Investment Options for American Expatriates
The life of an expat is filled with advantages, the lingering obligation to the IRS is not one of them. Regardless of where a US citizen resides, he is still required to pay taxes to the US government. There are right and wrong ways to reduce the amount owed, however.
The Wrong Way
Many expats focus so narrowly on reducing their tax bill that they make rash, and even harmful, choices. Unethical business owners make a living by convincing American expats that offshore products act as “tax havens” and are unseen by the IRS.
In this modern and rapidly shrinking world, however, governments are very adept at sharing information. Although tax havens did indeed exist, they are quickly becoming a thing of the past.
Even countries once determined to remain outside of the network are succumbing to the pressure. Not to mention that, in the online world, it’s difficult to keep a secret for long.
US law states that if, at any point during the year, an expat has more than $10,000 in all of his foreign accounts combined, he must report this amount to the US Treasury via Form 90-22.1. Because the US government must bring in more money to compensate for the rising deficit, and congress tries to avoid raising taxes, the US government has found that the most efficient way to increase revenue is to enforce preexisting laws (such as this one). It was never legal or advisable, but no longer is it safe to “hide” money offshore. Doing so puts you at risk of both criminal and civil charges.
If you are not informed, your actions may have the opposite result intended. For example, the IRS might view your saving strategy as a Passive Foreign Investment Company (PFIC). If this is the case, your gains will be taxed at the highest possible rate. Also, deferred liabilities are seen as underpayment. Expats should consult with an international tax expert before deciding on a tax saving strategy and especially before moving assets offshore.
The Right Way
For expats that prefer a safe and legal approach to lowering their taxes, a three part investment strategy is recommended by international tax experts. First, one should invest in tax efficient investments. Next, the investor should manage each of his investments well. Lastly, said investments should be held in the recommended accounts.
What are Tax Efficient Investments?
The goal of investing is to make more money off of your preexisting capital. As luck would have it, the best investments in terms of risk adjusted returns are usually also the most tax efficient. When investing wisely, a diversified portfolio is always best because it lowers your risk. Foreign index funds are also wise as you are not relying only on the US dollar.
How to Manage Your Investments
Wisely managing your investments involves careful research and planning. Dumping investments based on fear or emotion is a poor investment strategy. And, if done often, will result in higher than necessary transaction fees and taxes. Rebalancing must be done, but it should be based on a study of risk. Additionally, one should always plan to buy low and sell high, regardless of the worrisome dips that will naturally occur.
The type of account that investments are held in has a significant impact from a tax perspective. For example, Real Estate Investment Trusts should be held in an IRA (or another tax advantaged account). This legally ensures that the investment will bypass unfavorable taxes. Low growth stocks are a good match for brokerage accounts. Although these accounts are taxed, stocks will not be taxed until the gains are realized.
Onshore Investments and Conclusions
Although it is wise to reduce your tax bill wherever possible, that usually does not involve moving your money to offshore accounts and investments.
Moving money offshore is better motivated by a desire to reduce currency risk. Moving money to so called “tax havens” is not legally or financially worth the risk. There are legitimate offshore strategies offered by investment professionals, but these are pricey and do not make sense for the average investor.
The average investor may opt to avoid the additional filing requirements and simply keep his investments onshore. Even Americans without any physical ties to the US are able to open onshore accounts with US brokers (such as E*Trade and Charles Schwab).
Applying these strategies will result in lower taxes obtained in fully legal and ethical ways. Onshore investors can also expect lower service and product fees. In addition to the benefits, both financial and in terms of ease, the peace of mind that is available in the absence of the complexities of offshore investments is reason enough to invest onshore. To determine which investment choices are right for you as an expat, consult an international investment and taxes expert.
I.J. Zemelman, EA is the founder of Taxes for Expats