For US expats who moved to Australia decades ago, the idea that they should be filing annual US tax returns may be unreal. Many have been non-compliant for years. Because of this, FATCA and the resulting compliance push have (probably on purpose to some extent) entrapped long-term expats, who have found that the rules have changed while they weren’t looking.
One major area where long-term expats have been entrapped is superannuation. Even the IRS has no idea how to report super. There are two main alternatives during the accumulation phase (this applies to most accumulation accounts) – either just the contributions are taxable in the US, or the contributions plus the income inside the super fund are all taxable currently in the US. Under the first alternative, unless you’re maximising your concessional contributions, most likely Australian tax will be sufficient to offset the additional US tax and you won’t actually be paying US tax. Under the second alternative you may have a net US tax liability in years where your super does very well (in 2013 the median growth super fund returned 17.2%).
The problem comes when it’s time to start drawing on all those lifetime savings. If you’re over 60, then your withdrawals are tax free in Australia. On your US return, however, any portion of the balance that has not already been taxed by the US is taxable when withdrawn. Those who have been reporting contributions all along probably aren’t in too bad shape because their withdrawals will be only partly taxable (the part that represents the income inside the account over the years). Those who were reporting the income as well will have no additional tax on withdrawal (just the tax on the current year income inside the fund). The biggest problem is for those who didn’t know super was taxable in the US (or who weren’t filing) because they have no previously taxed amounts, so withdrawals are fully taxable. And, if the withdrawals are tax free in Australia, then there will be no FTC to offset the US tax liability.
The real injustice in this is that, had expats been reporting super contributions to the US all along, they would have paid no additional US tax on those contributions due to the much higher tax rate in Australia. But, just because they didn’t file returns showing zero balance due, they will pay US tax on 100% of their withdrawals in retirement (when paying little or no Australian tax to use as FTC)!