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Tax Treatments for U.S. Persons Living Abroad

October 22, 2020

Are you a U.S. person living abroad? Here are some essential things you should know about how you will be taxed.

Many expats move outside the U.S. with the expectation that the typical things they do in their host country will have the same tax treatment in as in the U.S. It’s a bit more complex. We share some insight below.

  • Tax Deferred Retirement accounts, for example U.S. Individual Retirement Accounts (IRAs) and 401(k) plans.
    • Typical U.S. tax treatment - Employee contributions to qualified traditional retirement accounts are made with pre-tax dollars. Employer contributions are not included in gross taxable income. The growth in these accounts is tax deferred.
    • U.S. treatment when outside the U.S. – It depends. The U.S. has tax treaties with over 50 countries and each one is unique. Some treaties allow for U.S. tax treatment that is similar to U.S. based qualified retirement accounts for foreign occupational pensions, some do not. There are many countries that have no income tax treaty.
    • The bottom line: Avoid unpleasant surprises with a pre-move tax consultation.
  • Investment accounts
    • Typical U.S. treatment - Mutual funds, ETFs, and other pooled investments are included in income in the year that the gains/losses are realized. Dividends are taxed as ordinary income or at preferential qualified dividend rate.
    • U.S. tax treatment for pooled investments registered outside the U.S. – These investments can potentially be taxed under the rules for Passive Foreign Investment Companies (PFICs.) The default treatment is that dividends are averaged over a comparison period. Dividends that are determined to be excess are taxed at the highest tax rate rather than ordinary or qualified dividend rates. When sold, these investments are taxed over the entire period the fund was held. They are also taxed at the highest tax rate for each day in the holding period and interest is calculated on the tax due in prior years. Elections can be made which allow taxpayers to opt out of the default treatment, for example, mark-to-market elections.
    • The bottom line – Be aware of the repercussions of owning PFICs. Avoid pooled investments or purchase these investments with the understanding that proper reporting will increase tax preparation complexity. Tax may be due even when gains are not realized, for example, under mark-to-market elections. Under the default treatment tax on disposition of the fund can be 50% or more of the gain.
  • Mortgage
    • Typical U.S. treatment – Pay principal and interest over the life of the loan, with little to no tax repercussions when the mortgage is paid off.
    • U.S. tax treatment for mortgages in a foreign currency – For U.S. taxpayers, the U.S. dollar is their “functional currency.” Fluctuations between the U.S. dollar and the foreign currency can create a foreign currency gain. Meaning, in the eyes of the IRS, you may have paid fewer USD on the loan than you took out. This foreign currency gain is taxable, even though you took out, for example, €500,000 and paid back €500,000.
    • The bottom line – Understand the potential repercussions of foreign currency gain on a foreign currency mortgage. Calculate and report the gain, if applicable, on an annual basis. Before paying down a mortgage, assess the potential currency gain and time your payments to your advantage when possible.

Please contact the KLR International Tax Services Team with any questions. We are here to provide you with the peace of mind that your tax affairs are appropriately managed.

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