International Taxation Overview
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International investments are some of the most difficult investments to report on your individual or your business tax return, and in many cases, international investments can end up having their own filing requirements in addition to your or your domestic business’ yearly return. Below I’m going to hit on a few of the more common types of international investments and I’m going to highlight some of the concerns relating to those investments. It’s our goal to help you come into compliance and to help you accurately report all of the investments that you have, but equally importantly, it’s our goal to have you closely analyze your own goals with your investments and to determine how you might like to change those investments to reduce your tax rates and possibly to simplify your financial life.
Foreign Bank Accounts (savings and current accounts)-
Income generated within foreign bank accounts is reported on Schedule B, with the rest of you interest, but there are some additional requirements. You have to include these accounts on your FBARs, your form 8938, and any foreign tax credits on your form 1116.
Foreign Portfolios and Share Investments-
Income from the sale of securities is included on your Schedule D with your domestic capital gains. These accounts also need to be included on your FBARs and form 8938 but this type of income gets a bit more complicated when it comes to foreign tax credits. The IRS’s application of source rules will generally prevent you from taking foreign tax credits for the sale of shares when you live in the United States.
Passive Foreign Investment Companies (PFICs)-
Let’s dive right in with one of the most tax disadvantaged types of investments, PFICs. A close look at the name casts some light as to what qualifies as a PFIC, a foreign company that has passive investments. There are some technical rules regarding what is and what isn’t a PFIC (ADD HERE ARTICLE LINK), but for most people this begins and ends with foreign mutual funds. Investing in mutual funds is very common, both domestically and overseas. It’s a good way to diversify your investment portfolio without having to personally manage a host of investments, and this is why most retirement plans around the world are invested in mutual funds. Domestic mutual funds receive regular capital gains treatment – sales of shares are taxed as capital gains to the extent the value of the shares has increased and dividends are taxed right on your schedule B. International mutual funds have a several different possible treatments, but unless you have made a timely election for the year of acquisition to utilize an alternative treatment, you are stuck with the default 1291 rules. The default treatment for PFICs (1291) effectively allocates the gain on any sales back to the date you originally purchased the shares through the sale date. That means if you purchased the shares ten years ago, these computations will spread the gain over the last ten years, you will be taxed at the highest marginal rate for each year (not your rate, the highest rate) and THEN interest will run for each year as though the tax from this allocation was due with your return for that year. The longer you’ve held the shares, the higher the effective rate on gains from those shares will be.
Foreign Life Insurance-
There are a host of complicated rules regarding life insurance and there are many policies around the world that are called ‘life insurance’ that do not resemble the U.S. definition of life insurance. Generally speaking, (it will depend on your specific policy) foreign life insurance is non-qualified life insurance and is ultimately given special tax treatment. People who have foreign life insurance generally have to pay tax annually on the growth of their plan. There is a less than straightforward computation (ADD HERE ARTICLE LINK), but it boils down to including the increase in the value of the policy as ordinary income on your tax return. With foreign life insurance we always look to the ‘surrender value’ to determine your interest in the policy, which means you need to know the surrender value at the end of the current year and the prior year to compute how much income you have from a policy in the current year.
Foreign Corporations-
The tax consequences and yearly reporting for owning foreign corporations are getting more and more demanding and the 2017 tax reform has created some substantial reporting requirements that didn’t previously exist. Returns for foreign corporations are required for dormant corporations, for corporations that only own property, for corporations that conduct all of their business abroad, by officers and directors of foreign corporations even in circumstances wherein they don’t directly own shares. When foreign corporations conduct business in the United States the reporting obligations double, as U.S. owners, officers, directors, and shareholders need to include the appropriate Form 5471 schedules with their personal returns AND the corporation needs to file it’s own 1120-F with the IRS as well. The bottom line is that if you have an interest in a foreign corporation and you haven’t consulted a tax professional experienced in the reporting of foreign corporations, you need to.
Much like the rules relating to PFICs, the foreign corporate taxation is an anti-deferral regime designed to prevent taxpayers from sheltering income within foreign corporations, which for many people means overly complicated yearly reporting resulting in income on line 21 of their personal return. Some of the issues for foreign corporations include: Subpart F income, constructive ownership, accounting adjustments in accordance with U.S. accounting rules (GAAP), GILTI, 965 Tax, reporting by officers and directors, transfer pricing, related party transactions on schedule M, foreign tax credits, loans to corporations, and loans that are recharacterized as contributions. The reporting for foreign corporations is so complicated and the issues are so varied that detailing all of the potential issues isn’t worthwhile, instead you should give us a call to determine what the potential issues are for your foreign corporation.
Foreign Retirement Plans and Foreign Trusts-
The IRS considers foreign retirement plans to be foreign trusts. This means that you need to analyze every foreign retirement plan you have to determine what type of trust it is and from there what tax consequences and what yearly reporting follows from that determination. Foreign retirement plans are often either grantor’s trusts or employee’s trusts and the reporting and tax consequences are completely different for grantor (ADD HERE ARTICLE LINK) and employee’s trusts (ADD HERE ARTICLE LINK). Foreign retirements offer require form 3520 and/or form 3520-A. The issues for foreign retirement plans aren’t nearly as varied as the issues relating to foreign corporations, but if you’re unsure if your foreign retirement plan is being correctly reported it’s worth giving us a call to determine if it’s been handled correctly, especially since the penalties can be so substantial if the IRS determines that you haven’t handled it correctly. Now is the time to correct any issues relating to foreign retirement accounts as the IRS still doesn’t have a firm handle on these issues and the available disclosure programs can protect you from the impositions of penalties when you correct your past filings. Some of the issues and questions relating to foreign retirement accounts are: do I need form 3520 or form 3520-A? Who is the trustee? Do I have a U.S. agent? Do I need to worry about accumulation distributions and the throwback tax? How do I handle the accounting for my form 3520-A? How do I determine my contributions to trust corpus? Do I need to get an Employee Identification Number (EIN)? Do I need a Foreign Grantor Trust Owner Statement, a Foreign Grantor Trust Beneficiary Statement or both? Can I ‘provide’ a Foreign Nongrantor Trust Beneficiary Statement to myself?
We have analyzed and correctly reported foreign retirement accounts from around the world. Some of the more common retirement accounts that we have handled include: TFSAs, RSPs, RRSPs in Canada, Superannuation and self-managed Superannuations in Australia, Superannuations and Kiwisavers in New Zealand, PPFs and EPFs in India, MPFs in Hong Kong, occupational pensions, personal pensions, company pensions, SIPPs, and SSASs in the UK. We come across new plans every year and we are more than capable of analyzing them, correctly reporting them, and explaining the U.S. treatment of your retirement plan to you.