The investment tax-trap expat US taxpayers need to know

Whether you are an Aussie living in the US, or a US Citizen in Australia, managing your finances can be tricky, especially when it comes to the tax treatment of your investments. One of the most common pitfalls is investing in assets that the US Government classes as a Passive Foreign Investment Company or PFIC.

There are complex rules around PFICs that can see them taxed on your US return at 37% or even above. Here’s what you need to know.

What Is a Passive Foreign Investment Company (PFIC)?

A passive foreign investment company (PFIC) is a corporation, located outside the US, which exhibits either one of two conditions, based on either income or assets:

1. At least 75% of the corporation’s gross income is “passive”—that is, derived investments or other sources not related to regular business operations.
2. At least 50% of the company’s assets are investments, which produce income in the form of earned interest, dividends, or capital gains.

Which Australian investments are likely to trigger PFIC treatment?

Any of the following investments domiciled outside the US are likely to be treated as PFICs and therefore taxed at a much higher rate:

• Managed Funds
• Exchange Traded Funds (ETFs)
• Retail Property Trusts (such as AREITS)
• Listed Investment Companies (LICs)
• Stapled Securities

This list is just some of the investments that could trigger this treatment. When it comes to investing outside the US as a US Taxpayer, it really pays to get personal financial advice.

How are these assets taxed?

Unless certain elections are made on a timely basis, income from the investment is typically taxed at the top individual tax rate of 37%.  In addition, capital gains can also be taxed at 37%, as opposed to the typically US CGT rates which are between 0-20%. When it comes to PFICs, however, complex rules around the timing of income recognition can see the tax rate on these investments soar above 50%.

You will also likely have additional tax filing requirements, with separate filing for each PFIC investment you own.

Which assets avoid this treatment?

It’s not easy to provide a definitive list of the assets that aren’t treated as PFICs, and it’s best to get tax and financial advice before making any investment decisions. Generally speaking, however, most direct shares in a company or US-domiciled investments avoid this treatment.

If you are going to undertake a direct investment strategy, it’s important to note that there are still some direct investments on the stock exchange that would trigger PFIC treatment. –   For instance, many aren’t aware that Transurban or Sydney Airport are “stapled securities” (part-share, part-unit trust) which would likely trigger PFIC tax treatment.

Does this apply to my super?

Most public-offer super funds will be invested in managed funds or ETF investments, however, in most cases this would not trigger PFIC treatment for US tax purposes.

If you trigger “foreign grantor trust” treatment for your super, however, you will likely need to worry about PFIC taxes. Foreign grantor trust treatment can be triggered if you are a member of an SMSF or your personal contributions to the fund exceed your employer contributions. It’s important to note that US tax treatment of superannuation is a grey area, as the IRS have never provided a formal opinion of superannuation tax treatment. Therefore, it is always best to speak with your US accountant to determine their tax treatment of your superannuation fund.

What’s the best strategy to mitigate the risk of PFIC treatment?

Navigating finances as an expat US taxpayer can be a minefield and your investment decisions today can have far-reaching impacts. Before making any financial moves, it’s best to get advice from an accountant and a financial adviser who understands both jurisdictions.

General Advice warning

The information provided in this blog does not constitute financial product advice or a recommendation to purchase a particular product. The information is of a general nature only and does not take into account your individual objectives, financial situation or needs. It should not be used, relied upon, or treated as a substitute for specific professional advice. Apt Wealth Partners Pty Ltd is not a registered Tax Agent. You should consider your individual situation and seek tax advice from a registered tax agent before making any decision based on the content of this document. Apt Wealth Partners (AFSL and ACL 436121 ABN 49 159 583 847) recommends that you obtain professional advice before making any decision in relation to your particular requirements or circumstances.