U.S. Tax on Foreign Investment Income (2018) – IRS Investment Tax Help
U.S. tax on foreign investments can be very complicated. That is because there are multiple factors that a U.S. taxpayer must take into consideration in order to determine whether a foreign investment is presently subject to U.S. tax — or qualifies for tax deferred or exemption status.
Common Foreign Investment Income Questions
- What type of income is the investment generating?
- Does the US have a tax treaty with the foreign country?
- Have taxes already been withheld at source?
- Does the investment meet one of the US tax-deferred status rules?
These are all important foreign investment U.S. tax related threshold questions necessary to determine whether the particular type of foreign investment income is taxable, and/or whether it meets an exception for tax deferred status — or even exemption from U.S. Tax
Here is a list of some of the basic issues to consider:
Is there a U.S. Tax Treaty?
One of the most important aspects of performing a foreign investment US tax analysis is to determine whether there is a tax treaty with a particular country. A tax treaty may impact the taxability of a foreign investment for many reasons — most importantly is because if there is a tax treaty, then the treaty may exempt, exclude, or defer the particular type of investment income from US tax.
Alternatively, even if the type of income is not exempted from tax, it maybe taxed at the reduced rate/qualify or qualify for beneficial tax treatment, such as qualified dividend status.
Is it Foreign Retirement?
Not all types of foreign income have immediate U.S. tax consequences by the US government. Oftentimes, depending on the type of foreign retirement, and whether there is a tax treaty, foreign retirement income may qualify for deferred status until the person is actually taking distributions from the income.
For example, the tax treaty between United States and UK is very in-depth on issues involving retirement. There are various exceptions, exclusions, and limitations as to the US taxability of a foreign retirement.
Conversely, the United States does not have a tax treaty with Singapore. Therefore, even though Singapore requirements contributions to the CPF (Central Provident Fund) — Singapores version of social security/retirement — under U.S. Tax law, and income deferrals or growth within a CPF is immediately taxable by the United States.
Is it a PFIC?
If the foreign investment qualifies as a PFIC then it will require a very complex analysis. This is because if the investment qualifies as a PFIC, and even though the investment may not currently be taxable by the US government unless there are distributions or excess distributions — which is unlike other types of foreign investments in which the growth within the fund is taxable even if it is not distributed — there is doom ahead.
That is because in future years, once there are excess distributions, it may lead to excessive taxes and interest which should bring the total amount of tax due to upwards of 50%+ vs. the typical 15% or 20% tax liability for Long-Term Capital Gains and/or Qualified Dividends.
*In order to avoid the harsh tax liability there are certain elections you can make come up with the elections must be made timely or meet very strict requirements.
Did You Already Pay Foreign Tax?
Is important to note that as unfair as it is for the United States to tax you on income that is being generated in a foreign country, the IRS does allow you to take the credit against the taxes you already paid.
Therefore, if you have already paid for tax on the foreign investments, then you can typically claim the foreign tax credit with your tax return — so that you’re not paying double tax.
It is no typically a dollar-for-dollar credit but in computing the analysis, oftentimes the credit reaches about 80% of what you paid in foreign income — and you can use the rest in other years.
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