Problems with (and a solution to) U.S. Rules on Foreign Investment

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  • Problems with (and a solution to) U.S. Rules on Foreign Investment


  • With the introduction of the U.S. Foreign Account Tax Compliance Act (FATCA) some years ago, many expat Americans have found that investing outside the US has become fraught with difficulties. In essence, what FATCA has done is to enforce existing rules so that the days of benign neglect by the U.S. tax authorities has ended.
  • American citizens and green card holders are subject to U.S. tax on all of their global income, even when they live outside of the United States. Though by virtue of Double Taxation Agreements or earnings falling below the threshhold for US tax, there may be only a limited or even no tax bill to pay in the US, they must still report annually.
  • A US expat’s present country of tax residence, the source and type of income, and any other tax jurisdictions that may be relevant – for example, if they are dual-nationality Americans or reside in a multi-nationality household – can all affect the way the IRS views these individuals, their income, and their wealth.
  • Where Americans invest their savings matters. Unfortunately, as an increasing number of Americans are living and working overseas have found, many have unwittingly subjected themselves to the IRS’s punitive Passive Foreign Investment Company (PFIC) rules.

There are a variety of problems facing the US expat wanting to invest outside the States, but a robust solution does exist.

The concrete investing problems include:

  1. The PFIC

The rules surrounding PFICs are complicated, but essentially, any non-U.S. incorporated investment fund that derives 75% or more of its income from passive activities is classified as a PFIC. This covers virtually all mutual funds, exchange-traded funds (ETFs), and hedge funds that have been incorporated outside the United States and distributed by foreign financial institutions. The intent of the PFIC rule is to discourage Americans from investing in financial products and through financial institutions that cannot easily be monitored by the IRS. In theory, a foreign fund manager could structure payouts and reporting on his fund to qualify for U.S. tax treatment similar to U.S. domestic funds – and a few do. The reality, though, is that most offshore funds have relatively few U.S. investors. Their managers may be unaware of the U.S. tax consequences to their American clients. Or it may simply not be economical for an offshore fund to be structured in the specific way needed to meet U.S. rules.

The tax treatment of a PFIC is punitive. The current penalty is 37%

Many Americans who’ve invested in PFICs have been unaware of their different treatment and have tended to report and pay tax on their foreign investments in the same manner as they would an investment in a U.S. domestic fund. Since this is not the correct way to handle PFICs for U.S. tax purposes, they could, and often do, end up facing significant penalties, back taxes, and interest when they try to rectify the situation later.

  1. Traditional Offshore Investments

Investing in offshore investment products that involve an insurance wrapper (the offshore investment vehicle normally used by British and other expatriates) usually doesn’t help. That’s because these products normally include an insurance structure that’s defined under the laws of an offshore jurisdiction only. Additionally, the IRS sees these for what they are – investment vehicles that can have an immediate cash value, not straight-forward insurance. Also, the underlying assets (usually funds) will likely mostly fall foul of the PFIC rules. While while such insurance wrappers do offer tax benefits in some jurisdictions, they almost never qualify for U.S. tax-deferral benefits from the IRS.

  1. Closure of Expat Brokerage Accounts

The global financial regulatory landscape is dramatically changing. FATCA imposes significant new compliance burdens on non-U.S. financial institutions with U.S. clients. As a result, many non-U.S. financial institutions now simply refuse to service U.S. persons. Unfortunately, U.S. financial institutions are following suit due to FATCA and other considerations. Among U.S. financial institutions, account restrictions differ between firms. Some firms are closing all accounts for non-U.S. residents while other firms are only restricting services available to Americans not resident in the U.S. In other cases, firms require very high minimum account values for non-U.S residents who wish to remain clients.

  1. Ban on non-resident holdings of U.S. mutual funds

This includes Americans citizens, and are now the norm. These new restrictions don’t just affect brokerage but also bank accounts and retirement accounts (IRAs and 401ks). Enhanced Treasury Department enforcement of existing anti-money laundering regulations and ‘Know Your Client’ (KYC) rules, interpretations of the 2003 Patriot Act, and new European regulation of cross-border investments (EU MiFID II) all play a part, and mean that financial institutions providing individual investment services across borders face a much higher level of compliance. It’s probably true to say that foreign banks took the lead in limiting their perceived risks by simply refusing to provide individual financial services across borders, but US banks and brokerages have followed suit.

  1. Doing Nothing

Many American expats are so put off by the complex rules and many horror stories they have heard about investing while living abroad that they feel pressured into doing nothing at all. However, remaining in cash will not provide for a comfortable retirement for yourself or pay for college education. Investing efficiently and compliantly while living abroad can be daunting, but it does not have to be overwhelming and, as noted above, there is a solution. Don’t give up, it’s far too important.

  1. Stock-only Portfolios

Non-resident Americans can choose the option of creating a portfolio made up of individual stocks (and bonds). This is least impacted by cross-border regulation, but itself faces serious shortcomings. Firstly, creating a risk-based and diversifed portfolio out of individual stocks is much more difficult than with pooled assets such as mutuals. Secondly, there aren’t many brokerages which have the analytical and monitoring tools to advise on or build such a portfolio.


To be successful, your offshore strategy needs to be legal, transparent, and effective, and you need to be willing to make the changes to do just that. The ideal is an offshore product in a highly-regulated jurisdiction which is IRS-friendly, but which still gives you the key benefit of offshore investing, which is tax-free gross roll-up of your investment, and which does not tax you when you are taking a benefit from it later.

  • This product now exists (see our Solution ‘US Individual Retirement Plan’.)
  • For more permanent results, you can become a resident of a country with low-to-no taxes and give up your tax residency at home (if you’re not a US citizen, that is), or you can even get a tax-friendly second passport. Increasing numbers of Americans are doing just that.

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