US Tax

For US citizens living in Australia, the US taxation of Australian SMSFs is a huge question.

Unfortunately, there is no easy answer. The US taxation of Australian SMSFs is complicated.

In this episode, Marsha Dungog of Withersworldwide in San Francisco will walk you through the issues your Australian SMSFs face in your US tax return.

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For an expansion into the US is it best if your Australian trust holds LLC interests directly? Rather than going through a C-Corp?

When you expand into the US, you very quickly look at significant tax leakage and double taxation. And this despite potentially enjoying zero withholding tax (WHT). And despite potentially having NANE income under s768A ITAA97 or s23AJ / s23AH ITAA36. The reason for this tax leakage is two-fold. 

1 – The tax you pay in the US doesn’t go into your Australian companies’ franking account and,

2 – The withholding tax you pay might give you a foreign income tax offset (FITO), which gets lost as the income is distributed to shareholders.

And so for that reason setting up a trust who holds your US business within an LLC might be a way to avoid this double taxation since the trust beneficiaries can claim a FITO for the US federal income tax the trust paid in the US.

To find out more let’s listen to Bryan Kelly of Withers in Los Angeles.

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Should an Australian loan to US operations go to your US blocker? Or directly to your US trading entity?

Let’s say your Australian holding wants to give a loan to its US operations. How should you structure this loan? Should the Australian holding loan to your US blocker or directly to your US trading company?

That is the question Marsha Dungog of Withers in San Francisco will discuss with you in this episode. Here is what we learned. But Marsha Dungog explains all this much better than we ever could, so please listen in.

Let’s assume your Australian holding holds 100% of a Delaware C-Corp which you use as your US blocker. And then this blocker holds 20% of an LLC with the other 80% held by a US holding, called HoldCo.

Whoever receives the loan from the Australian Holding, will need to receive Form W-8-BENE from the Australian Holding. W-8-BENE will tell the recipient of the loan what tax to withhold from any interest payments.

The form is not actually filed with the IRS, but just tells the loan recipient to withhold 10% from any interest payments it makes to Australia.

If the Australian holding loans to the blocker, Form 5472 will report this loan to the IRS. The blocker needs to file Form 5472 anyway since it has at least 25% foreign ownership. So the loan won’t change that. But the loan just means that there is more to report in the 5472.

If the Australian holding loans directly to the trading entity, the LLC reports the loan and interest payments to the IRS through Forms 1042-T, 1042-S and 1042.

So reporting-wise it doesn’t matter whether you go via the blocker or directly to the LLC. Either Form 5472 or 1042 will pick it up and report it to the IRS.

The issue with any cross-border loan is that the IRS might see these loans as a capital contribution. So it is really important that you charge and pay interest rates at market, not slightly below or above but right at market.

Interest above market will look like a repatriation of profits. Loans with an interest below market are at risk of being treated as a capital contribution by the IRS. So you are damned if you do and damned if you don’t.

Just like Australia, the US has Thin Cap rules.

The advantage of giving the loan to the blocker is that – in case of a loan default – you have a US entity trying to get their money back and not a foreign creditor. 

The majority shareholder – so in this case the US HoldCo – will dictate the accounting method for the LLC. So if the HoldCo uses cash accounting, that is what the LLC would use to account for the interest payments it makes.

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You either just show dividends paid or you have to use a look-through approach for Australian companies in US returns. 

How are Australian companies picked up in US returns? So-called 1040s? Do you just record the dividend as income when paid? Or is it a look-through approach and you recognise income based on attribution? 

These are just some of the questions Seth Hertz of Expat US Tax will discuss with you in this episode.

Here is what we learned but please listen in as Seth Hertz explains all this much better than we ever could.

There are two ways to show Australian companies in US returns, so-called 1040’s. You either just show dividends when and as you receive them. Or you use a look-through approach and disclose their financial statements in Form 5471.

Of course, you would prefer to just show dividends paid. But unfortunately, you don’t have a choice.

It all depends on whether you have control or not.

If you have control and hold – either directly or indirectly – more than 50% and hence control the company, then you prepare and attach Form 5471 to your 1040 and the income is attributed to you on an accrual basis. And watch out for GILTI – Global Intangible Low Taxed Income.

But if you don’t control the Australian company, then you just pick up dividends on a cash basis in your 1040.

An Australian company usually doesn’t have a filing obligation in the US. Usually. But there is a long list of scenarios that would trigger a filing obligation for your Australian company in the US. Doing business in the US through a permanent establishment (PE) would be one example.

This is just a very short summary. Seth Hertz covers a lot more in this episode. Please listen in since we only touched the surface here.

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As a non-US tax resident, should you run your US business through an LLC or C-Corp?

If you use a C-Corp blocker, should your trading entity sit within an LLC or C-Corp? This is the questions Alfonso Nuñez of Andersen in San Francisco will discuss with you in this episode.

Here is what we learned but please listen in since Al Nunez explains this much better than we ever could.

You start with the end. If your ultimate goal is a capital gain upon exit and you don’t worry about profit distributions in the meantime, then you might as well place the trading entity within a C-Corp. When you sell your shares, any capital gain will be tax exempt in the US and possibly also in Australia, at least while you hold the profits within your Australian holding company.

But if profit distribution is your goal, then you face double taxation since the US doesn’t have an imputation system. So your C-Corp trading entity pays tax and then your C-Corp blocker pays tax again on the net amount it received. Far from ideal.

So start-ups in Silicon Valley are more likely to use a C-Corp + C-Corp structure. But if you are a more traditional business looking at long-term expansion and not a quick exit, then C-Corp + C-Corp probably won’t work for you and you need to look at just one C-Corp and/or an LLC.

If your C-Corp blocker holds at least 80% of the C-Corp trading entity, you can probably consolidate and avoid double taxation in the US. But if you hold less than 80% in the trading C-Corp, then consolidation is off the table and you face double taxation.

These are just some quick notes. Please listen in since Al Nunez goes into a lot more details and shares many more insights than we listed here.

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When you expand your business into the US, what types of US corporations are there to choose from?

When your clients expand their business into the US, you will need one or two US corporations to optimise their US tax affairs. But what type of corporation?

That is the question Al Nunez of Andersen in San Francisco will discuss with you in this episode. Here is what we learned but please listen in as Al explains all this much better than we ever could. 

For federal tax you have three types of US corporations – S-Corps, C-Corps and then LLCs.

S-corps are only suitable for US tax residents. Foreign residents can’t hold a share in an S-Corp. So if you are a resident of Australia and not the US, S-Corps are off the table.

LLC stands for Limited Liability Corporation.

They are a state law concept, so it is really important that you choose a suitable state to create your LLC.

Under federal tax law LLCs are treated as a sole trader or partnership (depending on how many members you have) unless you make an election in time for the LLC to be treated as a corporation.

C-Corps are the closest thing to our Pty Ltd. You can use a C-Corp in combination with an LLC. You can set up your business directly in a C-Corp or just use the C-Corp as a blocker. make sure you create your C-Corp in a suitable state.

Some states in the US are better than others when it comes to forming your LLC or C-Corp. You need to look for simplified corporate governance rules as well as low state taxes.

There are seven US states with simplified corporate governance rules – Nevada, Ohio, Washington, Texas, South Dakota, Wyoming and – the most popular of all – Delaware.

South Dakota and Wyoming impose neither a corporate income tax nor a gross receipts tax.

Nevada, Ohio, Washington, and Texas have no corporate income tax but charge a gross receipts tax. 

Delaware imposes an income tax on businesses that operate there. But if you are merely incorporated in Delaware without any operations there, then no corporate income tax. However, the state receives a significant amount of revenue from the annual stock-based franchise tax imposed on corporations formed there

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In March and December 2020 all eligible US residents received US stimulus cheques. How do you treat those in Australian tax returns?

For US purposes stimulus cheques are refundable tax credits and as such are not recognised in Australian tax returns. But don’t take our word for it. Seth Hertz of Expat US Tax will explain all this in much more detail. Here is what we learned.

US Stimulus Cheques

Two sets of cheques. Two sets of legislation. Two dates – March and December 2020. Two support packages. But for tax purposes both the same thing.

Both US stimulus cheques are refundable tax credits in the US. If you haven’t received a cheque, you can claim the stimulus in your 2020 US return (Form 1040). The cheques are just a prepayment of the tax credit you are entitled to via your tax return.

Four Different Thresholds

The stimulus payments have four different thresholds – one for each of the four filing status in the US.

Preliminary Data

The US administration used the 2019 and for the payment in March, the 2018 tax information, since in March 2020 many of the US tax returns hadn’t been lodged yet for 2019. But all this is only preliminary.

In the end it all depends on your income in 2020. So if you didn’t receive a cheque, since your 2018 or 2019 income was too high. You can still qualify, if your 2020 significantly dropped thanks (or no thanks) to the pandemic.

First and Second Package

The first package was $1200 for an adult. $500 for a child. The second one in December was $600 for anyone whether it is an adult or a child. 

Effect on Australian Tax Returns

If most of your income is in Australia, then these US stimulus cheques will have little effect on your tax position, since you pay your tax in Australia and just handa foreign tax credit to the US.

But if most of your income is in the US, then these cheques will effect your tax position in Australia, since the cheques will reduce the foreign income tax offset (FITO) you can claim. The cheques reduced the tax you pay in the US. And hence reduce your FITO in Australia.

Summary

So when you prepare an Australian tax return for a US citizen, you can ignore the cheques. They are neither income nor NANE.

Just look for the US tax ultimately paid in the US. That is the FITO you can claim in Australia.

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How do you ‘read’ an US individual tax return for Australian tax purposes?

Your US clients will probably give you their US individual Tax Return – also referred to as Form 1040 – which you then build into their Australian tax return. But how do you ‘translate’ this form into an Australian tax return? 

This is the question we asked Seth Hertz of Expat US Tax in Sydney. Here is what we learned but please listen in as Seth explains all this much better than we ever could.

Schedules

When you prepare a US individual tax return, you often deal with a large number of schedules which can be confusing. So just remember that Form 1040 is the final answer. Everything feeds into the 1040.

All schedules feed into Form 1040 in some shape or form. Sometimes schedules A, B and C will feed into schedules 1, 2 and 3. Sometimes A, B and C feed directly into the 1040. It is not always 100% one way or the other. But the 1040 is the final destination for everything. You will always find the final summary in Form 1040. 

Thanks to all these schedules the US individual tax return can be huge. Returns with well over 100 pages are common.

Exempt Interest

US bonds are often issued to finance federal or state infrastructure projects. The interest on these is often tax-free, hence a popular way to offset your tax liability. Interest deemed exempt in the US is usually assessable income in Australia

Qualified Dividends

Qualified dividends also come tax-free. Organisations who benefit the common good might qualify to distribute qualified dividends. Qualified dividends are assessable income in Australia

Capital Gains and Losses

In the US you can offset US$3,000 of capital losses against ordinary income, the rest against capital gains. The Australian tax return will not recognise the offset against ordinary income.

Foreign Tax Credit

American residents living in Australia usually amass a high amount of foreign tax credits over the years in their US tax returns, since the tax rates in Australia are so much higher. However, these foreign tax credits can only be offset against foreign income. So you can only use them if you move into a low or zero tax country after living in Australia. The foreign tax credits expire after 10 years.

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This is a short overview of what we learned in this interview with Seth Hertz of Expat US Tax. But please listen in as Seth explains all this much better and in a lot more detail.

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US v Australian tax for individuals – how do you ‘translate’ a US tax return into an Australian tax return?

US citizens living in Australia are tax residents and hence assessable on their world-wide income in both countries. But what does this look like in practical terms?

How are Australian franking credits and super guarantee payments treated in a US tax return? And how are exempt interest and qualified dividends in the US treated in an Australian tax return?

These are just some of the questions we ask Seth Hertz of Expat US Tax in this episode ‘US v Australian tax for individuals’.

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