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December 8, 2017

How an Income Tax Treaty’s Saving Clause Works

I received a question from a reader, and it is a good way to explain the saving clause of an income tax treaty.

The question, from reader E.C., is simple:

Are U.S. Social Security benefit payments to a U.S. citizen who is a resident of Italy taxable in Italy or in the U.S.?

Tax Treaties

Income tax treaties are agreements between two countries. Treaties attempt to make live easier for residents of one country who have income from the other country.

So, for instance, a U.S. citizen living in Italy is:

  • taxable by the United States (because he is a U.S.
... continue reading
December 5, 2017

Roth IRA Taxation for Covered Expatriates

Let’s talk about how a covered expatriate’s Roth IRA is taxed at the time of expatriation.

Summary

Make-Believe Distribution

A Roth IRA is treated as if there is a make-believe distribution to a covered expatriate on the day before renouncing U.S. citizenship or abandoning green card status.

Income Taxation of the Distribution

The income tax cost of the make-believe distribution is zero if:

  • the Roth IRA has been in place for five taxable years (see the explanation below), and
  • the covered expatriate is age 59.5 or older.

If those two conditions are not satisfied, part of the fictional distribution will be taxable.... continue reading

November 30, 2017

Foreign Mutual Funds Investing in the US Are Still PFICs

Foreign mutual funds investing in the US

This is a question from an email:

I have a foreign mutual fund that invests in stocks of US corporations. Is the mutual fund a PFIC?

In this post, I will discuss why this mutual fund is a PFIC. Here is the tl;dr version: There is no exception in the PFIC rules for invests in the US.

What are PFICs?

Passive foreign investment company (PFIC) is a classification under US tax law. When a US person receives a distribution from a PFIC or sells shares in a PFIC for a gain, special rules apply.... continue reading

November 16, 2017

Pre-1997 Unit Trust Funds

Pre-1997 unit trusts

This scenario is loosely based on some analysis we did for a client:

I bought 10% of units in a private unit trust in a foreign country back in 1990. All other unit holders are nonresident aliens. We could transfer the units by giving notice to the trust without seeking permission. All unit holders are personally liable for the debts of the trust in proportion to their unit holding. It invested in stocks and bonds. It and its nonresident alien shareholders never filed anything in the US tax system.

In this post, I will discuss why this unit trust was a PFIC when it was bought and why it underwent a deemed liquidation in 1997.... continue reading

November 13, 2017

Foreign Trust Distributions and How They’re Taxed

Congress Hates Foreign Trusts

Congress hates foreign trusts.1 We know this because:

  • Distributions to U.S. beneficiaries from some foreign trusts (foreign nongrantor trusts, to be precise) can face a tax rate of up to 100%. You receive $100 and must pay $100 in tax? Yes.
  • Penalties are staggering if you don’t file the right paperwork2 on time: 35% of contributions and 35% of distributions not reported.

I like to convert foreign trusts to domestic trusts in order to eliminate these problems. Beneficiaries of domestic trusts do not have to file the offending forms (eliminating the penalty risk), and do not face the horrific tax cost imposed on distributions.... continue reading

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