Navigating the IRS requires expert advice

Complex: Australians who become American residents need to get expert advice sooner rather than later. The IRS play hardball.
Complex: Australians who become American residents need to get expert advice sooner rather than later. The IRS play hardball.

When baby boomers get together the conversation will often turn to their children, and in many cases at least one of those children will be living overseas. For those living in the USA, the tax treatment of a change in residency is especially complex.

Daniel Sparks of Pitcher Partners, Sydney, has given me an insight of the intricacies that face an Australian who becomes a resident of the USA. We are talking here about federal taxes, levied by the Inland Revenue Service (IRS). State and local taxes vary considerably, adding to the complexity.

Residency - Generally speaking, you become a US resident for tax purposes the first time you enter the country after receiving your 'green card'. It is also possible you became a US resident at an earlier point, due to the 'substantial presence' test, if you were spending significant time there before getting the green card. And remember that any child born in America is automatically an American citizen.

Superannuation - Daniel tells me you will be required to advise the IRS every year the balance of your superannuation fund in Australia, and potentially to pay US income tax on any gain in value, even if that value is unrealised. 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 cent per annum.

Investments such as property and managed funds - When you become a non-resident for Australian tax purposes, you have two choices with your investments. One option is to make a notional realisation 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 you will need to declare all income and capital gains on your American tax return.

The other option is to 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 per cent 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 this 'deferred CGT' issue. It essentially says that if you defer CGT for Australian purposes, the 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 you sell the assets. It wouldn't work if you moved to a third country before selling the assets. And if you moved back to Australia, you would be back to paying Australian tax on the gain and losing some of the CGT discount.

Gifts to an American resident - Often, parents give money to their children to help with living expenses, or with buying a house. If these gifts exceed US $100,000 in a year, the child is required to fill in Form 3520. Failure to report a foreign gift may result in a penalty of up to 25 per cent of the unreported amount.

Inheritances - Once again, Form 3520 has to be completed. Australian capital gains tax may be payable in the estate of the deceased, and if the beneficiary is a non-resident the capital gain cannot be rolled forward. In some circumstances a capital gain might be rolled forward if the asset is "taxable Australian property" (e.g. real estate situated in Australia). Obviously, it is critical when making a will to distinguish between non-resident beneficiaries and resident beneficiaries.

This 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. The IRS play hardball.

Pension and super Q&A

Question. Would I be correct in thinking, as a pensioner, if I lent money at 1 per cent above the deeming rate Centrelink is applying to me I would not be worse off, and could I still gift within the rules.

Answer. If the money is in your name it will be deemed at the appropriate rates, and if the money is lent to another person those deeming rates will still apply for as long as the loan exists. The only risk you take is the person who borrows the money from you may be unable or unwilling to pay it back.

Question. I have been retired for a couple of years, and am thinking of getting some part time work. We have $190,000 in our pension fund and own our home. If I do get a job, will I be able to create another super account, put some of my earnings into it, and simply roll it over into my super account at some stage?

Answer. You could certainly do that if you are under 75 and pass the work test, but ask your accountant to do the sums. Superannuation funds pay tax at 15% per annum on earnings from the first dollar - you may find that money held in your name is entirely tax free.

  • Noel Whittaker is the author of Making Money Made Simple and numerous other books on personal finance.