Looking after Aussies in America

Recent US efforts to crack down on tax evasion through overseas accounts are catching out expatriates living there, particularly Australians with existing superannuation funds back home, according to Brett Evans, the founder of Australia-based Atlas Wealth Management, one of the only firms currently advising such expats. Below, he explains some of the uniquely American complexities involved…

Since the Global Financial Crisis, a massive wave of Australian expats has swept across the Pacific Ocean to live and work in the United States.

Estimates are that there may be up to 200,000 Australian citizens in total who are living and working in the United States at present.

The surging numbers have been fueled by a number of factors, including a tech boom that’s currently under way in Silicon Valley, and a migration of financial services and legal jobs from the UK to New York.

But it’s not just an urban or East and West Coast trend: Aussie expats can be found in some of America’s small towns as well as its major cities, with the exact location usually being dictated by their reason for moving to the US.

Aussie expats who end up in America’s major cities have typically moved there to work for major companies, for example, while those living in the smaller towns tend to have moved there for personal reasons, which may include having married an American citizen.

We’ve seen a number who have found their way to largely-rural Northwest Arkansas, which is home to the world’s largest retailer, Walmart, even though the company, thus far at least, has never attempted to enter the Australian retail market.

And while the nature of the Australian diaspora means that quite often, they move from city to city and country to country while abroad, what we have found at Atlas is that those who have moved to the US generally seem to stay there for longer than those who end up in other countries.

We think this is due to the fact that working in the US isn’t a hardship posting compared to many other countries, and that the seniority of the positions held by Australian expats in the US tends to be higher than they are given in many of the other countries they tend to end up in, such as the UK.

This may be among the reasons Donald Trump has signaled his determination to make it harder for skilled workers to be employed in the US, in an effort to ensure more of the best jobs go to American workers. (A similar effort, ironically, has also been announced in Australia.)

20% of clients – and growing

At Atlas Wealth Management, US-based expat Aussie clients make up approximately 20% of our client base at the moment. But for reasons that we think include the recent introduction of the US Foreign Account Tax Compliance Act – and, we like to think, our specialised work in this space as well – US-based Aussies are accounting for as many as 60% of all of our new business enquiries.

This isn’t surprising, as we have seen similar surges in the past, whenever foreign jurisdictions introduce new legislation that affects Australian expats, and they suddenly find themselves in urgent need of advice.

And, at least as far as we know, we’re the only Australian financial services firm that is currently providing specialised financial advice to Australian expats located in the US.

That probably has a lot to do with the fact that you can’t just pitch up in the expat advice market one day and expect to be looking after American clients there the next, as you might with expats of some other nationalities. And as the numbers of non-US financial institutions that have recently announced that they are no longer willing to have American clients suggests, the US market is becoming ever more complicated.

We ourselves have spent the past three years talking to a large number of accountants and tax attorneys there, not just to improve our understanding of the jurisdiction, but also because we have been working on putting together our own end-to-end solution for our clients there, which we launched recently, called the “Pan Pacific Portfolio”.

‘Punitive’ IRS regs

Fundamentally, the problem for US-resident Aussies is that the US Internal Revenue Service’s regulations, as they apply to assets these expat Aussies hold back in Australia, can be extremely punitive.

The two main areas that are catching out such Aussie expats in particular are what the IRS deems to be, in its words, Passive Foreign Investment Companies (PFICs) – these are mutual funds, to you and I – as well as the IRS’s reluctance to classify Australian superannuation funds, for tax purposes, as a foreign pension – even though, of course, that’s exactly what they are.

The IRS’s harsh approach with respect to overseas investment holdings by US residents dates back to the 1980s, when non-US mutual fund and investment product providers were rolling up gains and distributions – offshore – for their US-based investors, and deferring payment to them, thus enabling them to defer any tax liability.

The US regulator responded to this with the Tax Reform Act of 1986, which established for the first time what is considered to be a PFIC. Thus, any foreign-based investment will be considered by the US tax authorities today to be a PFIC if it exhibits either one of two characteristics:

  1. At least 75% of the entity’s gross income is “passive”, eg, its income is derived from its investments, rather than from actual business operations, such as commerce
  2. At least 50% of the entity’s assets are investments that generate income by way of interest earned, capital gains or dividends

The problem for many Australian expatriates is that a lot of them arrive in the US already holding investment portfolios in Australia that include Australia-domiciled mutual funds, exchange traded funds (ETFs) and listed investment companies (LICs).

Unfortunately for these expats, all of these qualify as PFICs.

And the problem with an Australian investment being deemed a PFIC is that rather than receiving the benefit of the long-term capital gains rate of 15% being applied to the investment, all income these investments accrue (including any accrual of capital gains) is seen by the IRS as ordinary income – and the tax rate that applies instead will automatically be the highest individual tax rate, which is currently 39.6%.

What’s more, should the individual have any accrued capital losses in the United States, they aren’t able to use these offset capital gains accrued by a PFIC.

Also important to remember is that until recently, the US tax authorities weren’t generally privy to the offshore investment income of expats living in the US, and thus, these expats came and left the US without any problems.

But since the introduction of FATCA, non-US financial institutions – such as those managing the mutual funds, ETFs and LICs on behalf of expats now living in the US – are legally obligated to report their US-domiciled investors’ details to the IRS.

Not a lot of expatriates even now are aware of this.

Superannuation accounts

As for the superannuation accounts held by Aussie expats in the United States, meanwhile, the IRS has not, as of yet, handed down a definitive ruling on how it regards these – which has caused, and continues to cause, a lot of confusion.

Superannuation accounts, which are sometimes just called “super”, are the Australian government’s system for ensuring that people save for their retirement, with employers playing a major role in terms of contributions. Any Australians who have worked in Australia before emigrating are likely to have such an account in place, just as Americans tend to leave behind their IRAs and 401(k)s when they go abroad.

From private letter rulings that we have seen issued by the IRS, the US tax authorities seem to favour classifying superannuation accounts as “Foreign Grantor Trusts” – which doesn’t take into account the so-called “preservation state” of superannuation accounts, which has to do with the fact that scheme members can’t access the scheme’s assets before a certain age, even to fund tax liabilities.

This means that even though any income earned or capital gains that are crystallised inside of the superannuation account may be assessable at the personal income tax level in the United States, because they are seen as Foreign Grantor Trusts, Australian expats hit with such a tax bill must fund it from their current personal income.

The other problem with superannuation accounts held by Aussie expats who are resident in the United States is that the vast majority of investments inside of these accounts are held in managed or pooled funds, which in turn may trigger the PFIC ruling.

Due to the fact that expats have no control over the activity on their superannuation account, because the investment decisions are being handled by fund managers who aren’t taking into account the expat’s domicile, capital gains maybe crystallised without the expat’s knowledge.

As you can see, this may result in a multiplier effect that ends up exposing the expat to an excessive amount of tax.

The ‘Atlas Wealth answer’ 

For the past two years we have worked on designing and constructing a portfolio that is sympathetic to the above issues.
We call it the Pan Pacific Portfolio, and through it, we are able to control the turnover of the client’s portfolio, thus minimising, where possible, crystallising capital gains and thus incurring US tax.

It also enables us to ensure that the client avoids investing in any asset that the IRS is likely to deem a PFIC.

In conclusion

The US is currently undergoing an unprecedented political transformation, with the election as its president a man who talks about putting America, Americans and American interests “first”, and building a wall to keep out immigrants.

Despite this, thus far at least, none of our clients has indicated that they are thinking of leaving the country in the wake of Donald Trump’s election. This lack of response could reflect the fact that Australians, as a general rule, don’t get that caught up in politics, compared with some other nationalities.

That said, we could see changes down the road, if, as seems likely at this point, the US moves to tighten up its immigration policy.

If, for example, the US authorities make it significantly more difficult for Australians and others to obtain the visas they currently rely on to travel to the US and remain, we could see a shift in the Aussie expat tide. This happened in the UK in 2011, after the Government abolished a particular visa category that many Australians had relied on, and introduced a cap on the number who could be sponsored by UK employers.

For now, though, we’re concentrating on trying to find those US-resident Aussies who need us most, and don’t yet realise it.

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Brett Evans is the founder and group managing director of Atlas Wealth Management, the Southport, Australia-based, fee-only advisory firm which looks after Australian expats around the world. This article, which first appeared in the April issue of International Investment magazine, is intended for general information only, and is not intended as specific advice.

To read a recent profile of Atlas Wealth Management, click here. 

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