Whenever baby boomers get together socially two topics will almost certainly come up in the conversation.
The first will be about their ageing parents, and the increasing challenges that come when parents get older, and contemplate a move from the family home to some form of aged care facility.
The second will be about their children, and thanks to the global village that is now our world, you can bet that at least one of those children will be living overseas, possibly in the USA or the UK. A major issue that often arises will be how to handle the tax treatment of a change in residency.
Not born in the USA
I have had experience in both these issues, as I am a co-author with Rachel Lane in the book Age Care Who Cares, and my second son James is now a resident of the USA. Take it from me, if you think aged care is complicated, it’s a breeze compared to American tax law.
For what follows I’m indebted to Daniel Sparks of Pitcher Partners Sydney who took the time to explain the intricacies that face an Australian who becomes a resident of the USA, based on these five tips.
1. Residency
Generally speaking, you become an American resident for tax purposes the first time you enter the country after receiving your green card. Any child born in America is automatically an American citizen.
But, it isn’t necessarily the case that your Australian resident status ends at that time. You would still need to look at Australian principles of tax residency, which can be vague, to work out whether you have become a non-resident for Australian tax purposes.
It is possible you may be resident for tax purposes in both Australia and the US. In that case, you would have to look at the tax treaty to determine whether a tie-breaker test applies to treat you as non-resident from an Australian perspective. This is first based on where your ‘permanent home’ is but can become complicated if a person has a home in both countries, as is sometimes the case.
It is also possible you became a US resident at an earlier point in time due to the ‘substantial presence’ test if you were spending significant time there before getting the green card. Often, people move to the US on working visas initially and the green card comes later after they have already lived there a few years.
2. Superannuation
Daniel tells me that you will be required to advise the IRS every year the balance of your superannuation fund in Australia, and potentially pay America income tax on any gain in value, even if that value is unrealised. If the value has fallen because of market fluctuations, there is no deduction for the reduction in that value. This is particularly onerous because you will be paying income tax at American marginal rates, on earnings in your super fund which have already been taxed at 15% per annum.
3. Investments such as property and managed funds
When you become a non-resident for Australian tax purposes, you have two choices with your investments. The first option is to let a notional realisation happen for capital gains tax purposes and pay capital gains tax in Australia on that gain to date.
The assets then become part of your American tax affairs, and all income and capital gains need to be declared on your American tax return. If you keep assets such as Australian shares, you will need to advise the share registry you are now a non-resident - they will deduct tax from your Australian distributions at the normal non-resident rate.
Alternatively, you can keep the assets and pay capital gains tax when you dispose of them, while still including the income in your American tax return. The problem with doing this is that the capital gains tax discount of 50% slowly erodes, because no discount is allowed for non-residents.
I understand that there is a specific US/Australia tax treaty clause that might solve the ‘deferred CGT’ issue. It essentially says that if you defer CGT for Australian purposes, then US will tax the whole capital gain and Australia will not tax any of it. However, this only works if you are a US resident at the time of the sale. It wouldn’t work if you moved to a third country before selling the assets, or moved back to Australia, in which case Australia taxes the gain but you lose some of the CGT discount.
4. Gifts to the American resident
It is common for parents to give money to their children for help with living expenses, and possibly to help in buying a house. If these gifts exceed $US100,000 in a year the child is required to fill in Form 3520. In normal circumstances this would have no tax consequences, except that failure to report a foreign gift may result in a penalty of up to 25% of the unreported amount.
5. Inheritances
A bequest is similar to a gift and once again Form 3520 has to be completed. There may be Australian capital gains tax payable in the estate of the deceased, but if the beneficiary is a non-resident the capital gain cannot be rolled forward as it can be if you are a resident. In some circumstances a capital gain might be rolled forward if the asset is ‘taxable Australian property’ (eg. Real estate situated in Australia). Obviously it is critical when making a will to distinguish between non-resident beneficiaries and resident beneficiaries.
It can become complicated
What I have written is just a short summary of the complexity faced by Australians who become American residents. It also highlights the importance of getting expert advice sooner rather than later. It’s much easier to keep the car out of a bog than try to dig it out when the wheels are deep in mud.
Noel Whittaker is the author of Making Money Made Simple and numerous other books on personal finance. Email noel@noelwhittaker.com.au or visit the website. This article is for general information purposes only and does not consider the circumstances of any investor.