Category: Compliance Basics

Chapter 21: How #Americansabroad can continue to use the #IRA as a retirement planning vehicle

First, you should NOT be using the Sec. 911 FEIE (Foreign Earned Income Exclusion) if you want to invest in an IRA:

Second, okay assuming that you are able to invest in an IRA:

The post is referenced in he above tweet was written by Chad and Peggy Creveling and appeared in the Wall Street Journal on August 23, 2016. It is well written and very interesting. You will find some of their blog posts here. The post will NOT be of interest to “accidental Americans’ and other “long term” Americans abroad. The reason is simple. The rules are so complicated that only short term – “Homelanders Abroad” would undetake the compliance burden.

Nevertheless, I recommend the article to you. It will reinforce the impossibility of navigating U.S. tax rules if you live outside the United States.

Chapter 19: Is it better to take the “Foreign Tax Credit” or the “Foreign Earned Income Exclusion” – a discussion

Even for a basic U.S tax return, I have often said that:

Two different tax preparers could produce five different U.S. tax returns.

When filing their U.S. tax returns Americans abroad are faced with tho threshold questions:

1. What filing category should they use? Single, Married Filing Jointly, Married Filing Separately or Head of Household?

2. Assuming they have “earned income”, should they use the Sec. 911 FEIE (Foreign Earned Income Exclusion” or should they use the Sec. 901 FTC (Foreign Tax Credit Rules).

In most cases the Sec. 901 FTC rules lead to better results.

The above tweet references an excellent discussion by CPA Olivier Wagner which explains why in most cases the Sec. 901 Foreign Tax Credit rules would be preferred to the Sec. 911 Foreign Earned Income Exclusion.

The following discussion on Facebook illustrates the general points.

The above tweet references the following Facebook discussion. You will have to log in to your Facebook account to read it live. Note by the way the reference to the article about your “local pension”, which by the way, is considered to be “foreign” (with all the attendant horror) from a U.S. perspective. Note the title refers to  your pension as an “unexpected tax trap”. This article had about 43,000 views. On the issue of “foreign pensions” see:

But back to the “Foreign Earned Income Exclusion” vs. the “Foreign Tax Credit” discussion (better to read on Facebook if you can):

Naomi Hoffman
September 25 at 5:58pm · Edited

I’m partway through my 2nd attempt to complete our US tax return, and getting much further with TaxAct than I was a few months ago with HR Block. We emigrated mid 2014, so we have some income from the US, and a lesser amount from the UK. Here is my frustration: after all our foreign income was ‘excluded’ (Form 2555) we owed the IRS $1000 more than before the foreign income was added. In short, our (minuscule) foreign income for 2014 appears to have bumped us into a higher tax bracket and cost us $1000! I will experiment with the Foreign Tax Credit, but meanwhile can anyone please explain WHY a foreign earned income exclusion would negatively effect tax brackets? I don’t see how this is not double taxation. Thanks so much.
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2 people like this.
Comments
Tricia Moon

Tricia Moon Are you converting the UK income to US values before you apply the FEIE?
Like · Reply · 2 · September 25 at 8:40pm · Edited
Ashraf Khatib
Ashraf Khatib Did you use Form 2555 for each you and your spouse? Each can dedcut $99,200 from 2014 income for a total of $198,400, MFJ with both spouses working. Also, if you have any deductable income (i.e. mortgage interest) you stilll claim that on Schedule A.
Like · Reply · 2 · September 25 at 9:20pm
Scott Hochgesang
Scott Hochgesang It’s hard to imagine a scenario where taking the exclusion causes you to pay more US tax. Is it a partial year issue perhaps as you said you moved part year?
Like · Reply · 3 · September 25 at 9:24pm
Orlando Gotay
Orlando Gotay There’s something called the “Stacking rule”. The exclusion in effect excludes income at the lower ends of the tax “ladder” and not from the top where it is taxed at a higher rate. I’m not surprised you get that result.

Trivia: California does an analogous thing to its part year residents, too.
Orlando Gotay’s photo.
Like · Reply · 2 · September 25 at 11:28pm · Edited

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Naomi Hoffman

Naomi Hoffman Good to know you can take a FTC on tax paid on passive income. Looking for glimmers of hope to level the playing field!
Like · Reply · 20 hrs
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Susan De Paul
Susan De Paul You can only exclude “earned” foreign income on the 2555, but other types of foreign income (such as contributions of a foreign employer to a foreign pension plan) are added directly to your income and cannot be excluded. Is something like that causing the problem?
Like · Reply · 1 · Yesterday at 1:18am
Tom Paine
Tom Paine If you are in the UK, it is probably NOT to your advantage to use the Foreign Earned Income Exclusion period. To summarize the reasons given in the previous comments: (1) only what qualifies as “earned income” (not investment or pension income) can be …See More
Like · Reply · 2 · 21 hrs
Naomi Hoffman
Naomi Hoffman Orlando Gotay you are spot on. After seeing your email this morning my husband and I spent the last few hours doing calcs and reading through the article you linked (very informative & helpful article BTW) and that is exactly what is happening. Unbelie…See More
Like · Reply · 21 hrs
Sigrid Ore
Sigrid Ore To determine the actual tax bracket, your total income before exclusions is used. That means if your US income plus your foreign income is for example 120.000$, you are in the 28% tax bracket. Let’s say your income from the US is only 40,000$, than this income is taxed at 28%. The foreign earned 80,000$ is tax excempt.
Like · Reply · 20 hrs · Edited
Naomi Hoffman
Naomi Hoffman Many thanks everyone for your comments, the ‘Stacking Rule’ mentioned by Orlando is the cause. Tricia we did make the conversion to USD, Scott I agree hard to imagine but the FEIE does indeed cause us to pay more US tax -$1000 more. I will include my c…See More
Like · Reply · 1 · 20 hrs
Naomi Hoffman
Naomi Hoffman Scott in our preliminary calcs we would owe $75 using the FTC instead of $1000 using the FEIE. Now to go see if we can master Form 1116 & see if it concurs with our calculations…
Like · Reply · 20 hrs
Scott Hochgesang
Scott Hochgesang You must have a lot of passive income (interest, dividends, rent) which is not picked up by FEIE. Many here use local US tax accountants Down Under – they cost around $400-500 but do tax returns and FBARs too.
Like · Reply · 20 hrs
Susan De Paul
Susan De Paul Yes, I’m really saying that your employer’s contributions must be added to your income IF the foreign pension is not considered “qualified” under U.S. tax law. [This will depend on the nature of the tax treaty between your country and the U.S. I don’t …See More
Like · Reply · 1 · 20 hrs · Edited
Susan De Paul
Susan De Paul Here’s an article that explains the situation with the foreign pension plans:
http://www.forbes.com/…/pensions-create-yet-another…/…See More
Pensions Create Yet Another Tax Trap For U.S. Expatriates
forbes.com|By Janet Novack
Like · Reply · 1 · 20 hrs
Naomi Hoffman
Naomi Hoffman Thanks so much for your response Susan. Its just all unbelievable. And of course, because the foreign employers contributions are pre-tax, you could not claim tax credit on your 1040. I just don’t see how it is legal to tax ‘potential’ vs ‘actual’ inco…See More
Like · Reply · 1 · 19 hrs

John Hanson replied · 2 Replies · 6 hrs

Marco Sewald
Marco Sewald I like the FTC, you can carry unused credits forward or carry back if needed for several years – so the only U.S. tax you may face, while living in a high tax country and having a quite high income, might be the 3,8% Net Investment Income Tax / Medicare surtax…which is bad enough if you will never get any benefits from medicare…
Like · Reply · 16 hrs

Chapter 18: I don’t pay taxes in the country where I live. Can I “exclude” my foreign income from the U.S. tax return?

The short answer is, as long as it is “earned income”, kind of YES!!!

It’s about the S. 911 of the Internal Revenue Code Foreign Earned Income Exclusion or the “FEIE” for short

If you live in a country that does NOT impose income taxation at all, or you just want a very simple filing situation, read on!

The “Foreign Earned Income Exclusion” – For those who are NOT interested in claiming tax credits on “earned income” (Form 2555)

The Foreign Earned Income Exclusion is found in S. 911 of the Internal Revenue Code. I strongly recommend that you read the actual section in the Internal Revenue Code.

See form 2555 or (better yet) Form 2555EZ.
Continue reading Chapter 18: I don’t pay taxes in the country where I live. Can I “exclude” my foreign income from the U.S. tax return?

Chapter 17: How to get “credit” for taxes (foreign) paid to your country of residence

The United States will give you “some” but NOT all credit for non-U.S. taxes paid to your country of residence. In other words, you will NOT get credit for all taxes paid to your country of residence.

In order for you to get “credit” for a tax paid to your country of residence it must be recognized as a “tax” under U.S. law. Even then, then you may or may not get credit for the “tax” paid.

Non-creditable taxes (ouch!) commonly paid to non-U.S. governments

You know the answers.

  1. It includes the “sales tax” or common “VAT” tax that is imposed in many countries (including Europe and Canada). These are very significant sums paid. They are a significant percentage of the total tax you pay to your country of residence. Yet, you will get no credit for them under U.S. law.
  2. Social Security taxes in a country that does not have a “Totalization Agreement” with the U.S. government.

Non-creditable taxes (when filling out your local tax return) that have been paid to the U.S. government

  1. Possibly the brand new and exciting “Obamacare Surtax”! If Americans don’t pay for the medical care of Homelanders, then who else will?
  2. The U.S. capital gains tax on your principal residence.

The point is that the Americans abroad will be subjected to double taxation and the worst of the rules of the United States and your country of residence.

There are two ways to get some “credit” for some of the taxes you have paid to other countries.

1. Taxes that may be taken as “Itemized Deductions” but are not subject to the “Foreign Tax Credit” (Form 1116) rules.

An example of this might be property taxes paid on your principal residence.

2. Taxes that may be taken as “Foreign Tax Credits” (Form 1116)

Earned income: The taxes paid in your country of residence may (in general) be taken as a tax credit ONLY against U.S. taxes imposed on “Earned income”. Think wages, salaries and small business (non incorporated) profits.

Passive income: Passive income includes: dividends, interest and capital gains. In general the non-U.S. taxes that you pay on “passive income” can be taken ONLY as a “tax credit” against U.S. tax imposed on the same income.

Income resourced by treaty: Harder to understand but a separate bucket. Here is an example of how that might work.

“Earned income”, “passive income” and “income resourced by treaty” are treated as separate “baskets of income”. In both cases you an “build up” significant “foreign tax credits” that can be used in other years. This is why you would want to use “Foreign tax credits”. (Plus you will get a better result than using them as an itemized deduction.)

Chapter 16: Most “Form Crime” penalties can be abated if there is “reasonable cause”

This will be the shortest chapter. I am certain that after having read Chapter 15 about “Form Crime” and the possible penalties (usually $10,000 a form”) you will want to know how get “Form Crime Relief”.

Speaking of $10,000 – the “Standard Form Crime Penalty”

It is important for you to know that:

– “reasonable cause” does exist as a defense; and

– If you were truly ignorant of the form (who wouldn’t be?) then you it may work for you.

First, “Form Omissions” are generally what the IRS would call “Delinquent Information Returns“.

Second, what’s “reasonable cause” anyway?

Remember, …

Many “Form Crime” penalties can be abated based on “reasonable cause”.

Chapter 15: To be “FORMWarned is to be “FORMArmed” – It’s “FORM Crime” stupid!!

Introduction …

Since beginning the draft of this post, I have written a separate post:

Homelanders (and most U.S. tax preparers) really don’t understand the problem of “forms”. They seem to think that filling out, say Form 8938 is like completing a survey. The post referenced in the above tweet was an attempt to explain what the “form thing” is really about. well, I tried …

Forms and the life of an American citizen …

Continue reading Chapter 15: To be “FORMWarned is to be “FORMArmed” – It’s “FORM Crime” stupid!!

Chapter 14: The Obamacare “Net Investment Income Tax” – Pure double taxation of #Americansabroad

Introduction …

Looking for the Net Investment Income Tax …

IRCAll

IRCSubtitleA

IRCChapter2A

The argument for why Americans abroad are required to pay the Obamacare surtax AND why foreign tax credits cannot be applied to offset the tax

Continue reading Chapter 14: The Obamacare “Net Investment Income Tax” – Pure double taxation of #Americansabroad

Chapter 12: Issues surrounding 401k, IRAs, Roths and Americans Abroad

Are you living outside the United States?

Are you thinking about relinquishing U.S. citizenship?

Do you have an IRA or other retirement planning account in the United States?

Are you wondering about the effect of relinquishing U.S. citizenship has on your IRA?

The answers to some of these questions will depend on what country you reside AND the tax treaty that your country has with the United States.

This post is for  you!

_____________________________________________________

Introduction – In General

To quote from David Kuenzi of Thun Financial:

Introduction Expat IRAs and Roth IRAs

Even under the most conventional of circumstances, American taxpayers struggle to fully understand the myriad of tax advantaged retirement investment options they have. IRAs, 401(k)s, Roths, Individual 401(k)s, 403(b)s, deferred compensation plans, and defined benefit employer pension plans are some of the many possible investment choices from which American taxpayers might choose. Each has slightly different tax implications and a separate set of complex compliance rules, contribution limits, mandatory withdrawal requirements and other features. For Americans abroad, matters are further complicated by a broad range of special tax considerations, both U.S. and country-of-residence, that factor into the equation. The good news is that Americans abroad generally have the same opportunities as do Americans at home to accrue tax benefits from tax advantaged retirement accounts. In fact, under certain circumstances and with proper planning, U.S. expats may be able to manage their foreign residency to gain special advantage.

In this note, we guide U.S. expats to compliant and efficient use of IRAs and Roth IRAs. It also addresses the potential advantage of Roth conversion and broader oversea U.S. citizen tax strategies to use.

For the sake of simplification, this discussion assumes all traditional IRA contributions are pre-tax contributions only. The effect of U.S. state and local tax rate are not factored, except where explicitly discussed.
There are a number of issues that arise in relation to to Americans abroad and their IRAs and Roths.

Source: IRAs, Roth IRAs and the Conversion Decision for Americans Living Abroad (2018) – Thun Financial

This post introduces a range of issues which include:

1. In General: Americans abroad can invest in traditional of Roth IRAs but they can’t file their tax returns excluding their income using the FEIE

2. In General: American expatriates: The proper care and feeding of the IRA

The post is referenced in he above tweet was written by Chad and Peggy Creveling and appeared in the Wall Street Journal on August 23, 2016. It is well written and interesting. You will find some of their blog posts here. The post will NOT be of interest to “accidental Americans’ and other “long term” Americans abroad. The reason is simple. The rules are so complicated that only short term – “Homelanders Abroad” would undertake the compliance burden.

Nevertheless, I recommend the article to you. It will reinforce the difficulty of navigating U.S. tax rules if you live outside the United States.

A second post from the same authors:

3. Canada: The U.S. Canada Tax Treaty provides many benefits for Americans who move to Canada with a pre-exising Roth – it can grow forever tax free

4. Canada: How Americans moving to Canada can maximize the use of their existing Roth IRA

5. The UK: Similar benefits are available to Americans living in the UK

https://twitter.com/andygr/status/1086269396400525313

6. Canada: An IRA can be rolled into a Canadian RRSP – but be very very careful how this is done or you will erode the value of the IRA. This requires the proper integration of both U.S. and Canadian tax rules

7. In General: Relinquishment and “covered expatriates”: “Deferred compensation plans” and “Specified tax deferred accounts” are subject to particularly punitive tax treatment (full income inclusion) upon relinquishment of citizenship if the individual is a “covered expatriate” (unless a timely election is made with respect to an “eligible” deferred compensation plan)

8. In General: Relinquishment and “non-covered expatriates”: Traditional 401Ks and Roths are U.S. situs assets for the purposes of the U.S. Estate and Gift Tax

9. In Conclusion: It is essential that you get country specific advice – probably from advisors in your country of residence

https://twitter.com/andygr/status/1086296327259152384

John Richardson

 

 

 

Chapter 10: Paying into Social Security – #Americansabroad, double taxation and the payment of “Self-employment” taxes

Introduction:

The article reference in the above tweet includes:

Although 25 countries have signed a bi-national social security agreement (what the IRS calls a Totalization Agreement) with the U.S. that prevents double taxation of income with respect to social security taxes, Morocco isn’t one of them. In fact, not one country in the Middle East has signed the agreement, and Chile is the only Latin American country to do so. In Asia, only Japan and South Korea have totalization agreements with the U.S.

“The double taxation makes me crazy, especially because Morocco and the U.S. have so many treaties relating to trade, the military, and many other things,” Ms. Ponzio-Moutakki said. “This just penalizes Americans who are living abroad.”

 

The problem:

Self-employed “Homelanders” are required to pay a tax on self-employed earnings. This is a tax “Social Security” tax. This tax is found in the Internal Revenue Code. The Internal Revenue Code treats Americans abroad and “Homelanders” the same.

An excellent description from U.S. tax lawyer Virginia La Torre Jeker includes:

What is Self-Employment Tax?

The self-employment tax is a social security and Medicare tax based on net earnings from “self- employment”.  We’ll review what it means to be “self-employed” later in this posting.  The dollar threshold trigger for paying self-employment tax is quite low – you must pay self-employment tax if your net earnings from self-employment are at least US$400.

For self-employment income earned in 2013, the self-employment tax rate is 15.3% imposed on your net earnings. The rate consists of two parts: 12.4% for social security (old-age, survivors, and disability insurance) and 2.9% for Medicare (hospital insurance).

If you are a “self-employed” US citizen or US resident, the rules for paying self-employment tax are generally the same whether you are living in the United States or living and working overseas.

Effect of Foreign Earned Income Exclusion (FEIE)

You must take all of your self-employment income into account in figuring your net earnings from self-employment, even income that is exempt from income tax because of the FEIE. Briefly, for those who may not be familiar with the FEIE, Americans working abroad may be eligible to exclude certain foreign earned income (wages, compensation for services) from US taxable income under the rules governing the Foreign Earned Income Exclusion (FEIE), and certain foreign housing costs paid by their employers. If one is self-employed, then instead of taking a housing exclusion, a housing deduction is taken which further reduces the amount of taxable income. For self-employed persons, both the FEIE and the housing deduction will be calculated based on the individual’s net income as figured on Schedule C or Schedule F. Calculating the right amount of the exclusion depends on figuring one’s business income accurately.

The above-mentioned beneficial rules apply regardless of whether any foreign tax is paid on the foreign earned income or housing amounts. These tax benefits can be claimed, however, only if a US tax return is filed within certain time deadlines. More details can be found in my write-up here.

Therefore the question becomes:

Under what circumstances do Americans abroad become exempt from paying the U.S. “self-employment” tax? There are two possible ways to avoid the U.S. “self-employment tax”.

First – the “Totalization Agreement”

Americans abroad are exempt if they reside in a country that has a “Totalization Agreement” with the U.S. Government. So, what’s a “Totalization Agreement” and what purpose does it serve?

The short answer is that if you are “self-employed” in a country that has a “Totalization Agreement” you will NOT have to pay the U.S. Social Security tax.

This means that as a “self-employed” U.S. citizen abroad your U.S. tax liability is largely determined by your country of residence. If you don’t live in a country with a “totalization agreement” you will pay higher U.S. taxes! You cannot use your Foreign Tax Credit to offset Social Security taxes. The message is:

The takeaway: U.S. citizens abroad need to carefully consider the implications of being “self-employed”!

The Social Security site describes “Totalization Agreements” in the following way:

107. Totalization Agreements

107.1 What are Totalization agreements?

The Social Security Act allows the President to enter into international agreements to coordinate the U.S. Social Security Act’s title II (old age, survivors and disability) insurance programs with the social security programs of other countries. These agreements are known as “Totalization agreements.”

107.2 With what countries does the U.S. have Totalization agreements?

The United States currently has social security agreements in effect with 24 countries – Australia (2002), Austria (1991), Belgium (1984), Canada (1984), Chile (2001), Czech Republic (2009), Denmark (2008), Finland (1992), France (1988), Germany (1979), Greece (1994), Ireland (1993), Italy (1978), Japan (2005), Luxembourg (1993), the Netherlands (1990), Norway (1984), Poland (2009), Portugal (1989), South Korea (2001), Spain (1988), Sweden (1987), Switzerland (1980), and the United Kingdom (1985).

107.3 What are the purposes of Totalization agreements?

Totalization agreements have three main purposes:

  1. To eliminate dual social security coverage and taxation. This situation occurs when a person from one country works in the other country and is required to pay social security taxes to both countries for the same work;

  2. To avoid situations in which workers lose benefit rights because they have divided their careers between two countries. Under an agreement, such workers may qualify for partial U.S. or foreign benefits based on combined work credits from both countries.

  3. To increase benefit portability by guaranteeing that neither country will impose restrictions on benefit payments based solely on residence or presence in the other country.

107.4 Totalization Agreements – Other Resources

For additional information on “Totalization agreements” see: http://www.socialsecurity.gov/international/agreements_overview.html

Second – the creation of a “Foreign Corporation”

I will create a separate chapter on this issue. For the moment, borrowing again from Virginia La Torre Jeker:

Circumventing Self-Employment Tax

One method that can be considered is the creation of a foreign entity, such as a foreign corporation and being hired by that entity as an employee, generally with full salary being eligible for the FEIE and elimination of self-employment tax concerns .  Whether this is a viable solution will require very careful consideration of many factors and professional tax advice should be sought.   For starters, one must consider the US tax impact of owning a foreign corporation.  Some initial guidance can be found in my tax blog posting here.

 

 

 

 

 

Chapter 6: I have made the decision to renounce citizenship – does the US “Exit Tax” apply to me?

Okay, I lied it’s now more than 9 parts. But anybody considering renouncing U.S. citizenship needs to consider the issue of whether you will be subjected to an “Exit Tax”. By the way, this is IN ADDITION to the $2350 renunciation and the tax compliance fees. Prepare to be absolutely shocked by this!!!

Here are the posts:

Part 1 – April 1, 2015 – “Facts are stubborn things” – The results of the “Exit Tax”

Part 2 – April 2, 2015 –“How could this possibly happen? “Exit Taxes” in a system of residence based taxation vs. Exit Taxes in a system of “citizenship (place of birth) taxation”
Part 3 – April 3, 2015 – “The “Exit Tax” affects “covered expatriates” – what is a “covered expatriate”?”

Part 4 – April 4, 2015 – “You are a “covered expatriate” How the “Exit Tax” is actually calculated”

Part 5 – April 5, 2015 – “The “Exit Tax” in action – Five actual scenarios with 5 actual completed U.S. tax returns.”

Part 6 – April 6, 2015 – “Surely, expatriation is NOT worse than death! The two million asset test should be raised to the Estate Tax limitation – approximately five million dollars – It’s Time”

Part 7 – April 7, 2015 – Why 2015 is a good year for many #Americansabroad to relinquish US citizenship – It’s the “Exchange Rate”

Part 8 – April 8, 2015 – “The U.S. “Exit Tax vs. Canada’s Departure Tax – Understanding the difference between citizenship taxation and residence taxation”

Part 9 – April 9, 2015 – “Why understanding the U.S. “Exit Tax” teaches us all we need to know about “citizenship taxation”

Part 10 – April 10, 2015 – “The S. 877A Exit Tax and possible treaty relief under the Canada-U.S. Tax Treaty”

Part 11 – April 11, 2015 – “S. 2801 of the Internal Revenue Code is NOT a S. 877A “Exit Tax”, but a punishment for the “sins of the father (relinquishment)”

Part 12 – April 12, 2015 – “The two kinds of U.S. citizenship: Citizenship for “immigration and nationality” and citizenship for “taxation” – Are we taxed because we are citizens or are we citizens because we are taxed?”

Part 13 – April 13, 2015 – “I relinquished U.S. citizenship many years ago. Could I still have U.S. tax citizenship?”

Part 14 – April 14, 2015 – “Leaving the U.S. tax system – renounce or relinquish U.S. citizenship, what’s the difference?”

Part 15 – May 22, 2015 – “Interview with GordonTLong.com – “Citizenship taxation”, the S. 877A Exit Tax, PFICs and Americans abroad”

Continue reading Chapter 6: I have made the decision to renounce citizenship – does the US “Exit Tax” apply to me?