a US Person, you must complete a form W-9 (or equivalent) disclosing your US connection and Social Security Number. This data will be sent to the ATO, who will forward it on to the IRS.

Think about that.

Private Australian financial information of Australian citizens and permanent residents is being sent to a foreign government.

How can they do that? Do they really have the authority to send private financial data to the IRS?
Continue reading “How can they do that?”

FOI Take 2

Just over a week ago, I received a message through this website from someone who had submitted an FOI request to the ATO. “Sam” expected that one of his accounts had been reported because the bank had identified him as a US Person and the balance was above the bank’s reporting threshold. The response from the ATO puzzled Sam, and it puzzled me as well. The ATO response stated that they needed to consult with a “foreign government” about whether Sam’s FATCA records were exempt from FOI under Section 33 of the FOI Act: Continue reading “FOI Take 2”