[rionada]

This might be too arcane for this forum, but I thought I'd give you all a go since clarification on this topic has been hard to come by.

Background: We are married US expats living in Australia as a permanent residents (just applied for citizenship... woohoo!). My partner in a physician - so a high wage earner, while I am a stay at home carer. We pay lots of Australian tax on my partners earnings, which completely offsets our US tax (we file every year and pay zero US tax). We are now finally starting to accumulate enough to start investing in Australia.

Since Australia treats married couples as individuals for tax purposes and does not differentiate between earned and unearned income, and since Australia allows you to make $18,200/year before any taxes are due... we are thinking that we should open a brokerage account in my name (I am the one with no income) rather than opening a super for me - since a super charges 15% on earnings and has rules about withdrawals.

Finally to the question: How will the US treat my unearned Australian income?

When I experimented with TurboTax - it looked like there would be a 3.8% tax on the earnings due to the Obamacare Tax (yep, so even though we get Australian Medicare and don't pay US Social Security -we now make enough to hit the $250,000 USD threshold for the "Net Investment Income Tax") ... does any of this sound correct to you? Thoughts? Recommendations?

Cheers everyone

 

[JustLurking]

Welcome. I'm neither Australian nor American -- with luck, someone with more direct experience might come along soon -- but the following points leapt out at me from your post ...

... we are thinking that we should open a brokerage account in my name (I am the one with no income) rather than opening a super for me - since a super charges 15% on earnings and has rules about withdrawals.

The US does not recognise Aussie super accounts as tax-deferred. Results can be pretty horrible.

https://www.greenbacktaxservices.com/blog/australia-superannuation-us-taxation/

Taxation on the growth depends on whether your superannuation trust is considered a foreign grantor trust or an employee trust. The determining factor is control. As a grantor trust, superannuation ownership and income need to be reported on Form 3520 and 3520A, respectively for all years of ownership. On Form 3520A, realized and unrealized income (growth) plus contributions are reported and then taxed on the US return.

Also, PFIC investments held within a foreign grantor trust must be reported separately on Form 8621 on an annual basis.

Independently of any interaction with supers, these appalling PFIC rules will also apply if you hold any non-US domiciled funds or ETFs in an ordinary taxable brokerage account.

https://thunfinancial.com/home/amer...-shares-in-a-non-us-incorporated-mutual-fund/

The tax treatment of PFICs is extremely punitive compared to the tax treatment of similar investments that are incorporated in the U.S. For example, an American holder of a U.S. incorporated mutual fund invested in European stocks pays the low long-term capital gains rate of 15% if the fund is held for more than one year. The same American investor who buys a nearly identical fund listed in the UK or in Switzerland (or any place outside the US) will find their investment subject to the PFIC taxation regime, which counts all income (including capital gains) as ordinary income and automatically taxes it at the top individual tax rate (39.6%). In some cases, the total tax on a PFIC investment may rise to well above 50%. Furthermore, capital losses cannot be carried forward or used to offset other capital gains.

When I experimented with TurboTax - it looked like there would be a 3.8% tax on the earnings due to the Obamacare Tax (yep, so even though we get Australian Medicare and don't pay US Social Security -we now make enough to hit the $250,000 USD threshold for the "Net Investment Income Tax") ... does any of this sound correct to you?

Entirely believable. The NIIT is famously out of scope for foreign tax credits, leading to probable double-tax.

https://www.pwc.com/gx/en/hr-manage...ent-income-tax-may-result-double-taxation.pdf

A critical issue is whether the NIIT may be offset by foreign tax credits for US federal income tax purposes. This question has been resolved under the final regulations in an unfavorable manner for US taxpayers – no foreign tax credit may be claimed to reduce the NIIT imposed under Section 1411 of the Internal Revenue Code (Code). Though the final regulations did not directly rule out the possibility of a foreign tax credit being possibly available under the terms of an income tax treaty, comments in the preamble to the final regulations indicate that both the Treasury Department and the IRS do not believe that such a credit should generally be permitted.

As a result, many high earning US taxpayers with net investment income that is subject to both the NIIT and foreign income tax may be faced with double income taxation.

 

[rionada]

Thanks so much JustLurking,

You have confirmed that the Super investment is off the table due to being taxed by both USA and 15% Australia.

It sounds like you are saying that we may incur US taxes on my brokerage investments. But, it also sounds like those taxes may be offset by the taxes we have already paid in Australia (we pay way more in Australia than we owe in the US - so if they treat my passive Australian income as personal income that could work because our Aussie taxes would offset the US taxes) - is that correct.

I see no way around the NIIT and, not that I want to pay it, but it's only 3.8% - far better than 15% Super tax or even any capital gains tax.

From my research it appears that I could make up to $18,200 AUD, pay no Australian taxes, and only pay 3.8% US taxes. Is that how it appears to you?

Cheers mate

 

[Nononymous]

I don't have enough specific knowledge to get into the weeds on this, but in the long term, you will probably need to take one of the following paths.

1. If you want to live and invest like a normal Australian, without paying a US surtax, you'll need to either renounce or stop being fully compliant with US taxes. Depending on your ties to the US, the latter is a perfectly valid option, particularly once you have dual citizenship.

2. Don't live and invest like a normal Australian - which means either limiting the options available to yourself, or investing in the US, though that might create complications for your Australian taxes.

There may useful resources for you via fixthetaxtreaty.org, Karen Alpert's organization.

 

[rionada]

Thank you for your thoughts Nononymous

There may useful resources for you via fixthetaxtreaty.org, Karen Alpert's organization.

Excellent resource - thanks mate

1. If you want to live and invest like a normal Australian, without paying a US surtax, you'll need to either renounce or stop being fully compliant with US taxes. Depending on your ties to the US, the latter is a perfectly valid option, particularly once you have dual citizenship.

Renouncing US citizenship looks like a serious and expensive undertaking. And I have no idea how I would stop being fully compliant without invoking the wrath of the IRS

2. Don't live and invest like a normal Australian - which means either limiting the options available to yourself, or investing in the US, though that might create complications for your Australian taxes.

I may be wrong, but I think that my Australian taxes paid do not offset any gains made in the US... so if I invested through a US brokerage account I would owe US capital gains tax.

So far, it still looks to me like an Australian brokerage account might be the way to go. I'm waiting to get talked out of it.

 

[Bevdeforges]

Renouncing US citizenship looks like a serious and expensive undertaking. And I have no idea how I would stop being fully compliant without invoking the wrath of the IRS

Renouncing is a serious decision - best left until you've cut most or all ties back to the US. Maybe not such a great idea if you still have investments or close family members back there (though that can depend on personal circumstances).

Invoking the wrath of the IRS isn't really a huge risk for us "overseas taxpayers." It's very often a matter of making a "good faith effort" (or just not being too obvious about any shortcuts you take). Chances are, with a brokerage account, there will be reporting requirements for the brokerage house (i.e. to report that they have a US person as a customer) - and that does tend to lead some institutions to want to avoid opening new accounts for US citizens. But find out what exactly they do report and work with or around that.

I may be wrong, but I think that my Australian taxes paid do not offset any gains made in the US... so if I invested through a US brokerage account I would owe US capital gains tax.

I'm not entirely sure about that (and you do need to do a bit of research into the US-Australian tax treaty). One thing for sure is that using the Foreign Tax Credit, you have to offset taxes paid on "passive income" (like investment income) against the taxes accrued on "passive income" on your US returns. As long as you are paying Australian tax on your brokerage account assets (i.e. interest, dividends and gains) that should probably offset your US obligation on the investments.

So far, it still looks to me like an Australian brokerage account might be the way to go. I'm waiting to get talked out of it.

Possibly. A "foreign" brokerage account will get you a certain level of additional reporting - which can become time consuming. But if Australian taxes on the income are higher than the US taxes, it's definitely worth considering.

 

[Nononymous]

Renouncing US citizenship looks like a serious and expensive undertaking. And I have no idea how I would stop being fully compliant without invoking the wrath of the IRS.

Yes and no. It will cost you US$2350 to renounce. Contrary to popular myth, it is not necessary to be compliant before you renounce, nor is it required to file the exit tax paperwork after renunciation. (That is necessary to exit to the US tax system, which is quite separate from giving up US citizenship. If you had been compliant before and it was straightforward to make the final filings, probably worth doing as long as no money was owing. For those who've never been in the US tax system, renouncing is not a good reason to enter and begin filing.)

The wrath of the IRS is highly overrated. There is no legal basis for them to collect penalties in Australia, even if you are only a US citizen. I would however recommend obtaining Australian citizenship before dropping off the radar, because there is a possibility in future of US passports being denied to those with significant tax debts. It's perhaps an extreme measure, but for some folks - particularly those who run businesses and face ruinous bills from the new "transition tax" - suddenly ceasing all communication and going dark is the best course of action. Your family and financial ties back to the US will of course factor into your decision.

Long-term, it's not really possible to live like a "native" in terms of investment, pension and savings IF you choose to continue being compliant with US tax filing requirements. You will either be punished with double-taxation or you will need to forego opportunities available to your neighbours. If you don't want this outcome, you must choose between renunciation and/or non-compliance with US tax laws. The good news is, there is much less risk to non-compliance than people first assume.

 

[Moulard]

I think I am the token Aussie who posts on this forum.

This is long and rambling, as I am trying to rush this, before I have to head out the door this morning...

On superannuation, there has been no formal guidance from the IRS in terms of either revenue rulings, private letter rulings or regulations that indicate how superannuation should be treated. There are a number of PLR which are assumed to be from Australian super funds which did clarify that the fund itself is a trust. But that is pretty much as far as the formal advice goes.

The closest we have is an IRS FOIA request which makes it pretty clear that even within the IRS internal counsel there is disagreement. So basically like every other person with super you are more or less on your own.

Paraphasing the direction the IRS appeared to be leaning, was that SMSF would be treated as grantor trusts in which the contributions and earnings would be treated as income, while Industry and company type funds would be treated as employee trusts under s.401(b) and employer contributions would be taxed as income, but the growth would be treated as income on distribution.


There are a couple more way out there positions that have been taken.

The first one is that superannuation is treaty exempt. There is a lot of skepticism on this one because the tax professional who pushes this view has kept his cards rather close to his chest on how. But just recently he published an article that gets into his mindset. I haven't read it carefully (no time yet), but fundamentally, he argues that the US is bound to use the OECD definition of a pension, and that super meets the OECD definition, and thus super is exempt under the relevant clause of the US-Oz tax treaty.


Another out there position, is that you need to consider superannuation in light of the relevant superannuation legislation. Super has been introduced through a legislative slight of hand. Legislatively, employer contributions are actually a tax debt to the employer which is put in trust for the employee. The way that the Superannuation guarantee (administration) act works is that if an employer fails to pay super, there is no debt to the employee, it is a debt owed to the ATO. The legislative arguing behind this position, means that technically the Australian government is the grantor of all superannuation trusts and thus only distributions would be taxable.


On the NIIT, I think it is worth exploring at the ability to take an Australian Foreign Tax Offset on US taxes paid on Australian sourced income. Its been a long time since I looked at the the relevant Interpretive Decisions, Rulings and legislation in the ATO Legal Database, but I suspect that

Depending on the sums involved it might be worth exploring administratively binding advice from the ATO (cheaper and quicker that a private ruling).

I can say, from memory at least, you are unlikely to be able to take the same approach on taxation of super as an individual, because under australian tax law contributions are unassessed income and thus ineligible for an offset. However (and I suspect that this is the case) if you have a SMSF it may be possible that the fund itself may be able to take a position that claws back some of the US taxation of the fund.

Sorry this is a bit rushed...

 

[rionada]

Thank you so much everyone for your responses!

Disclaimer: since I am not a tax preparer - I may use the wrong terminology, but I'll do my best.

After further experimentation with TurboTax (Home and Business 2018) - it looks like all of our foreign income is treated as personal income (I tried all sorts of foreign income... interest, dividends, mutual funds, stocks, bonds... ) This is good news for us because we always have lots of unused US tax credit (repurposed by treaty) due to high taxes paid in Australia.

So, no matter how I run it, the only additional tax burden appears to be the NIIT (Obamacare tax) at 3.8%. Even though Australia will not tax my first $18,200 - the US taxes my Australian unearned passive income at only 3.8% (albeit unfairly - since I can't receive Obamacare) - the personal brokerage account still seems like the way to go.

Side question - if anyone wants to comment: Best/cheapest brokerage account available in Australia (I'm leaning toward Vanguard Australia since I only buy mutual funds and I am not a short term trader)

Back to the main question about US tax ramifications on Australian passive unearned income

We can end the discussion about the Super investment option as I have ruled out investing in a Super (for me... my partner has a super through work) Also, I can't renounce my citizenship any time soon... I have lots of family and some reasonable investments in the US - so that's off the table as well.

I am curious about what "noncompliance" looks like - what do you have in mind?

And I would love to have final clarification on my opinion that I will only owe 3.8% US tax on my unearned passive Australian income (on mutual fund investments).

Cheers everyone - I am very appreciative of your help

 

[Bevdeforges]

You should NOT be paying any sort of "Obamacare" tax - none whatsoever. As a taxpayer who is resident overseas, you are exempt from that. On the new tax forms (2018) there is a little check box on the top of the 1040 form to indicate that you either have an approved plan or you are exempt (it's all the same check box). Check that box and there's no 3.8% (or any other) tax on your health care status. (And besides, didn't the latest tax bill do away with that penalty anyhow?)

And be aware that TurboTax is set up for domestic taxpayers. While you can use it for filing from overseas, there are lots of tricks and tips in order to get your taxes to come out correctly. Make very very sure that you have indicated in all the necessary places that you are filing from an overseas address and that you are eligible for the Foreign Earned Income Exclusion, whether or not you take the exclusion.

As far as non-compliance goes - simple example is to first see if you can find a broker to open an account for you. And then, you simply don't report the "earnings" from the account - or even the account itself, if you prefer. Depending on your tax risks (i.e. do you have accounts or investments in the US? level of overall income, born in the US or not, etc.) it may not even produce a question from the IRS. But the IRS' ability to audit those living overseas is very limited, unless and until you get into very high income figures and/or very complicated and obvious types of "tax dodge" schemes.

There is also the option to open an investment account through your (or another) bank in your home country. (Not all countries do things this way.) Report the account, but as a plain old ordinary bank account, declaring the income from the account each year like you would interest on a bank account. It may require a bit more reporting (when the balance goes over $200,000 or $400,000) but at least you're reporting it in a "good faith" manner - while avoiding all the needless complication.

 

[rionada]

US-AU tax treaty and the NIIT

Alright - I'm really going to get into the weeds now...

I have been reading the actual tax treaty between the US and Australia and the IRS interpretation of said treaty. Here's where it gets interesting...

IRS section 301.6114-1 - Treaty-based return positions, Subsection (c) Reporting requirement waived.

(1) Pursuant to the authority contained in section 6114 (b), reporting is waived under this section with respect to any of the following return positions taken by the taxpayer:
(v) That income of an individual is resourced (for purposes of applying the foreign tax credit limitation) under a treaty provision relating to elimination of double taxation.

There's also this from section 4 of the same Subsection (c) Reporting requirement waived.
(iv) That a treaty reduces or modifies the taxation of income derived from dependent personal services, pensions, annuities, social security and other public pensions, or income derived by artistes, athletes, students, trainees or teachers

Maybe I'm reading it wrong... I probably am, but it seems to say that reporting is not required for anything deemed by the taxpayer to be double taxation. The 3.8% NIIT is an Obamacare tax. I get Australian Medicare... and I am exempt from US tax by virtue of the taxes I pay in Australia. If I really pushed it - maybe I don't owe ANY US taxes on an Australian brokerage account.

Anyone want to take a crack at this one?

 

[rionada]

Sorry Bey - I hadn't seen your previous response. Ordinarily I would owe no NIIT tax, BUT, as soon as one crosses the $250,000 US threshold then one, in theory, is subject to the 3.8% NIIT. I have seen many opinions on weather or not an expat should owe and/or pay the NIIT. Most tax "experts" say it must be paid, but, as seen in my prior post, it looks to me like it may not need to be paid... there is no consensus on this though.

 

[Bevdeforges]

And that's what's called "taking a treaty position." File your returns that way and if the IRS has a problem with it, they'll be in touch. (But don't hold your breath - chances are that will be the end of the matter.)

 

[Moulard]

Not to try to muddle things here on the NIIT too much, but when considering how to treat it, the NIIT is covered in Chapter 2 of the IRC. Chapter 2 is all about self-employment taxes, not income taxes. So technically it is not an income tax. NIIT has been tacked on as Chapter 2A. This is why IRS regulations on the NIIT state that you cannot use foreign tax credits to offset it (as an example)

I haven't had time to read all of the fine print on the totalisation agreement , but I would suggest that it might be worth exploring exemption from it under the totalisation agreement (given its purpose to fund medicare). Of course the totalisation agremeement was written before the NIIT came into play so you might have to dig around a bit.

If the IRS do have a problem with however you treat it (regardless of the approach you take), there is one last possible solution to reduce your tax burden, which in intimated in my original post. Using domestic Australian tax law to offset the US tax. Of course this ends up eroding the Australian tax base... but lets set this aside for a moment.

While Australian residents are normally subject to foreign income tax only on their foreign source income, the foreign income tax offset applies to all income on which foreign income tax has been correctly applied. This situation will arise in very limited circumstances and the fact that the US uses citizenship based taxation is in my belief, one of those circumstances.

You would have to factor in any component of the NIIT amount that was on Australian Non-Assessed, Non Exempt income... as you can only claim a foreign tax offset on amounts that were actually assessable income in Australia (key one being any US tax on Super growth, if for example you had a SMSF or other foreign trusts)

Are you able to provide a link to the IRS interpretation of the treaty that you cite? I collect stuff on the US-Aus treaty and I don't think I have ever seen that before.

 

[rionada]

Interpretation sited

Thanks Moulard,

Much of what you just said is going straight over my head. At this point, I am planning on opening the brokerage account and then will most likely just pay the 3.8% NIIT. But, it's possible that I will not declare the brokerage account (based on the interpretation sited) and see if they come after me for it. And, if they do, I'll quote the interpretation as my reason for filing as I did. I'll do some more research before I make the final decision on that one. In the mean time, it's been very helpful understanding the ramifications of each decision and it's nice to have clarity on my original brokerage vs super question.

Here is the interpretation sited, I'll be interested to know what you think:
https://www.law.cornell.edu/cfr/text/26/301.6114-1

 

[Nononymous]

Always better to ask forgiveness than to ask permission. And if the IRS starts demanding huge fines, turn out the lights and don't answer the door.

If you plan to not declare something, just be careful that it isn't being reported by FATCA. At present it doesn't sound like the IRS has any ability to use the data, but one day in the future it might.

 

[Moulard]

Rionada,

... and then will most likely just pay the 3.8% NIIT.

While you may, of course choose to do as you like, but personally, I would be taking the view on my US return that I was exempt under the totalisation agreement between the US and Australia.
For the United States, the totalisation agreement covers Social Security contributions (including the U.S. Medicare portion) and Social Security retirement, disability and survivors insurance benefits.
The net investment income tax was designed to pay for an expanded Medicare. In the statute, it is called a “Medicare contribution.”
Obviously as the Totalisation agreement came into force in 2002 it doesn’t specifically mention NIIT, but the agreement does state that the it also applies to future laws which amend or supplement the laws in scope of the agreement; those being covered under Chapters 2 (self-employment tax) and 21 (FICA tax) of the IRC.
If the IRS disagreed and deemed that you were not exempt, then I would be looking to take relief via my Australian return. If the sums involved are large, then I might obtain administratively binding advice from the ATO before filing my US return to have that ace up my sleeve.

 

[rionada]

US AU tax discussion continues...

Thank you for checking back in Moulard... and thanks to everyone that has weighed in,

After further research and review, and in consideration of the learned advice of those who shared their opinions here... I am now planning to not pay the NIIT. If possible, I will simply not declare my brokerage account to the IRS. Which looks to have legal precedent and cover considering all of my research and our previous discussion.

The tax involved in paying the NIIT will likely be less than $1000/Yr USD so it may not be worth seeking administratively binding advice from the ATO? I know nothing of that process or cost.

New Question:
So far, I have not filed any FBAR or FATCA forms (on any of our accounts) - should I being doing either? Both?

Cheers all

 

[Bevdeforges]

It may depend a bit on your plans, but technically you "should" be filing FBARs if the total of your foreign financial accounts (i.e. bank and investment accounts) exceeds $10,000 at any point during the year.

The main factor to consider, however, is whether any of your banks or brokerage firms have asked you to provide your US SS number or asked you to give them a W9 form or equivalent. If that's the case, then they will probably be reporting the existence of your account(s) plus the year-end balance to the US Treasury Department each year. What the Treasury Dept. does with that information is anyone's guess at this stage, but since the information is tied to your SSN, they could potentially compare it all to your tax and FBAR filings.

Up to you how you want to handle this. But FBAR filings are informational only and don't result in any additional taxes.

The FATCA forms are additional forms for your tax returns that mostly report the existence of the accounts and then trace any income from each account to where you have included it on your tax returns.

 

[Moulard]

Information on all the types of advice and rulings that the ATO can provide..

https://www.ato.gov.au/General/ATO-advice-and-guidance/