What does it mean to be a US connected Person and how does one identify if they meet the criteria? The first port of call would be to identify what constitutes an US Citizen/Connected Person?
A US Citizen is:
- A person who was born in the U.S.
- A person born outside of the U.S. with one U.S. citizen parent, the passport of your birth may be irrelevant in this case
U.S. connected persons are:
- Green Card Holders
- Visa holders living in the U.S.
- Persons ordinarily tax resident in the U.S.
Thus, if you meet any one of the above criteria, this will mean that you are a U.S. citizen or connected person.
One important takeaway from it all, if you are an American or a U.S. connected person you will be obligated to report your taxes to the IRS, irrespective of your current place of residence. Upon any significant taxable event in your life would result in the IRS knocking on your door irrespective of your residency. Failures to report your U.S. taxes result in significant fines/penalties.
What is FATCA?
The Foreign Account Tax Compliance Act (FATCA) was introduced by the U.S. Department of Treasury and the U.S. Internal Revenue Service (IRS) in order to combat tax evasion and encourage stricter tax compliance by U.S. persons engaged in offshore financial activity. FATCA requires all U.S. persons, living in the U.S. or abroad, to pay tax on assets exceeding $50,000 in value. U.S. taxpayers must report on their foreign financial assets through Form 8938, Statement of Specified Foreign Financial Assets. Failure to comply with FATCA is costly and will have a significant effect and may take the form of:
- 30% penalty on withholdable payments
- Up to $50,000 for failure to file Form 8938
- 40% penalty on understatements of tax attributable to non-disclosed assets
Who is subject to FATCA?
The FATCA legislation affects clients treated as a ‘U.S. person’ for tax purposes, which is a very broad segment, referring to more than just U.S. citizens, including, but not limited to:
- Any person residing in the U.S.
- Green card holders
- S. residents for tax purposes
- Individuals who spend a significant portion of the year in the U.S.
- S. citizens residing in a foreign country
Any American living in Europe is subject to FATCA, but there are also other instances of individuals who are exposed to the U.S. tax system in some way or another and will have to comply with U.S. tax laws. Such instances include, obtaining some form of education in the U.S., individuals having U.S. parents or family among others.
Why should you consider using a European based Financial Adviser?
- S. advisers in most cases cannot provide regulated advice in your home country
- The ability to access mutual funds in the U.S. while overseas
- Advice can encompass and compare European based products such as pensions
- S. banks are closing brokerage houses to U.S. citizens based in Europe
- Understanding and comparing the tax implications of investing in both Europe and the U.S.
In addition to this, U.S. advisers do not typically possess the expertise and knowledge to be able to guide you through financial planning within Europe, especially when considering that opportunities for Americans based in Europe tend to be limited and include complex investment structures. Through our joint venture partnership with an SEC regulated firm, our financial advisers with ‘Series 65’ qualifications are able to function as an investment adviser representative in the U.S., for U.S. individuals both in and outside the U.S.
What is PFIC (Passive Foreign Investment Companies) and why it matters?
If you are considering a move to the US, are currently in the process of relocating there, or have been living in the US for a number of years after living in another country, It’s good to know what a passive foreign investment company (PFIC) is, because if you’re invested in one, you may be required to file certain tax forms, follow certain tax rules, and probably pay more in tax than you expected to. Thus, you should bear in mind the drawbacks that come part and parcel with holding Passive Foreign Investment Companies (PFICs). The PFIC regulations are only applicable to US persons, which includes US citizens, US green card holders, and US residents.
First, let’s clarify what “passive income” means. Passive income is money that comes to you with little effort of your own — examples include interest, dividends, royalties, rent, or certain capital gains.
PFICs are defined as non-US corporations held by a US person that satisfy at least one of the following criteria:
- 75% or more of its gross income in a particular year is from passive income. This includes dividends, interest, rents, royalties, as well as capital gains.
- 50% or more of the assets produce passive income or are held for the production of passive income.
Examples of PFIC investments, among others, might include:
- Non-US mutual fund trusts, mutual fund corporations and pooled funds.
- Exchange-Traded Funds (ETFs) listed on a non-US stock exchange.
- Non-US income trusts and non-US real estate investment trusts (REITs) that do not primarily carry on an active business.
- Shares of private corporations that do not carry on an active business, such as a non-US holding company, regardless or not if the underlying assets in the holding company are themselves PFICs.
Why is it important to understand PFIC Rules?
- PFICs are subject to draconian taxation by the U.S that often have significant tax implications and require careful consideration.
- S. person that is a direct or indirect shareholder of a PFIC must file Form 8621 for each tax year.
Let us Talk Tax!
Holding assets of these sort whilst being based in the United States will subject you to the US ordinary income tax rate on the capital gains and income you receive from PFIC-designated investments. Distributions from PFICs, such as dividends are taxed as ordinary income and do not qualify as “Qualified Dividends”. Which are taxed at the generally more advantageous long-term capital gains tax rate. With the highest federal tax rate currently sitting at 37%, what this means is that you could end up paying considerably higher taxes on PFIC investments when compared to their non-PFIC, US domestic counterparts. Unfortunately, it is common for expats who unknowingly own PFIC shares to end up being subjected to significant taxation by the US.
PFIC gains, and dividends what are known as “Excess Distributions” are subject to special U.S. tax rules. Thus, PFIC gains and “excess Distributions” are:
- Not eligible for capital gains treatment
- the gains and distribution amounts allocated to prior years in the holding period are taxed at the highest tax rate.
- Interest is also charged on the tax allocated to prior years as though it was due at that time.
The PFIC regulations are complex in nature and the resulting tax implications can vary from investor to investor. Over the past few years, we have helped a great number of clients during their move to the US. In so doing, we considered the additional costs of holding PFIC investments and used our experience to deliver customised solutions, depending on the client’s specific situation, and were able to lower the client’s overall tax burden. If you think the above could be applicable to you, we recommend reaching out to one of our representatives to discuss your needs.
Reporting of Foreign Bank and Financial Accounts
Under a law known as the Bank Secrecy Act, US connected persons must report certain foreign financial accounts, such as bank accounts, brokerage accounts and mutual funds to the Treasury Department and to keep certain records of those accounts. You report the accounts by filing a Report of Foreign Bank and Financial Accounts (FBAR) on FinCEN Form 114.
Who Must File?
A United States person, including a citizen, resident, corporation, partnership, limited liability company, trust and estate, must file an FBAR to report:
- a financial interest in or signature or other authority over at least one financial account located outside the United States if
- the aggregate value of those foreign financial accounts exceeded $10,000 at any time during the calendar year reported.
Generally, an account at a financial institution located outside the United States is a foreign financial account. Whether the account produced taxable income has no effect on whether the account is a “foreign financial account” for FBAR purposes.
But, you don’t need to report foreign financial accounts that are:
- Correspondent/Nostro accounts,
- Owned by a governmental entity,
- Owned by an international financial institution,
- Maintained on a United States military banking facility,
- Held in an individual retirement account (IRA) you own or are beneficiary of,
- Held in a retirement plan of which you’re a participant or beneficiary, or
- Part of a trust of which you’re a beneficiary, if a U.S. person (trust, trustee of the trust or agent of the trust) files an FBAR reporting these accounts.
You don’t need to file an FBAR for the calendar year if:
- All your foreign financial accounts are reported on a consolidated FBAR.
- All your foreign financial accounts are jointly-owned with your spouse and:
- You completed and signed FinCEN Form 114a authorizing your spouse to file on your behalf, and your spouse reports the jointly-owned accounts on a timely-filed, signed FBAR.
Note: Income tax filing status, such as married-filing-jointly and married-filing-separately has no effect on your qualification for this exception.