Australia is one of the most influential countries in the world.
It has an extraordinarily large expat community, including a large population of individuals who are either U.S. citizens that relocated to Australia, or Australian citizens who either obtained a Green Card, U.S. Work Visa, or relocated to the United States and are now subject to U.S. Tax.
As one of the few international tax law firms in the world that focuses exclusively on IRS Offshore Voluntary Disclosure, we have represented numerous individuals worldwide who have Australian-U.S. tax related issues.
With the introduction of FATCA (Foreign Account Tax Compliance Act), along with the renewed interest by the United States in enforcing FBAR Reporting (Report of Foreign Bank and Financial Accounts) — as well as other related international reporting forms (3520, 3520-A, 5471, 5472, 8865, and 8621) – it is absolutely crucial that you remain in U.S. tax compliance.
The following summary is a basic analysis of various Australia – U.S. Tax related issues.
This is not intended on tax advice, or to rely upon to avoid penalties or take a tax “position.” It is for information purposes only.
- 1 Tax Basics – Australia
- 2 Foreign Tax Credits
- 3 Foreign Earned Income Exclusion
- 4 Superannuation Funds
- 5 Franking Credits
- 6 Rental Property
- 7 General Reporting Requirements
- 8 FATCA and Foreign Account Reporting
- 9 FATCA Form (8938)
- 10 Foreign Gift Form (3520)
- 11 Foreign Corporation or Foreign Partnership (5471 or 8865)
- 12 Passive Foreign Investment Company (PFIC)
- 13 Foreign Trust (3520-A)
- 14 Foreign Real Estate Income
- 15 Golding & Golding, A PLC
Tax Basics – Australia
Australia is similar to the United States, in that it taxes individuals at a progressive tax rate on all types and sources of income. Unlike many Asian countries for example, which do not tax various forms of passive income — Australia taxes its citizens and permanent residents on all types of income.
Unlike the United States, Australia is RBT (Residence-Based Tax) and not CBT (Citizen-Based Text). As such, if you are a Australian person for tax purposes and relocate the United States, you will file a nonresident tax return similar to many other countries.
Foreign Tax Credits
If you are subject to U.S. tax and work in Australia and/or earn income and pay tax on your Australian Income, then you would receive a Foreign Tax Credit for the majority of taxes you pay in Australia when you complete your U.S. tax return. For example, if you reside in the United States and you earn $20,000 of passive income in Australia (excluding more complex issues involving franking credits and related investment issues), you would owe tax in Australia when you file your non-resident tax return.
Likewise, if you are in the United States as a U.S. citizen, Legal Permanent Resident, or Foreign National subject to U.S. tax because you are in the United States on a work visa (H1-B, L-1, E-2 etc.) and meet the Substantial Presence Test, you would be required to report this $20,000 on your US tax return as well. But, when it comes time to pay your U.S. tax, you would receive a Foreign Tax Credit against the taxes you already paid in Australia. Therefore, you do not pay double tax on this income.
It should be noted that depending on what your tax rate was in the United States, coupled by the total amount of your U.S. income, you may not be entitled to use the full credit — but you can carry it forward to subsequent years.
Example: Let’s say you are filing Australian tax returns as a nonresident because you reside in the United States. You earned $100,000 of income in Australia and pay $30,000 of income tax in Australia – you do not have to pay that same $30,000 again in the United States.
Rather, you report all of your income on your U.S. tax return, and then either make a claim for a Foreign Tax Credit (or, if applicable, the Foreign Earned Income Exclusion if you meet the requirements) and/or a hybrid of both. This way, the $30,000 you already paid on the income you earned in Australia will be credited to the U.S. tax when you report your foreign income in Australia to the United States.
If you paid more in Australia then you would have paid in the United States, then you can carry the remainder of the credit forward to be used in subsequent years in which you have a tax liability from Australia (in other words, you cannot use the tax money you paid in Australia to offset taxes due on US source income in years you do not have any Australian income).
If you paid less in Australia than you would have paid in the United States, you will pay the difference in the United States. If you paid the identical amount, then congratulations – nice tax planning.
Foreign Earned Income Exclusion
If you qualify for the Foreign Earned Income Exclusion, you will qualify to have $100,000 of your Australian income, along with a portion of your foreign housing excluded from U.S. tax. For example, if your salary was $110,000 in Australia, and you meet either the Physical Presence Test or Bona-Fide Residence test, you would be entitled to exclude $100,000 of the income from your US Income.
Two important facts: You still have to report the income on your U.S. tax return, but you would thereafter claim the exclusion by filing form 2555 along with your tax. In addition, even though you only have $10,000 of income remaining, under relatively recent changes in the law, that $10,000 (along with any other income unless subject to lower taxes such as qualified dividends) will be taxed at the income bracket tax rate you would have been taxed at.
For example, if you have any additional $50,000 of income, then your total income would’ve been $160,000. Even though there is only $60,000 of remaining income, you are taxed as if you earned $160,000 (so you will be taxed at the progressively higher tax rate).
Superannuation funds are very common in Australia and required for most, if not all individuals working in Australia. It is similar to a retirement fund and the “super” as it is referred to is basically a structure of investments in which the Australian government wants individuals to plan for retirement. Under most circumstances, the employer and the employee deposit money into the super and it grows tax free.
It cannot be withdrawn until retirement age, and there are many other “super-specific” factors you may need to consider which require you to first speak with an Australian tax attorney regarding the impact of the Super on your Australian Taxes.
With respect to U.S. Tax related issues, the following facts are very important:
Superannuation funds should be reported on an FBAR form each year, if on any day during the year, your annual aggregate total of all foreign accounts exceeds $10,000. Even though it is a retirement type investment, you do have an account number — and therefore it should be reported.
The failure to file a form 8938 may result in significant fines and penalties. As such, it is probably in your best interest to file this form as well to report your Superannuation Fund. There is some confusion as to whether theSsuperannuation may be considered a foreign trust and therefore you would file a form 3520-A (instead of the form 8938) but to play it on the safe side, in most situations filing a form 8938 will be sufficient.
Your Superannuation is Probably not a Trust
The rules regarding the complexities of whether superannuation is a foreign grantor trust work or non-exempt employee trust is far beyond the scope of this introductory article. Other than to say, if you are able to obtain the necessary information from your superannuation fund to make this determination in accordance with Internal Revenue Code section 402 et seq. then by all means you should.
Presumably, your Superannuation reporting requirements include an FBAR and FATCA Form 8938. With that said, if your superannuation fund has been funded primarily by the employee (you) and not the employer, then it is different. In that case, once the trust is funded in excess of 50% by employee contributions, the trust must be split, and the portion involving the employee’s contributions would not be considered a nonexempt employee trust and thus the employee and/or Trusts may be required to report a form 3520-A and/or form 8621.
Unlike a 401(k) in the United States, the U.S. government does not acknowledge tax-deferred treatment of a Super. Therefore, if your foreign employer contributes money to the superannuation fund, then it should be reported as salary on your U.S. Tax Return. In addition, any contributions made from the employee are not deductible.
If a person receives distributions from the superannuation fund, than those distributions are taxed along with their regular income. If possible, the taxpayer may try to obtain qualified dividend treatment for any distribution that is considered a foreign qualified dividend.
Annual Fund Growth
This is where it gets very sticky.
In reality, the superannuation fund is mandated by the government and therefore should receive some form of 401(k) treatment (aka deferred tax). Unlike a Canadian registered retirement investment fund (RRIF) or registered retirement savings plan (RRSP), which can receive deferred treatment, the United States does not outright state that a Superannuation Fund is the same as a 401(k) — the tax treaty is silent on the superannuation fund.
The general understanding amongst tax attorneys is that if a person is in the top 20% of earners and is considered a Highly Compensated Employee (HCE), then the annual growth – even though not distributed – should be included in the taxpayer’s annual income.
In reality, it is not so bad (aside from the bad taste of paying tax on income you cannot presently touch) since the tax will increase the your basis in the super, and therefore when the person receives distributions in the future, he or she will have a higher tax base (and presumably less tax).
We will not spent too much time on franking credits, other than to explain that they are credits you receive as an Australian resident for certain passive income derived from Australian companies. The general method of franking credits generally goes like this:
A company in Australia may $1,000.00 in dividends to the taxpayer. In addition, the company may have already paid certain taxes to the Australian government on behalf of the individual. As a result, the individual may not owe any additional tax on the income year she earned dividends. Moreover, the taxpayer maybe in a lower tax rate and therefore be entitled to a refund as a result of there being “franking credits” than there is tax liability.
The question we receive often from our clients with Australian income is whether they can claim this credit as a foreign tax credit in the United States. The answer is probably no.
Why? Because you did not actually pay the tax. Rather, the company paid the tax and passed through the tax savings to you – thereby reducing your Australian tax liability for the dividend. You did not actually reach into your pocket and pay the tax; thus, the IRS will presumably not allow you to take the credit, since you did not actually pay the tax from your own money.
It is similar in concept to Taiwanese tax imputations, and/or dividend payments made on behalf of individuals with Central Provident Funds in Singapore.
If you own rental property in Australia, then you must report the income in the United States. With that said, you get the same deductions that you would ordinarily receive in Australia under US tax return by way of schedule E.
You report gross income, along with all the deductions you took abroad for your rental property. In addition, you are also entitled to depreciation (which is handled differently than in Australia). Depreciation is a rather complex idea, which can be simply stated as follows – if you own a rental property and you can distinguish between what portion of the property is land, and what portion of the property the structure – then you can depreciate the structure over a 40 year period.
For property located in the United States – depending on the classification – you may be able to deduct it over a shorter period of time such is 27.5 years or 39 years (leading to more deductions quicker), but when it comes to foreign property, it must be depreciated over 40 years. In other words, you have to extend time of the depreciation over a longer period, so that you can depreciate less each year then you could for a property located in the United States.
General Reporting Requirements
Depending on the type of assets, income, investments, etc. you maintain overseas, you may have several (read: Tedious) reporting requirements.
The following is a brief summary of some of the more “basic” reporting requirements:
FATCA and Foreign Account Reporting
United States requires individuals to report there Foreign accounts, specified assets and other investments to the United States in a variety of different circumstances. The most common is the annual FBAR statement – which is a report a foreign bank and financial account form.
If you, your family, your business, your foreign trust, and/or PFIC (Passive Foreign Investment Company) have more than $10,000 (in annual aggregate total at any time) overseas in foreign accounts and either have ownership or signatory authority over the account, it is important that you have an understanding of what you must do to maintain FBAR (Report of Foreign Bank and Financial Accounts) compliance. There are very strict FBAR filing guidelines and requirements in accordance with general IRS tax law, Department of Treasury (DOT) filing initiatives, and FATCA (Foreign Account Tax Compliance Act).
Penalty: The penalty ranges from a Warning Letter, to $10,000 per account, per year (non-willful) to 50% value of the account per occurrence (willful)
Golding & Golding Resources: FBAR Basics, FBAR FAQ, FBAR Penalty Guide.
Beyond the FBAR, there are also many other reporting requirements to keep in mind. There summarized below for you (this is not an exhaustive list but rather a representative list of what the majority of individuals may have to report)
FATCA Form (8938)
FATCA is the Foreign Account Tax Compliance Act. For individuals, it requires the reporting of financial accounts and certain specified foreign assets (ownership in businesses, life insurance, etc.). There are different threshold requirements, depending on whether a person is Married Filing Jointly (MFJ) or Married Filing Separate (MFS)/Single, and whether a person resides in the United States or outside of the United States.
Penalty: The penalty for failing to file each one of these information returns is $10,000, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return. Total Penalty can reach $60,000
Golding & Golding Resources: Form 8938 FAQ; Form 8938 Penalties
Foreign Gift Form (3520)
If you receive a gift or inheritance from a foreign person that exceeds $100,000 either in a single transaction, or a series of transactions over a year, you are required to report the gift on this form. You have to file this form, even if you are not required to file a tax return (although it is normally filed at the same time as your tax return).
Penalty: The penalty for failing to file each one of these information returns, or for filing an incomplete return, is the greater of $10,000 or 35 percent of the gross reportable amount, except for returns reporting gifts, where the penalty is five percent of the gift per month, up to a maximum penalty of 25 percent of the gift.
Golding & Golding Resources: Form 3520 Penalties
Foreign Corporation or Foreign Partnership (5471 or 8865)
The rules are somewhat different for these two forms, but essentially the same (with the 5471 being much more commonplace for U.S. investors). If you own at least 10% ownership in either type of business, you are required to report the information on either a form 5471 or 8865. Both of these forms require comprehensive disclosure requirements, involving balance statements, liabilities, assets, etc. Moreover, the forms need to be filed annually, even if a person does not have to otherwise file a tax return
Penalty: The penalty for failing to file each one of these information returns is $10,000, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return.
Golding & Golding Resources: Form 5471 Penalties
Passive Foreign Investment Company (PFIC)
One of the most vilified type of financial assets/investments (from the U.S. Government’s perspective) is the infamous PFIC. A PFIC is a Passive Foreign Investment Company. The reason the United States penalized this type of investment is because it cannot oversee the growth of the investment and income it generates. In other words, if a U.S. person invests overseas in a Foreign Mutual Fund or Foreign Holding Company — the assets grows and generates income outside of IRS and U.S. Government income rules and regulations.
As a result, the IRS requires annual disclosure of anyone with even a fractional interest in a PFIC (unless you meet very strict exclusionary rules)
Penalty: The Penalties for not filing an 8621 run concurrent with the 8938 penalties (see above).
Golding & Golding Resources: Form 8621 Penalties; PFIC Form 8621 Excess Distribution Calculation
Foreign Trust (3520-A)
A Foreign Trust is another type of Foreign Investment that is frowned upon by the IRS. From the IRS’ perspective, the only purpose behind a Foreign Trust is to illegally avoid US reporting and income tax requirements by moving money offshore. While there are many people who may operate illegally in this fashion, there are various legitimate reasons why you would be a trustee or beneficiary of a Foreign Trust (Your cool grandma really loves you, and placed $5 million in a foreign trust for you overseas). Form 3520-A is a relatively complex form, which must be filed annually by anybody that owns a foreign trust.
Penalty: The penalty for failing to file each one of these information returns or for filing an incomplete return, is the greater of $10,000 or 5 percent of the gross value of trust assets determined to be owned by the United States person.
Golding & Golding Resources: Form 3520-A Foreign Trust Penalties
Foreign Real Estate Income
Even if you are earning rental income from property that is located outside of the United States, you still must report the income on your U.S. taxes (even it is exempt from tax in the foreign country). Remember, United States taxes individuals on their worldwide income. Therefore, the income you are earning from your rental property(s) must also be included on your US tax return.
A few nice benefits of reporting the income is that the United States allows depreciation of the structure – which many foreign countries do not allow. Moreover, you can take the same types of deductions and expenses that you otherwise take the property was located in the United States.
Penalty: Varies, depending on the Nature and Extent of the non-disclosure.
Golding & Golding Resources: Foreign Real Estate Income FAQ
Golding & Golding, A PLC
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