What do US Expat Taxes, PFIC and FATCA have in common?
American expats living in Canada need to be aware of the tax implications from holding such certain securities. US citizens and green card holders who have been advised to acquire foreign mutual funds as a part of their investment strategy should be prepared to deal with harsh US expat tax consequences. We have seen more and more clients with PFIC holdings who are astonished by the increasing complexity of US expatriate tax returns.
- Income test. A foreign corporation that generates 75% of its gross income as a passive income (dividends, interest income, rent, capital gain) is considered a PFIC.
- Asset test. If 50% or more of assets held by a foreign corporation produce a passive income, then this foreign corporation is a PFIC.
Currently a PFIC form must be filed in one of the following scenarios:
- American expatriates who received direct or indirect distributions.
- US taxpayers who sold PFIC shares.
- US persons who make an election on Part II in regards to their PFIC holdings.
However, US citizens and green card holders with PFIC holdings must keep records of their investments whether they are currently required to file a PFIC form or not. American expats should be prepared for an unpleasant surprise while navigating the murky waters of the US tax law.
PFIC and FATCA
US citizens and green card holders who keep on ignoring PFIC filing requirements are advised to read more What is FATCA. Canada signed a FATCA agreement with the USA on February 5, 2014. Financial institutions will be required to report the information about financial accounts of US holders. The IRS will match this information to US expatriate tax returns and penalize PFIC owners.
Another important aspect to be aware of when it comes to Federal taxes is the U.S Self-Employment Tax. If you’re an employee of a foreign company (which could, in fact, be your own foreign corporation) and have payroll taxes from that country taken out of your pay, you don’t have to also pay social security taxes to the U.S. If you are self-employed, however, acting as an independent contractor, then you must file a Schedule C with your U.S. Tax return and pay the appropriate U.S. payroll taxes on your net earnings. The self-employment tax rate is 15.3% and the foreign income exclusion mentioned before does not reduce this liability.
You need to claim exclusions on your Form 1040 for each calendar year – they are not automatic – and the exclusions only apply to earned income, not rental income, interest or dividends or any income that’s not a result of your work efforts. You will need to fill out and attach IRS Form 2555 to your 1040 to take advantage of these exclusions. The form will also help you to determine what you do and do not qualify for in terms of being eligible for the exclusions. Year-to-year, Form 2555 will also provide what the latest caps on what those exclusions are.
As an American residing in Canada, it’s important to make sure your financial affairs are structured properly to avoid double taxation issues and ensure compliance with the laws of both countries.
Whether you are transitioning residency between Canada and U.S. or you have already made the move but continue to hold investment assets or financial interests in both Canada and the United States, proper cross-border financial planning can integrate and coordinate the asset management of your investments, reduce taxes and maximize your estate.
For those Canadians and Americans moving or living abroad, careful cross-border financial planning considerations must be given to ensure tax and regulatory compliance in both your home and adopted countries.