Top 10 Tax Issues for Australian Expats Living in USA
In addition to “The top 10 expat tax issues when living in the U.S.”, the following are considerations specific to Australians living in the U.S.
Are you a “U.S. Person” for tax purposes?
The Internal Revenue Code of 1986 (IRC) section 7701(a)(30), provides for the U.S. to tax “U.S. Persons” on their worldwide income regardless of whether the income is U.S. or foreign-sourced, and non-residents on U.S. sourced income.
An individual is a “U.S. person” if they are a citizen or a resident of the United States. Every person born or naturalized in the US and subject to its jurisdiction is a US citizen. A foreign individual, who is not a citizen, is an “alien”. An alien can be a resident alien or a non-resident alien. An individual will be a resident alien if he or she:
- holds a green card;
- passes the substantial presence test; or
- elects to be taxed as a resident.
Under the substantial presence test, an individual is considered a US resident alien if the individual is in the US:
- for at least 31 days during that calendar year; and
- for at least 183 days in the previous two calendar years (calculated based on a weighted number of days in each year: current year x 1 + year prior to current year x 1/3 + 2 years prior to current year x 1/6).
So, if you are in the U.S. on an E3 visa (or other work or business visa), you are likely to pass the substantial presence test and be subject to U.S. tax reporting obligations.
Are you an Australian resident for tax purposes?
You may be a ‘resident of Australia’ if you meet any of the tests set out in section 6 of the Income Tax Assessment Act 1936. These tests are often referred to as the Primary Test, the Domicile Test, the Physical Presence Test, and the Superannuation Test.
- A taxpayer is a resident under the Primary Test if they ‘reside’ in Australia, within the ordinary meaning of the word. This means that they have a settled abode or are present in Australia permanently or for a considerable amount of time
- A taxpayer is domiciled in Australia, unless the commissioner is satisfied that that person’s “permanent” place of abode is outside Australia. A taxpayer may be domiciled in Australia if:
- their father was born in Australia (domicile of origin);
- they have chosen to reside permanently in Australia (domicile of choice); or
- they are dependent on a taxpayer who is domiciled in Australia (domicile of dependency).
- A taxpayer satisfies the Physical Presence Test if they are present in Australia for more than half the income year unless the commissioner is satisfied that that person’s permanent place of abode is outside Australia. This means that if the taxpayer was present in Australia for 183 days or more, they would be considered a ‘resident’ of Australia.
- The Superannuation Test applies if a taxpayer is a contributing member to an Australian government superannuation scheme.
For a taxpayer who was domiciled in Australia, the question becomes whether they have chosen a new domicile in the U.S.? What were / are their intentions on leaving Australia? How long do they intend to reside in the U.S.? Whether a taxpayer has chosen a new domicile is a question of fact. A person whose domicile is in Australia is deemed to be a resident of Australia unless the Commissioner is satisfied that the person’s permanent place of abode is outside Australia. A taxpayer can have a permanent place of abode outside of Australia even if they intend to return eventually to Australia after a lengthy absence. Factors indicative (but not conclusive) of a permanent overseas place of abode include, the intended and actual length of the stay overseas generally, a period of about two years would normally be considered to be a minimum), whether a fixed home has been established outside Australia and the durability of the person’s continuing association with a place inside Australia (ATO Tax Ruling IT 2650). However, none of these factors is conclusive by itself.
If there is uncertainty surrounding your long-term plans in the U.S. it is possible that you are still a resident of Australia by virtue of the Domicile Test up and until you make a decision to be permanently based in the U.S. If so, you may be a dual Australian and U.S. resident and consideration will need to be given to the US-Australia Tax Treaty. The Treaty provides that the primary residence taxing right will be granted to the country in which the taxpayer has a permanent home.
FBAR disclosure obligations
You must file a Foreign Bank Account Report if you have $10,000 or more in your Australian (or other foreign) bank and financial account(s) at any time during the tax year.
Penalties for non-disclosure are steep, depending on whether the non-disclosure is considered to be willful or non-willful. Further, under the FATCA (Foreign Account Tax Compliance Act) reporting, foreign banks are now obliged to report accounts with balances exceeding specific thresholds, so the failure to report these accounts can be readily ascertained by the IRS.
Australian trusts and companies – U.S. disclosure obligations
If you control an Australian resident company or an Australian resident trust, you are required to comply with additional IRS disclosure obligations such as Forms 3520 and 3520-A (for foreign trusts) and 5471 (for foreign companies). The purpose of these forms is to disclose:
- transactions with foreign trusts and corporations;
- ownership of foreign trusts and corporations; and
- receipts of gifts or bequests from foreign persons.
Generally, a company will be an Australian resident (foreign company) if it is registered in Australia and its central management and control is in Australia. A trust will be an Australian resident (foreign trust) for an income year if a trustee was an Australian resident at any time during the income year or the central management and control of the trust was in Australia at any time during the income year. If the trust is a unit trust, it is a resident trust if:
- either any property of the trust is situated in Australia or the trustee carries on business in Australia; and
- either the central management and control of the unit trust is in Australia or residents held more than 50% of the beneficial interests in the income or property of the trust.
Not completing and filing these forms in the appropriate matter can lead to an audit and potential investigations into perjury and the imposition of harsh penalties.
Foreign Grantor Trusts
If you are the settlor, notional settlor, trustee, or appointor of an Australian resident trust, you may be taxable in the U.S. under the foreign grantor trust rules, on income that is derived by the trust and which can be attributed to you.
The IRC and Treasury Regulations provide that a foreign trust can be classified as a grantor trust in the circumstances described in sections 671 – 679 of the IRC. Sections 671 – 678 of the Code provides “grantor trust” status in circumstances in which the grantor or other owner retains the power to control or direct the trust’s income or assets.
The Treasury Regulations define a grantor to include “any person to the extent of such person either creates a trust, or directly or indirectly makes a gratuitous transfer of property to a trust.” Additionally, “if a person creates or funds a trust on behalf of another person, both persons are treated as grantors of the trust.”
Where the grantor or another person is regarded as the owner of any portion of a trust, their taxable income will include the income, deductions, and credits against tax of the trust which are attributable to them.
The IRC provides that U.S. beneficiaries of a foreign grantor trust will generally be treated as the trust’s owners in proportion to the value of the transferred property. Any person treated as the owner (or grantor) of the trust is taxed directly on income earned by the property placed in the trust – they must report their share of trust income, deductions and credits, as if those items were received or paid directly by them.
The treatment of Australian superannuation for U.S. tax purposes raises issues that require careful consideration – is it a foreign grantor trust (especially if it is held in a SMSF which you control) or is it a form of social security?
If the superannuation is characterized as a foreign grantor trust, contributions and earnings within the fund may be taxable to you in the U.S. However, superannuation funds are highly regulated under Australian law and the benefits may not be accessed other than in compliance with the SIS Act and regulations. So, if your superannuation can be characterized as social security, you may be able to rely on the U.S.-Australia Tax Treaty to treat gains and distributions as being exempt from U.S. tax, if the treaty position is appropriately disclosed to the IRS.
Australian-sourced Investment Income
If you are not a tax resident of Australia, you are subject to tax in Australia on your Australian sourced income only – such income can include income from a rental property, dividends from Australian listed shares, distributions from managed funds in Australia, Australian sourced interest income (from Australian bank deposits and loans).
Interest and unfranked dividend income from these Australian sources to non-residents can be subject to Australian withholding tax of up to 30% (subject to the US-Australia Tax Treaty provisions). Fully-franked dividends paid to non-residents are not subject to withholding tax or additional Australian income tax, although they need to be disclosed on your Australian income tax return.
Australian-sourced capital gains
How you structure your Australian assets prior to ceasing to be an Australian resident for tax purposes can have a significant impact on your Australian capital gains tax (CGT) exposure.
Following the recent release by the Australian Taxation Office of Draft Taxation Determinations TD 2019/D6 and TD 2019/D7, the Australian CGT position can be summarized as follows:
- non-residents of Australia are subject to capital gains tax on the sale of “taxable Australian property” (TAP) such as direct and indirect interests in Australian real estate and business assets of a permanent establishment in Australia. As a non-resident, you would not be eligible to apply the CGT general 50% discount as from the date you ceased to be an Australian-resident;
- if the capital gain is attributable to a CGT event happening to a CGT asset of a “fixed trust” (such as a unit trust) and the asset is not TAP for the fixed trust at the time of the CGT event, the gain would be exempt from tax in Australia;
- a capital gain (whether foreign sourced or not), that is attributed to a non-resident beneficiary of an Australian resident trust, will be assessable to that beneficiary; and
- a non-resident of Australia who directly holds non-TAP and the trustee of a foreign trust who holds non-TAP can both disregard a capital gain or capital loss from a CGT event in relation to the non-TAP.
Main Residence Exemption and non-residents of Australia
In October 2019, a new Bill was introduced in the Australian Federal Parliament, which proposes that a non-resident for Australian tax purposes will no longer be entitled to claim the CGT main residence exemption unless, at the time they sign the contract to sell their residential property in Australia:
- they were a non-resident for tax purposes for a continuous period of six years or less; and
- during that period, they, their spouse, or their minor child, had a terminal medical condition, or died, or the CGT event involved a family law property settlement.
These changes apply retrospectively:
- for property held prior to 7:30pm (AEST) on 9 May 2017, the exemption may be claimed for disposals occurring to 30 June 2020 if they meet the existing requirements for the exemption; and for disposals that happen from 1 July 2020, only if the events described above occur within 6 years of the individual becoming a non-resident for Australian tax purposes; and
- for property acquired at or after 7:30pm (AEST) 9 May 2017, the exemption may be claimed only if the life events described above occur within 6 years of the individual becoming a non-resident for Australian tax purposes.
The changes will also apply to legal personal representatives, trustees and beneficiaries of deceased estates of non-residents, surviving joint tenants and special disability trusts.
Australian Estate and Succession Planning
We recommend that prior to leaving Australia:
- you have your Australian assets valued by an appropriately qualified valuer – this will assist in determining asset values for CGT purposes in the future; and
- you review your business structures and determine whether:
- you may qualify as a Grantor of a foreign trust and the associated implications for U.S. tax purposes;
- any Australian private companies and trusts you control can continue to be Australian resident entities;
- changes should be made to the structure to address unnecessary tax inefficiencies or undesired regulatory consequences (for example, from a company not having an Australian resident director); and
- you prepare individual Australian financial and personal Powers of Attorney – this will assist in the timely management of your Australian financial and personal affairs in the event that you are unable to do so personally whilst overseas or in the event of your incapacity;
- you prepare an Australian Will in respect of your Australian assets (only), taking into account the likely tax residency of your beneficiaries (especially if setting up testamentary trusts within your Will) or bequeathing Taxable Australian Property to non-resident beneficiaries; and
- review your insurance policies for income protection, life and total permanent disability, to determine whether each policy would cover you on ceasing to be a resident of Australia. Insurance policies maintained within superannuation often exclude non-residents from receiving payouts and should be carefully reviewed and supplemental insurance should be sought while you are in the U.S.