Common Australian financial strategies that can complicate US taxes

You may hear your Australian friends talking about their financial strategies and wonder if you should be considering doing the same. However, if you are a US taxpayer living in Australia or an Australian living in the US, it’s an area where you need to tread carefully.

Many financial strategies that work from an Australian tax perspective can be problematic for your US taxes. They may lead to additional reporting requirements or tax obligations, so it’s essential to be aware of potential complications before making financial moves.

Here, we look at some of the common Australian financial strategies that can lead to unintended consequences for US taxpayers.

Non-US indirect investments

Non-US domiciled managed funds held by an individual with a US tax obligation can have harsh consequences on your US tax returns. These may be deemed ‘Passive Foreign Investment Companies (PFIC)’, potentially incurring penalty tax rates and onerous reporting requirements.

The same treatment will likely apply to the following investments domiciled outside the US:

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

Certain direct share investments held outside the US can avoid PFIC treatment. However, care needs to be taken to ensure that you fully understand PFICs before undertaking a direct share strategy.

Paying down debt

Many people are unaware of the potential US tax implications of paying down a large lump sum on or refinancing your Australian debt. At the time of making a lump sum repayment or refinancing your loan, if the US Dollar value of your Australian loan is less than when you took it out, this will be perceived as a US Dollar ‘gain’, which may well be taxable on your US tax return.

For example, a US citizen living in Australia takes out a $1M loan to buy property when the US Dollar is at parity with the Australian dollar and keeps the loan as interest-only. Five years later, they receive an inheritance and decide to pay the loan off in full. The loan in AUD remains at $1M. However, due to currency fluctuations alone, the US Dollar value is now only $800K. The $200K ‘reduction’ in the loan value from when the loan was taken out to when it was paid off will likely be taxable on their US return.

Superannuation

Super is a complex area for US taxes as US authorities have not made a clear determination on how it is to be treated for US taxes.

Earnings within the fund will typically either be taxed each year as part of your US income tax return or when you draw down from your superannuation account in retirement.

In addition, personal contributions to super that exceed employer contributions to the fund can be problematic and lead to your fund being deemed a ‘Foreign Grantor Trust’ for US tax purposes. This means additional filing or accounting costs to your US return, as the earnings of the super will be assessed on your personal income tax return.

Self-Managed Super Funds (SMSF)

While an SMSF can offer more flexibility and control over your Australian retirement savings, these will likely be deemed ‘Foreign Grantor Trusts’ for US tax purposes. This means US tax authorities will ‘look through’ the structure and tax the earnings in the individual’s hands.

It can offer more flexibility and control of Australian retirement savings. However, your SMSF may be considered a ‘Foreign Grantor Trust’ if you are liable for US taxes. This will mean that US tax authorities ‘look through’ the structure and tax the earnings in the individual’s hands. There would then be great scrutiny of the investments held within the structure as a PFIC (see point one).

Family trusts

Family trusts can be an effective tool for Australian tax planning, offering flexibility in earnings distribution between your family group.

However, family trusts established by a US citizen, or where capital is contributed by one, may be seen as ‘Foreign Grantor Trusts’, meaning US tax authorities would look through the structure and attribute earnings to the US citizen taxpayer.

There are many benefits of a trust, including asset protection and Australian tax planning. However, it is highly complex, and specialist advice should be sought in advance.

Corporate structures

Corporate structures are an important tax planning tool used by many business owners in Australia. However, it will likely be more complex for US taxpayers. US taxpayers need to consider Controlled Foreign Corporation (CFC) rules for businesses domiciled outside the US.

The primary elements of determining if you have a CFC is when the foreign corporation is:

• Owned more than 50% by U.S. Persons (aka, a US Shareholder); and
• Each US Person owns at least 10% of the vote/value of the company (attribution rules apply).

CFC treatment can lead to more complex reporting and tax treatment under US tax law.

Advice from a cross-border accountant is necessary whenever a US taxpayer sets up a business in Australia to work out the most appropriate structure for Australian and US taxes.

So what does this mean for US taxpayers?

It might seem a little overwhelming, but you can still build wealth in Australia. When making financial decisions, you just need to understand and consider US and Australian tax treatment.

To make sure you make the right moves, it’s essential to get advice from tax professionals and financial advisers who understand both jurisdictions.

If you are considering your next move, speak to the specialist expat financial advisers at Apt Wealth Partners. We can help you navigate complexity and put you in touch with a range of other specialists who can make sure you make the most of your money on either side of the globe.

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.