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US citizen living abroad - Unearned income?

US citizen living abroad - Unearned income?

Old Feb 27th 2011, 5:11 pm
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Default US citizen living abroad - Unearned income?

My US wife is aware of the "Foreign Earned Income Exclusion" but I was wondering if there was something similar for "Unearned income"?

We have investment under my wife name in shares and the dividends/capital gain will be taxed in our residence country (up to 28%). In that case, should the net profit be declared on her 1040 under line 9a and/or 13 therefore be taxed again in the US or is there some "exclusion" for unearned income so it is not double taxed?

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Old Feb 27th 2011, 10:17 pm
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Default Re: US citizen living abroad - Unearned income?

Originally Posted by hisokajp View Post
My US wife is aware of the "Foreign Earned Income Exclusion" but I was wondering if there was something similar for "Unearned income"?

We have investment under my wife name in shares and the dividends/capital gain will be taxed in our residence country (up to 28%). In that case, should the net profit be declared on her 1040 under line 9a and/or 13 therefore be taxed again in the US or is there some "exclusion" for unearned income so it is not double taxed?

thank you
It is included in 9a and 9b (if qualified for the lower tax rate) for dividends and Schedule D (line 13) for capital gains. Then you fill out form 1116 to offset US taxes.

http://www.irs.gov/pub/irs-pdf/f1116.pdf

You can also offset taxes owed above the earned income/housing exclusion level in a similar way but you cannot use the taxes paid to a foreign government for income that was excluded. The exclusions are normally only beneficial for low tax countries since taxes in a foreign high tax country (most of Europe) will normally offset US taxes anyway.

I'm not sure about this but although the IRS gives those exclusions, I believe that the IRS does not start your marginal tax bracket at 0% after income is excluded but at the tax rate that it would be if the exclusion was included. Therefore the immediate tax rate on unearned income could be 25% or higher. Therefore if taxes are owed when you calculate taxes using the exclusion, you should probably also calculate taxes without the exclusion and use form 116 to offset taxes for both earned and unearned income (the second method may give enough foreign taxes paid to offset 100% of your earned and unearned income). I'm not sure if the second method will work better than the exclusions because of the complexities of foreign tax credits and AMT.

Last edited by Michael; Feb 27th 2011 at 10:59 pm.
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Old Feb 28th 2011, 1:05 am
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Default Re: US citizen living abroad - Unearned income?

I will elaborate a little on my previous post.

For US common stocks, dividends are always paid after corporate taxes and are therefore normally qualified (maximum 15% tax rate) if you hold the stock for 61 or more days before or after the ex dividend date and the stock is unhedged. Therefore US common stocks normally have qualifed dividends if you hold them for 61 days and don't hedge the stock. Unfortunately foreign common stocks, may or may not be qualified due to the way corporate accounting works in different countries. As far as preferred stocks, both US and foreign dividends can be qualified depending on whether the dividends are paid before or after tax.

I found that about between 60%-80% of foreign common stock dividends are qualified. In the US this is easy to determine since the brokerage firm will provide a year end statement defining the amount of dividends that are qualified and which stocks have qualified dividends. However, it will probably be difficult to determine which stocks have qualified dividends when working with a foreign brokerage.

As far as AMT, I don't think that will give you a problem no matter how you calculate taxes (unless a low tax country). That is because AMT is calculated before foreign tax credits are subtracted. Many people get confused since the regulations for AMT state that foreign tax deductions cannot offset AMT but the key word is deductions and not credits. The reason for the confusion is that the taxpayer has the option of using either foreign tax credits or foreign tax deductions but very few people use foreign tax deductions so AMT is normally not affected.

Last edited by Michael; Feb 28th 2011 at 1:50 am.
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Old Feb 28th 2011, 8:00 pm
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Default Re: US citizen living abroad - Unearned income?

Originally Posted by Michael View Post
As far as AMT, I don't think that will give you a problem no matter how you calculate taxes (unless a low tax country). That is because AMT is calculated before foreign tax credits are subtracted. Many people get confused since the regulations for AMT state that foreign tax deductions cannot offset AMT but the key word is deductions and not credits. The reason for the confusion is that the taxpayer has the option of using either foreign tax credits or foreign tax deductions but very few people use foreign tax deductions so AMT is normally not affected.
What if the Capital Gain I/my wife make in the UK fall under the tax free "allowance" offered by the government. This way I would not pay tax here, so would there be no "US tax credit" to offset the US tax (15-25%)?
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Old Feb 28th 2011, 8:26 pm
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Default Re: US citizen living abroad - Unearned income?

Originally Posted by hisokajp View Post
What if the Capital Gain I/my wife make in the UK fall under the tax free "allowance" offered by the government. This way I would not pay tax here, so would there be no "US tax credit" to offset the US tax (15-25%)?
If the security is in your name and is your separate asset, she doesn't need to report the income.

If the income is both of your assets, I'm not quite sure how much of the income she would need to report (50% or 100%).

That is what the IRS is trying to stop. They don't want US citizens to be able to go to a low tax foreign country to try to evade US income taxes on unearned income. However, foreign tax credits can normally be global in nature (eg. tax credits from one security can offset taxes from another security). Therefore if you paid more foreign taxes on one security than would be owed in US taxes, the excess taxes paid can offset taxes owed on another security where little or no foreign taxes were paid.

That is why I stated in an earlier post that she should run the tax calculations both ways (both with and without exclusions) if US tax is owed when calculating using exclusions. There may possibly be the case where she has excess tax credits from her earned income when exclusions are not used which may possibly offset taxes owed on unearned gains.

I'm not a tax expert so I don't know all the ins and outs of foreign tax credits.

Last edited by Michael; Feb 28th 2011 at 8:30 pm.
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Old Feb 28th 2011, 8:31 pm
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Default Re: US citizen living abroad - Unearned income?

right sorry, this is for my wife "Share ISA" which is tax free in the UK. She will receive dividends from the share on her portfolio and then she would make capital gain (hopefully ) when selling the share.

All of those, excluded of tax in the UK but I am under the impression that when she will declare those (9a/b and 14) on her 1040 since there is no "tax credit" because if was tax free here, she would just end up paying the whole US tax on those (15-25%).

fair assumption?
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Old Feb 28th 2011, 8:45 pm
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Default Re: US citizen living abroad - Unearned income?

Originally Posted by hisokajp View Post
right sorry, this is for my wife "Share ISA" which is tax free in the UK. She will receive dividends from the share on her portfolio and then she would make capital gain (hopefully ) when selling the share.

All of those, excluded of tax in the UK but I am under the impression that when she will declare those (9a/b and 14) on her 1040 since there is no "tax credit" because if was tax free here, she would just end up paying the whole US tax on those (15-25%).

fair assumption?
Normally in the US, a tax free account doesn't have capital gains or dividends but can be treated as income or possibly excluded. Pre-tax contributions are normally treated as income when withdrawals and made and after tax contributions are normally excluded from income.

However, I believe that foreign tax free accounts are always treated as normal income on US tax returns except some tax treaties exempt certain pensions from taxation. That subject is too complicated for me to answer how that should be reported but it is unlikely to be reported in line 9a/b and 14 and suspect it should be reported in line 16a/16b pensions and annunities. But as stated earlier she may be able to offset taxes owed from her foreign earned income tax credits if she files without exclusions.

Last edited by Michael; Feb 28th 2011 at 9:52 pm.
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Old Mar 13th 2011, 7:58 pm
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Default Re: US citizen living abroad - Unearned income?

Hello,

may I "hijack" this thread for a similar problem?

I am a dual citizen of Germany and the US, living/working in Germany, but I have bank accounts in US and Germany and I dont know how to handle the 'interest' (unearned income).
...and doing my taxes for the first time...


From the double taxation treaty I found out that Germany is my tax home and that all interests must be taxed in Germany (from US and German banks).

Now I also have to report them on the US 1040, but how do I avoid double taxation?

Another problem. In Germany interests/capital income up to 801 € is tax free. As a result no tax amount to set of my american tax. Do I have to pay tax on this interest in the US?

Is there a limit below which I don't have to report any interests (in the US)?

----
another question: I seem to have to file Schedule B (1040) because I have a foreign bank account. But then in part III I mark no, since I don't have 10000 bucks in there. Is that really correct? Do I have to put the "10 $" in interest in part I, or can I ignore that?
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