International Tax Matters

Traders have access to global markets.

U.S. traders move abroad; others make international investments and non-resident aliens invest in the U.S. How are their taxes handled?

U.S. resident traders living abroad

U.S. tax residents are liable for federal tax on worldwide income whether they live in the U.S. or a foreign country. A U.S. tax resident has U.S. citizenship or a Permanent Resident Card (green card). If you qualify for “bona fide” or “physical residence” abroad, which is living abroad for an entire tax year, try to arrange Section 911 “foreign earned income” benefits on Form 2555. Avoid the double taxation of paying tax in both a foreign country and the U.S. by availing yourself of foreign tax credits reported on Form 1116. If you live in a country which charges higher taxes than the U.S., it may make sense to skip the Section 911 exclusion, because creating officer compensation in a TTS S-Corp also causes some U.S. payroll taxes (FICA and Medicare)…

The U.S. has tax treaties with many countries, and these agreements specify which country is entitled to collect tax on different types of items, like capital gains and retirement plan distributions…

U.S. resident traders with international brokerage accounts

Some traders living in the U.S. have a foreign brokerage account. It’s complicated when traders open these accounts held in a foreign currency. Counterparties outside the U.S. do not issue Form 1099-Bs, and accounting is a challenge. Many foreign banks and brokers report U.S. resident’s account activity to the U.S. Treasury and IRS per FATCA (more on this later). Traders should separate capital gains and losses, including currency appreciation or depreciation, from changes in currency values on cash balances, which are Section 988 ordinary gain or loss…

Report of foreign accounts

U.S. residents with a foreign bank, brokerage, investment, and another type of account (including retirement and insurance in some cases) who meet reporting requirements must e-file FinCEN Form 114, Report of Foreign Bank and Financial Account (known previously as Foreign Bank Account Reports or “FBAR”). If your foreign bank and financial institution accounts combined are under $10,000 for the entire tax year, you fall under the threshold for filing FinCEN Form 114 and no filing is required…

IRS offshore voluntary disclosure program

The IRS closed the 2014 IRS Offshore Voluntary Disclosure Program (OVDP) on Sept. 28, 2018. OVDP encouraged taxpayers to come clean before getting busted by the IRS. The OVDP penalties are high (though there are exceptions)…

Foreign retirement plans

Don’t assume international retirement plans are like U.S. pension plans with tax deferral on income until you take taxable distributions. For U.S. tax purposes, the IRS considers many international retirement plans taxable investment accounts because they aren’t structured as qualified plans under Section 401 unless they qualify under Section 402(b) as an employees’ trust established by an employer…

In October 2014, the IRS acknowledged the tax-deferral problem on Canadian retirement plans and assisted. In Revenue Procedure 2014-55, the IRS repealed the need for filing a tax election, which means Canadian retirement plans automatically qualify for tax deferral…

Foreign assets reported on form 8938

Tax Form 8938 is more about giving the IRS a heads up regarding your international assets. It’s not about reporting income and loss — there are other tax forms for that. The filing threshold for Form 8938 is materially higher than the FBAR threshold, and it’s even higher for Americans living out of the country. (See Form 8938 instructions.)

U.S. traders move to Puerto Rico to escape capital gains taxes

Puerto Rico (PR) is not a U.S. state or foreign country; it’s a U.S. “territory” with its own government and tax system. Residents of PR report particular types of income to Puerto Rico and other forms of income to the IRS. Trading gains are capital gains on “personal property” taxed where the seller’s tax home is, which could be in PR.

PR enacted tax incentive acts that are tailor-made for traders/investors, investment managers, and financial institutions. Passed in 2012, PR Act 22 allows investors and traders with bonafide residence in Puerto Rico to exclude from PR and U.S. taxes under Section 933 100% of all short- and long-term capital gains from the sale of personal property accrued after moving there. Personal property includes stocks, bonds, and other financial products. Act 22 does not require investment in Puerto Rican stocks and bonds; trades can be made with a U.S. broker or on any exchange around the world. This capital gain tax break applies to professional traders using the default realization method, or Section 475 MTM.

There is a different PR tax incentive act for investment managers, who charge advisory fees. They sell their services to investors outside of PR and hence, they can qualify for PR Act 20 tax incentives for “export service businesses.” The Act 20 tax incentive is a 4% flat tax rate on net business income. The owner also receives Act 22 100% exclusion on dividends received from the PR business entity, and exclusion from U.S. tax, since PR residents exclude PR-sourced dividends from U.S. tax…

Renouncing U.S. citizenship or surrendering a green card

Some countries have lower tax rates than the U.S. and a few countries exempt capital gains from tax. Increasingly, traders, investment managers, and other taxpayers are surrendering their U.S. resident status (citizenship or green card), which requires potentially paying a Section 877A expatriation tax. The expatriation tax only applies to “covered expatriates” who have a net worth of $2 million or five-year average income tax liability exceeding $165,000 (2018 Form 8854). The IRS assesses the expatriation tax on unrealized capital gains on all assets — fair market value less cost-basis including debt — on the expatriation date. Only the net amount over $600,000 is taxable. Deferred compensation and IRAs are included and taxable, too…

Non-resident aliens are opening U.S. brokerage accounts

The U.S. stock markets have been stellar, and many non-U.S. persons have been accessing them from their home country. Other foreign individuals and entities prefer to open U.S.-based brokerage accounts for lower commissions, and better trading platforms.

In either case, the foreign individual or company is subject to U.S. tax withholding on U.S. dividends and certain other U.S. passive income. The default withholding tax rate is 30%, and income tax treaties provide for lower rates, usually around 15% or less. U.S. brokers handle this tax withholding and pay those taxes to the IRS. The foreign investor does not have an obligation for U.S. tax compliance if withholding is done correctly.

The critical point is that capital gains are not taxable in the U.S. if the nonresident alien does not spend more than 183 days per year in the U.S. Most active traders don’t generate significant dividend income paid by U.S. companies, so tax withholding is not a problem. Many of them get a foreign tax credit for U.S. tax withholding in their resident country.

Some nonresident aliens establish a spousal-member LLC in the U.S. and file a U.S. partnership tax return. The LLC/partnership opens a U.S.-based brokerage account as a domestic entity. The LLC files a W-9 with a U.S. tax identification number. The broker treats the U.S. LLC/partnership as a U.S. account, which means the broker does not handle the tax withholding on dividends and other passive income for the foreign owners of the LLC. Therefore, the nonresident alien owners must file a W-8BEN with the U.S. partnership. The U.S. partnership assumes responsibility for tax withholding on dividends and other portfolio income, and payment of those taxes to the IRS on a timely basis. It’s extra tax compliance work, but it’s not too complicated.

U.S. estate tax might come into play. Estate tax treaties may exempt brokerage accounts for nonresident aliens or provide higher exemptions from the tax. U.S. partnership interests are likely not includible in an estate for a nonresident alien. Brokers are not responsible for estate tax compliance, so it’s a tax matter for nonresident aliens and their tax advisors. Brokers require a conclusion of IRS estate proceedings before releasing assets from the account of the deceased…

Foreign Account Taxpayer Compliance Act

Foreign Account Taxpayer Compliance Act (FATCA) regulations went into effect in July 2014. The IRS and U.S. Treasury are intimidating foreign banks into reporting their American clients — even in countries like Switzerland known for bank secrecy…

Foreign-based forex brokers/banks

CFTC rules require foreign forex brokers and banks to be registered with the National Futures Association (NFA) and U.S. bank regulator, respectively, if they want to handle American retail customers. These CFTC rules limit allowable leverage to 50:1 on major currencies and 20:1 on minor currencies. These CFTC rules don’t apply to U.S. “eligible contract participants” (ECP) meeting those high net worth thresholds…

Excerpt from Green’s 2019 Trader Tax Guide Chapter 14 International Tax. 

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