US tax issues for Australian expats

Top 4 US tax issues for Australian expats

As an expat moving to the US, there are countless things to consider, including: insurance, employment, housing, a good school for the kids and more. However, one of the most important considerations that is often forgotten – taxation laws, and more specifically, the US tax issues for Australian expats.

To make your transition to expat life easier, here are the top 4 US tax issue for Australian expats to remember.

4 US Tax Issues for Australian Expats

1. Determine your US tax residency

This is essential, as you tax residency status, whether you are a resident alien (i.e. a tax resident) or a non-resident alien, determines how much you will pay. If you’re classified a tax resident of the United States, you’re liable to pay tax on your worldwide income and worldwide capital gains.

The IRS has two tests to determine if you’re a US resident alien (and thus subject to US taxation on your :

  • Green Card Test – If you have been issued with a Green Card (less commonly known as an alien registration card) you will be considered a lawful permanent resident of the United States. If this is the case then you will automatically be deemed as a resident alien for US tax purposes from the date of issue of your Green Card.
  • Substantial Presence Test – Under this test, you will be a resident alien for US tax purposes if you are considered to have established a “substantial presence” in the United States. You will be considered to have established a “substantial presence” in the United States if:
    • you were or will be in the US for at least 31 days during the current year; and
    • Will spend at least 183 “days” in the US within a three-year period, comprising of all of the days that you are/were present in the United States in the current US financial year, plus one third of all of the days that you were present in the United States in the prior US financial year, plus one sixth of all of the days that you were present in the United States in the year two years prior to the current US financial year.

Understanding how US resident alien rules is critical, in terms of tax planning for an Australian expat’s move to the United States particularly in relation to your Australian investments and superannuation. Careful planning and timing of is required because US tax rules can cause your Australian superannuation and Australian assets (e.g. your Australian investment properties and Australian shares to become subject to US income tax and capital gains tax, even where the majority of your gains were made prior to ever setting foot inside the United States.

2. Your Australian Superannuation May Be Subject to Taxation in Your US Tax Return

Most Australian expats are blissfully unaware that their Australian superannuation fund is not treated as a qualifying 401(k) plan for US tax purposes. Unfortunately, the IRS treats your Australian superannuation fund as an investment trust, owned by you personally. The legal structure of an Australian superannuation fund is indeed a trust and so the IRS’s treatment of an Australian superannuation fund as being an investment trust is consistent with reality.

The downside to this approach is that under US tax law, any investment income earned by you as a resident alien (for US tax purposes), is taxable in the US and as such is required to be declared in your US tax return, and is subject to various other reporting requirements (e.g. FBAR, PFIC etc).

As an Australian expat living and working in the US as a resident alien, this means that potentially, you will be required to pay US tax on your Australian superannuation contributions and earnings, and potentially on any growth in your superannuation fund balance regardless of the fact that you are not presently entitled to such income (as your superannuation is preserved and inaccessible until you reach your preservation/retirement age).

Unfortunately, the issues surrounding Australian superannuation fund investments held by Australian expats in the US is not simple. Sadly the Australia-USA double taxation treaty does not deal with this scenario and as such there is no tax deferral article or provision that allows Australian superannuation funds to be treated as if they were a US qualifying funds for US tax purposes and neither is there any article or provision that exempts your superannuation from US tax in your hands.

As such, your Australian superannuation fund earnings, growth and/or contributions will potentially be subject to US tax in some manner. Ultimately, just how your superannuation fund will be taxed for US tax purposes depends upon whether your fund is treated as an ‘Employee Benefits Trust’ or a ‘Foreign Grantor Trust’. The difference between these definitions under US tax law is beyond the scope of this article, however if you’d like to learn more take a look at an earlier article that we wrote on this topic – see below:

Is my superannuation assessable in my US tax return? A detailed overview

In making a decision whether to live and work in the United States, it is critically important that you understanding just how the US taxes your Australian superannuation investments as this will have a bearing on the financial aspects of your decision and it will require some tax planning to ensure that you minimise your tax exposure.

3. Understanding the Australian-USA double taxation agreement

When moving overseas, many Australians will straddle two countries in terms of where they generate income, and potentially, one or both countries may seek to tax that income, independently of how the other country taxes that income. Where both countries seek to tax you on your income, Australia’s double taxation treaties are designed to prevent you from being double taxed. It should be noted that this does not mean that you will not pay tax in both countries, but you won’t generally pay tax on the same income twice!

The most important features of the Australian-USA double taxation agreement for Australian expats are:

  • If, whilst living and working in the United States, you are treated as being a resident alien for US domestic tax purposes AND you are treated as being a tax resident of Australia for Australian domestic tax purposes, Article 4 in the Australia-USA double tax agreement (DTA) has a tie-breaker test that causes you to be treated as a tax resident of one country only (that for DTA purposes).
  • If you earn income from any source, and both the US and Australia wish to tax you on that income, the double tax agreement will provide taxation rights to one country, or the other (or to both countries) covering the particular income categories that you may earn.
  • If the double tax agreement allows both countries to tax you on a particular class of income that you earn, the secondary taxing country will allow you to claim a foreign tax credit for tax paid in the primary taxing country (usually the country where the income was sourced). The amount of the tax credit will generally be limited to the lesser of the average rate of tax payable in the secondary country, OR the total amount of foreign tax paid (in the primary taxing country).

As an Australian expat, living and working in the United States, it is important that you understand just how the Australia-USA double tax agreement will apply to you. Failing to do so may cause you to pay taxes unnecessarily in the United States, or Australia, or in both countries. Understanding how the double taxation agreement applies to your circumstances is important if you wish to minimise your tax exposures to each country.

4. Navigating multiple income taxes

Unlike the Australian taxation system where personal income tax is paid federally only, when moving to the United States, you’ll be expected to pay income taxes both federally in the US and separately on a State basis also – see below:

  • Federal income tax – Depending on your income, tax rates can vary from 10%-39.6%. As an expat, taxable income is based on global income minus deductions.
  • State income tax – Generally lower than federal income tax, state income tax is typically capped at under 10% although State based marginal tax rates for California can be as high as 13.3%. Note that your State taxes will generally be deductible in your federal income tax return, and any State tax refund will be assessable in your Federal return ( in the year that you receive the refund).
  • Federal social security and medicare – Currently the social security tax rate is set at 6.2% (this is assessed on the first (US) $118,000). The Medicare tax is 1.45% (this is assessed against total income, increasing by 0.9% for higher earners).

Taxation is a major issue for Australian’s moving overseas and so it is vitally important that you’re aware of the impact that moving overseas will have on your income, on your finances and on your taxes.

Moving overseas to live and work, or retire takes an enormous amount of planning and organisation.

It is important to understand how your income, assets and superannuation are taxed, and how both Australia and the United States’ rules apply to your own individual circumstances whilst you are an Australian citizen living abroad.

Seeking expert assistance from specialist expatriate tax advisors such as our firm can help you in this regard.

If you wish to understand the tax issues as they apply to your circumstances, and/or to understand your tax exposure in the United States and Australia, and to make your move to the United States as smooth as possible, call or email our team at Expat Tax Services or alternatively, book a tax advisory appointment with our team today.

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Shane Macfarlane

CEO & Founder at Expat Tax Services
Shane's an Australian Chartered Accountant and Australian expat tax specialist who's also an expat himself (based in Asia). Shane's passionate about tax and legitimate tax minimisation, tax-planning and structuring, particularly as it relates to Australian expats who are often subject to high rates of tax back home in Australia.
Shane Macfarlane
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