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American Investors: Investment options when you live outside of the USA

Investing as an American living abroad has become a greater challenge in recent years due to changes in US law and the availability of forms willing the assist US expats. This article discusses the options available.

Written on 12 March 2020

For American Investors (i.e. US connected people such as citizens, green car holders and residents) looking to invest outside of the US, investing became much more complicated following the tax reforms of 1986 which defined “PFICs” (Passive Foreign Investment Companies).

The changes were originally designed to close a tax loophole which some people were using to shelter offshore investments from taxation, however, we now find ourselves in a world which is a minefield for Americans living abroad to try to invest, even those who are “happy” to pay their taxes where due to the US.

An explanation of Passive Foreign Investment Companies (PIFCs)

A PFIC or “Passive Foreign Investment Company” can be defined as a foreign based corporation which shows one of two characteristics –

  • Based on the company's income, at least 75% of the corporation's gross income is passive. Income from investments would be passive, but not that from the company's regular operations.
  • Based on the company's assets, at least 50% of the company's assets are investments which produce income in the form of earned interest, dividends or capital gains.

This means that the vast majority of UK and offshore mutual funds, ETFs etc. fall within the scope.

Those that own rental property through a Ltd company or “special purpose vehicle” should be aware that this would also be classed a PFIC unless other trading activities were taking place.

The main differences in investing in a PFIC vs a US based mutual fund for example, are the reporting requirements, and the tax treatment. A great example of how complicated it can be is that a PFIC AND its shareholders, are required to keep accurate records of every transaction related to PFIC, this includes dividends earned, undistributed income, share cost basis… and so on. A nightmare for someone who just wants to invest in a standard mutual fund and hold it for 20 years. Have a look at (IRS) tax form 8621 if you want an idea of how complex this reporting can be.

In addition to the arduous form filling, capital gains are not eligible to be taxed at the lower long-term capital gains tax rates but are taxed as regular income at the highest rate of federal tax. All distributions are also taxed as regular income at the highest possible rate of federal tax (over 40%).

If you defer the gains, you would be assessed with a non-deductible penalty interest charge that is compounded over the deferral period, creating a huge amount of interest to pay.

Some side notes for Americans living in the UK – ISAs are not recognised in the US, so your ISA investments need to be US compliant too. Company pensions are considered OK at the moment. The IRS are looking at SIPPs (self-invested personal pensions) with interest and other UK personal pension products may well full into the spotlight as time goes on. If you want to be ultra-cautious, then you may want to invest your pension in a US compliant manner too.

Three options for American investors living outside of the USA

With this in mind, what are the options for US connected people wanting to invest overseas?

  1. Invest in US based funds (with UK reporting status if in the UK), easier said than done most of the time when not a US resident but some platforms do accept US clients and give access to the right sort of investments.
  2. Invest in companies that are not PFICs, which basically involves picking individual stocks and shares. Fine if you have the inclination/knowledge/risk appetite/time to research that this involves but not suitable for most.
  3. Find a US compliant investment portfolio. These are rarer than standard ETFs/mutual funds etc. but do exist. Typically made up of single stocks and US compliant funds/ETFs and managed by specialist investment managers. Portfolios start from around 0.50% per year so not as expensive as you may think for a specialist investment portfolio with tax reporting requirements.

The best thing that you can do is to understand the rules as best you can, take action early on and be proactive in finding an investment solution that works for you.

Investment advice for American investors

Due to the complexity of the American tax system and reporting requirements of US connected citizens, regardless of their country of residence, many financial advisory firms will simply not work with American investors unless they are considered high net worth individuals and have in excess of $1m to invest.

Unfortunately, this makes financial decision making much harder for American’s living abroad that most other citizens as it is much harder to find an independent financial advisor willing and able to help.

Thankfully, there are a number of firms in the UK that can assist American investors living in the UK and through Experts for Expats, we can make an introduction to someone who will be able to discuss your situation, guide you through the various options, regardless of the amount you are looking to invest.