Tips for U.S. Expats Doing Trading Offshore

U.S. Expats Doing Trading Offshore

With a world wide economic market, world trade and investing is convenient, accessible and happening all the time.  According to the source, in today’s society, U.S. traders make international investments or even more over seas while foreigners choose to trade and invest in the United States.  With all this business coming and going some may ask how are all these taxes controlled?

Lets take a look at U.S resident traders who live overseas. If you are a US resident, regardless of where you live (whether abroad or in the United States), you are held accountable for federal tax on all worldwide income. Below are some things to consider if this is your situation.

  • Avoid double taxation (paying tax in the US and the foreign country you live in). You can do this by filing Form 1116 you can avoid foreign tax credits
  • Try qualifying for “bonafide” or “physical residence” -if you live overseas for an entire tax year. If you qualify, you need to arrange Section 911 “foreign earned income” benefits found on Form 2555.

An important note to remember, if the foreign country’s taxes are higher than the United States’ you would skip the Section 9111 exclusion and just use Form 1116 for the foreign tax credit.

Foreign Earned Income Exclusion

Each year the IRS decided an amount for the Section 911 exclusion on foreign earned income.  In 2018 the amount was set at $104,100 and it has continued to rise each year. Another benefit includes a housing allowance dependent upon location.  Despite these tax benefits, many traders are unable to use the Section 911 benefits, because capital gains and trading gains are not considered foreign earned income.  This is where trader tax status (TTS) can be beneficial. US traders can develop a Delaware S-Corp to pay officer compensation, and in return, that compensation is now foreign earned income. In addition to the foreign earned income exclusion and the housing allowance, traders will use the S-Corp to also unlock retirement plan deductions and receive health insurance.  Make sure to compare your expected net income minus payroll tax costs to using a foreign tax credit to see which option will be best for you.  It is not surprising that the U.S has tax treaties with many foreign countries. These treaties help traders know how much countries are allowed to tax and on what goods and services. Remember tax treaty provisions are used to lower tax liability and you can reverse a regular tax on Form 8833.

It is common for U.S. traders to have an international brokerage account.  When traders open these accounts in the foreign countries’ currency, things start to get complex.  Accounting becomes complicated and other countries do not abide by our tax laws, which results in discounting Form 1099-B.  It is vital for traders to understand Section 988 ordinary gain or loss-, which separates capital gains and losses (including currency appreciation or depreciation) from changes in currency values on cash balances.  There are few, if any, tax benefits for traders to form foreign entities.  If a foreign broker is requiring this to get access to or enable you to set up accounts, do your research. You may jeopardize messing up your tax report. International tax compliance is very complicated and there are plenty of tax punishments for non-compliance. Even though it is uncommon to achieve material deferral on foreign income, there are still many good reasons to trade in foreign markets.  

FinCEN Form 114 Report of Foreign Bank and Financial Account

Formally know as (FBAR) any US resident with a foreign bank, investment, brokerage and any other type of account (even including some insurance and retirement accounts) who meet reporting requirements must e-file FinCEN Form 114. You many only use file FinCEN IF your foreign bank and financial institution accounts COMBINED are under $10,000.

Notice of date change as of July 31, 2015: filing due date has been changed from June 30 to April 15 starting with filing in 2016 for 2017.  To coordinate with FinCEN Form 114 Congress did give an automatic extension for six months to October 15 with individual income tax returns.

For various different reasons, findings have shown that many taxpayers have not shown foreign bank account reports when filing their taxes.  The FBAR rule states  “a financial interest in, signature authority or other authority over foreign financial accounts.” This rule allows traders and executives of hedge funds (and other financial institutions) and trustees to have signature authority or other authority over foreign financial accounts when dealing with FBAR filings for them.  You can avoid penalties by honestly reporting your foreign accounts correctly, which most taxpayers do. By doing this many have been allowed to file a late FBAR if necessary, avoiding penalties.  

Foreign retirement plans are very different than U.S. ones. Because foreign retirement plans aren’t structured plans under Section 402(b) which is set up as an employees’’ trust established by an employee, the IRS taxes many of them. If Section 402(b) does not apply, you may still be held liable to pay a high Passive Foreign Investment Company tax (PFIC).  These plans need to be recorded on your yearly FinCEN Form 114 regardless of if it has deferred.  The IRS has made some adaptions to the rule regarding Canada in October 2014. These changes do not apply to international retirement plans outside of Canada. While these rules may seem unfair, it is important to be attentive and make sure you are following the necessary steps to avoid any problems.

Download The Guide

Form 8939 Foreign Assets

Please see Form 8939 for detailed instructions; however this form is mostly just making the IRS aware of your international assets.  (Which is usually high for American living out of the country)

Puerto Rico

Many traders or investors move to Puerto Rico (PR) to escape capital gains taxes because PR is a “possession” of the government. It is not a state or a foreign country.  Residents of PR report particular types of income to Hacienda and other forms of revenue to the IRS.  Trading gains are capital gains on  “personal property” taxed where the seller’s tax home is.

PR is a gold mine for traders/investors, investment managers and financial institutions because of PR Act 22. Passes in 2012, this act allows investors and traders with bona fide residence in PR to be excluded from PR and the U.S. taxes under Section 933 100% of all short-term and long term capital gains from the sale of personal property acquired after moving there. Personal property includes stocks, bonds, and other financial products and in ACT 22 these do not have to be investments/bonds etc. in Puerto Rico.  Any trade/exchange can be made anywhere in the world as well. Section 475 MTM- professional traders using the default realization method also apply to this tax break. 

PR Act 20 Tax

This act applies to investment manager who charge advisory fees.  Because these managers sell their services to people outside of PR they qualify for “export service business” or the PR Act 20 tax incentive. This act is a 4% flat tax rate on net business income. The business owner also receives Act 22 100% exclusion on dividends received from the PR business entity and exclusion from U.S. tax since Section 933 excludes PR – sourced dividends.

In 2015, a new Act was created, the Act 197-2015, which amended Acts 20 and 22. Some new requirements to make Act 22 harder entailed all new applicants to purchase a home in PR within two years of moving there and to have an open bank account. To receive the Act 20 incentives, you now have to gradually hire five full time employees. As you can see, these PR benefits are difficult to manage, especially with an ever-changing economy. You must move your family there to receive these tax benefits.

Section 877A Expatriation Tax

Section 877A expatriation tax is paid to the IRS when a U. S. citizen or green card holder gives up their U.S. status. This is appealing to traders, investment manager and other taxpayers who are “covered expatriates” and have a net worth of $2 million or a 5-year average income tax liability exceeding $139,000.  This is attractive because other countries have extremely lower tax laws than the United States.  The IRS decides the tax amount based on the expatriation tax on unrealized capital gains on all assets (fair market value minus cost –basis including debt) on the expired date. The IRS can then tax the amount over $600,000, which includes deferred compensation and IRA’s.  There are many factors to contemplate when deciding if this is the right move for you, such as, US beneficiaries of US real property and estate planning and choosing to defer tax with applicable income rates. There is much to learn about this tax so make sure to take time to become familiar with all the fine details.

The United States has always encouraged foreign taxpayers to invest and trade with U.S. business and in the financial markets, whether they live in or out of the United States. A non- resident alien living in the US is held to similar tax laws as a citizen. They are subject to tax withholding on dividends, sales of master limited partnerships, and certain interest income.  U. S.  (ECI) non- resident alien living abroad can open a futures trading account or a U.S. based forex and not owe any taxes to the U.S; however this does not apply to dealers. Opening a U.S. based securities account is also available to them, but be prepared for some dividend tax withholding. Depending upon the length of stay in the United States, a non-resident could owe taxes on net U.S. source capital gains. Even if he doesn’t count as a resident under the substantial presence test, if he stays more than 183 days he will be taxed. If you are an employee of a foreign government living in the United States or a student attending school, there are some exceptions to the rule.  W-8BEN is the form to fill out if you are a non-resident individual and then give it to the broker.  When chooses a single-member LLC (filed in Delaware W-8BEN-E) to establish a U.S. entity for opening a U.S. based brokerage account; there are some things to consider as you consult with your broker. For example, does the broker allow international payments? How can you send money back home? Can you open a U.S. bank account for the business without physically being there or with out a U.S. address?

There are many business partnerships that include a non-resident and a U.S. resident.  In most cases the foreign partner would have U.S. ECU on their K-1 income. If the Non-resident is a member of a U.S. based “pass through” taxable entity (ex. Proprietary trading firm, hedge fund) that person is still considered as receiving no income.  There are some changes when the partnership is a trading company but only in a financial market (not goods) in which case the income is considered portfolio income on both partners. It is not required to withhold taxes on a foreign partner if he has portfolio income not subject to U. S. tax.  Adding dividends to the partnership complicates things because dividends tax isn’t withheld for the foreign partner’s share. 

Much effort and careful time and consideration needs to happen when dealing with world trade and taxes. There is so much opportunity for foreign trade and foreign partnerships, but with all the excitement comes lots of rules and regulations. There needs to be a balance in managing international trading and staying on top of your taxes.  Be responsible in showing all income in and out of the United States.

Please,  contact us with your questions in relation to U.S. Expats Taxes.

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Fulton Abraham Sanchez, CPA

Fulton Abraham Sánchez, CPA I am Certified Public Accountant, specialized in Tax Planning & Offshore Strategies for Real Estate, Hedge/Equity Funds, Fintech, Crypto, Expats, IRS Debt Resolution. You can email me and follow us on Facebook : FAS CPA & Consultants.

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