How to deal with tax?

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Ilija
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How to deal with tax?

Post by Ilija » Wed Nov 22, 2017 3:19 pm

Hi,
We hold 3 funds (70/15/15) with well over $200k now.
We are citizens and residents of EU country.
Our law currently is that after 5 years of holding the funds we do not pay any capital gains (0), our dividends are taxed with 15% in US (tax agreement).

Yesterday we got approved for green card via my mother and will be moving to US to work there.
I read online that with green card we are tax residents of US, even if we earn income in other country and we should still report it to IRS.

My question is how will this affect our current investments that we had before we got a green card?
Would we be able after 5 years of holing the funds take it without capital gains (only those that we bought before getting a green card), or would we be owning tax on all capital gains and money that we invested before becoming residents in US (before getting green card).
I can sell the funds today and pay 15% tax, and then reinvest once we arrive to US in retirement accounts, but would like to understand if we can keep previously invested money (as citizens/residents of EU - before getting a green card), as that would make sense to me...
Not sure if someone has that experience or knowledge of this.
Thank you.

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whatusername?
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Re: How to deal with tax?

Post by whatusername? » Wed Nov 22, 2017 4:45 pm

I have no knowledge or experience with this, but I would start by looking at the instructions for the Form 1040 published by the Internal Revenue Service. It walks through what you have to report and where, and directs you to the other forms required. Then I would track down the instructions for those forms and read them too. All of them are available at www.irs.gov. They change annually, but should give you at least an idea of what would be required, as well as "known unknowns".

TedSwippet
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Re: How to deal with tax?

Post by TedSwippet » Wed Nov 22, 2017 5:30 pm

Ilija wrote:
Wed Nov 22, 2017 3:19 pm
Would we be able after 5 years of holing the funds take it without capital gains (only those that we bought before getting a green card), or would we be owning tax on all capital gains and money that we invested before becoming residents in US (before getting green card).
In the best case, you would owe tax on the entire gain, including the part that happened perhaps long before you even set foot in the US.

You might owe US tax on exchange rate fluctuation too, because the gain for US tax purposes is the amount you paid for these funds converted into USD at the rate on the day(s) when you bought them, less the amount you receive on selling them converted into USD at the rate on the day(s) of sale. In the worst cases this can work out to a capital loss in your own currency but a phantom capital gain in USD, upon which tax has to be paid with real money.

Note that that is the best case scenario. It could well be worse.

If these funds are domiciled anywhere other than the US -- and it's likely that they are, but you should check them carefully -- then for the period that you hold them while in the US the PFIC tax rules subject you to an extra-special punitive tax on every distribution and the final capital gain. This PFIC tax could, in the worst case, consume 100% of your gain. It is also extremely complex to calculate, making professional help with it very costly.
Ilija wrote:
Wed Nov 22, 2017 3:19 pm
I can sell the funds today and pay 15% tax, and then reinvest once we arrive to US in retirement accounts, but would like to understand if we can keep previously invested money (as citizens/residents of EU - before getting a green card), as that would make sense to me...
15% is not exactly a low rate, but it is almost certainly going to be lower than what you might end up owing to the US.

Your actual US rate, if you had to pay it, is going to be somewhat tricky to determine. If your funds are PFICs then you can reckon on paying full income tax rates on your gains, so anything up to around 39%. If not, for a start you have to have held everything here for at least a year, otherwise it's 'income' and is probably going to face a higher tax rate than the 15% 'standard' capital gains rate. Secondly, if you earn enough to take you into higher US income tax brackets then the capital gains rate moves up to 20%.

Either way, you also have to consider state tax on top of this, for example California taxes capital gains as income, and in the worst case this could add a further 13% or so to your overall tax on this gain.

One point to consider is the potential for finessing your entry date into the US. Even though you might have a green card, you do not actually become a US resident until you move to the US. Once you have, you are in the lobster trap even if you later leave the US, but your US tax liability doesn't start the day you receive a green card but rather the first day of presence in the US. You do however also need to beware of a sneaky IRS rule that can backdate your first day of residence if you spent enough time earlier on in a year on vacation, say, in the US but before receiving a green card.

Finally, I'd recommend a careful read of this document from KPMG. Dense, but well worth taking the time to understand. Perhaps pay particular attention to timing of starting your US residency, usefulness of selling anything with a built-in gain before becoming US resident, and the complications of selling any home you might own after, rather than before, becoming a US resident.

TL;DR -- If it were me, I would either sell these funds before moving to the US or, if that creates a larger tax bill than is acceptable, reconsider whether to move to the US later rather than now, or at all.

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grabiner
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Re: How to deal with tax?

Post by grabiner » Thu Nov 23, 2017 11:02 am

Two other things to check:

Is there a tax treaty between your current country and the US? This may affect how the two countries tax you, and at what rates.

And there is a foreign tax credit if two countries tax the same income. In the US, the foreign tax credit is the lesser of the tax actually paid to the foreign country, or a prorated share of the US tax (with some adjustments' the treatment of large foreign capital gains is not quite fair). Thus, while you may pay foreign tax on the capital gain, this could reduce or eliminare the US tax on the same capital gain.
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TedSwippet
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Re: How to deal with tax?

Post by TedSwippet » Thu Nov 23, 2017 12:35 pm

grabiner wrote:
Thu Nov 23, 2017 11:02 am
Is there a tax treaty between your current country and the US? This may affect how the two countries tax you, and at what rates.
Worth checking, but almost certainly of no use when it comes to reducing any US tax liability incurred after the OP becomes a US resident:
U.S. Citizens and Residents
U.S. citizens and residents generally will not be able to reduce their U.S. tax based on treaty provisions due to the saving clause. However, those who are subject to taxes imposed by a treaty partner are entitled to certain credits, deductions, exemptions and reductions in the rate of taxes paid to that foreign country.
In general, selling assets that have a built-in gain before moving to the US is almost always the better move. Doubly so when PFIC enters the picture.
grabiner wrote:
Thu Nov 23, 2017 11:02 am
And there is a foreign tax credit if two countries tax the same income. ... Thus, while you may pay foreign tax on the capital gain, this could reduce or eliminate the US tax on the same capital gain.
Yes. But. The aim here is to avoid incurring any US tax liability. Paying 15% to another country before becoming a US resident beats paying 30-40% to the US (or US and other country combined) after becoming a US resident. Potentially more than 40% where PFICs are involved.

Of course, paying nothing to either country beats both of those, but that requires either delaying or cancelling a move to the US. The largest decision factor will probably be how much of the aforementioned "well over $200k" in holdings is capital gain.

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