We approached Seth, who has 29 years of experience in handling expat taxes for people who are heading either way between Australia and America, to answer a few questions about tax commitments for Americans living in Australia.
Are there people who have double taxation issues or is everyone only paying a portion in each country?
In a nutshell, people are generally paying the higher of the two rates otherwise there would be no reason for them to leave their country and work elsewhere. In Australia, any income that is subjected to tax in both countries will pay the Australian tax rate, which is quite a bit higher. For an income of above $AU180,000 the tax rate is at 45% and it will be 47% for those subject to the Medicare levy. This ensures that there is no double taxation and minimal U.S. taxation.
In America there is a 3.8% surtax on net investment income and that cannot be reduced by any Australian tax. Unlike the U.S., in Australia there is a more concessional approach on managed funds, superannuation plans, family trusts, etc.
What is the main mistake that Americans make when they move to Australia for a business or job opportunity?
Many Americans assume that when they move to work offshore, they don’t have to file a tax return in the U.S. anymore, because they are paying taxes in their new place of abode, in this case, Australia.
Therefore, we often find that by the time people approach us, they may have skipped quite a few years of tax filing in the U.S. People are shocked and worry about how much they will end up paying, but because Australia has very high taxes, most people either don’t pay much or nothing at all. However, they do have to file their returns.
Why is their tax liability either nil or very low?
Foreign tax credit earned from the taxes is what reduces the tax liability in most cases, but there are some cases where there may be an exclusion on salary, business income, or a combination of the two.
What about the child tax credit refund?
This refund is $1,400 per qualifying child of U.S. citizens and many children born from couples in Australia, even if the one spouse is Australian qualify for this credit on their U.S. return. Therefore, those parents need to get a social security number for their children so that they don’t lose the refund. If parents need time to first get social security numbers for their children, they do qualify for the extended deadline of their tax return as offshore residents. Amendments can also be done, but take more time.
These refunds can be deposited by the IRS directly into a U.S. checking account for those who haven’t closed them, making it easier to receive the money.
Why are superannuation accounts such an issue?
The U.S. tax code is not designed to account for the retirement plans of other countries and that is why these accounts must be analyzed for the IRS. Unfortunately, many people compare them to 410 K and think that they only need to declare when they get distribution. However, they always need to be accounted for in their U.S. tax return.
How are the employer contributions to superannuation funds treated by the IRS?
These are not considered the same as the 401K and the employer contributions are considered as taxable salaries. They also look at the growth in the fund.
Employee benefit trusts are funds where contributions are made by the employer and not so much by the employee. Their growth is not seen on a year on year basis but at distribution.
On the other hand, if the employee has made supplemental contributions to the fund more than the amount the employer has put in, then that portion of the funds are considered as grantor trusts by the IRS. Whatever happens to that portion of the funds, is an extension of the taxpayer.
The same applies to superannuation funds that are set up by someone who has their own business, or even by partners in a business called Self-Managed Super Funds (SMSF). Many also roll over into these funds from a retail fund. These contributions are taxable in the U.S. but the higher tax rates in Australia may mean that no tax is liable or people may have some carried-over foreign tax credit that will cover any tax. Grantor trusts require additional forms and these are 3520 and 3520-A.
Tax preparation of these can be the most expensive part because reporting must be timely and accurate otherwise there are penalties. We saw lots of penalties last year at a hefty $10,000 each. These are difficult to eliminate.
When does the grantor trust reporting kick in?
Over the lifetime of the fund, any extra money put in by the employee needs to be reported, including any other money that someone may put into the superannuation account.
If these have not even reported for several years, quite a lot of digging is required to find the exact amounts contributed. However, people should realize that the financial impact of taxes due may not be significant at all when considering the tax already paid in Australia.
With a grantor trust the underlying investments are also important to the U.S., especially managed funds that are treated harshly by the IRS because they are PFICs (passive foreign investment companies).
When is the superannuation taxed?
In Australia whatever comes out of the superannuation is tax-free, but the same does not apply in the U.S. The IRS looks at any distributions and considers what part of the money has already been taxed in the U.S. When removed, that money won’t be taxed again. Any growth in the funds that may not have been taxed will be taxed when removed, but that amount will depend on any carry forward tax credits.
What about family trusts?
Family trusts are used for tax planning by individuals to spread out their income, especially if they are high earners. From a U.S. point of view, family trusts are regarded as grantor trusts and all their earnings are attributed to the person who funds them. In the U.S. the earnings will go to the U.S. individual in the fund, regardless of who pays tax on the family trust in Australia. Investments must be chosen accordingly for these trusts to avoid double-tax situations.
What is the first move anyone should make when wanting to start looking at their U.S. tax?
Tax planning must always be done on a global basis and the sooner the better. It’s worthwhile having a chat with an expert first so they can understand where they stand with the IRS. Planning can also help lower their Australian tax, putting them in a better position than when they started.
Some people only need to catch up with their filing, others need to submit returns for quite a few years and this is where the streamlined amnesty is helping people avoid big penalties.
What advice would you give Americans moving to Australia?
If they have a choice, Americans should avoid investing in any manage funds before they get some advice from a tax expert and knowing the tax impact.
Contact us at Expat Online for more information.