Market Insights

The Impact of US Citizenship on Global Investment Strategies

The Impact of US Citizenship on Global Investment Strategies

As the world of investment has become increasingly interconnected, offering investors a wealth of opportunities beyond their domestic borders, global investment strategies which involve diversifying portfolios across various international markets, boast numerous advantages. 

Studies by Barclays have shown that international diversification can lead to enhanced risk-adjusted returns and potentially smoother portfolio performance over time. This is due to the tendency of markets in different regions to exhibit varying levels of correlation.

However, for US citizens, navigating these exciting investment opportunities of investing globally presents unique challenges. US citizens, living in the continent and abroad, are subject to a worldwide taxation system. This means that regardless of where they reside, they are still liable to the US taxation legislation and laws on any capital gains or income generated and invested. This additional layer of complexity necessitates a more nuanced approach to crafting a global investment strategy for US citizens.

Complexities for US Investors Living Abroad

Navigating international investment opportunities can be a complex endeavor for American expats. While they may be dutifully paying taxes in their new home country, the US still considers them financially responsible for their worldwide earnings. This situation arises from the long-standing legal principle of “citizenship-based taxation,” enshrined in the US tax code.

The Foreign Account Tax Compliance Act (FATCA), enacted in 2010, further amplifies this reality. FATCA requires foreign financial institutions to report the financial holdings of US citizens to the US Internal Revenue Service (IRS). This legislation significantly increased awareness of US tax obligations among expats, prompting many to seek guidance on managing their investments while navigating this complex tax landscape. Understanding these unique tax implications is crucial for US citizens venturing into global investing. 
Another hurdle that US expats face that can significantly restrict their investment options and strategies is the infamous Passive Foreign Investment Company (PFIC) rules. These complex regulations categorize certain foreign investment vehicles as PFICs, subjecting US investors to a slew of reporting requirements and potentially punitive tax consequences. For instance, qualifying PFICs may incur a hefty annual information return filing burden, along with the risk of excessive taxation on undistributed earnings.

A 2021 survey by the American Citizens Abroad Council found that 72% of respondents reported facing challenges due to PFIC regulations, highlighting the significant limitations these rules place on investment flexibility for US expats.

Impact on Global Investment Strategies

The core challenge lies in the concept of citizenship-based taxation. It necessitates a different approach to investment planning for US expats compared to their non-US counterparts. Further complicating matters is the Foreign Account Tax Compliance Act (FATCA). Implemented in 2010, FATCA requires foreign financial institutions to report account information of US citizens to the IRS. This increased transparency makes it nearly impossible for US expats to blanket financial assets abroad, pushing them towards compliant investment strategies.

Investing in Passive Foreign Investment Companies (PFICs) can be costly. Unlike US-domiciled funds, PFICs often come with complex tax reporting requirements and potential penalties. Using US-domiciled funds through an expat-friendly US brokerage is the recommended approach for American expats.
Many US citizens living abroad contribute to foreign pension plans during their overseas assignments. While some countries have bilateral tax treaties with the US that simplify tax reporting and allow the deduction of contributions, most do not. Thus, careful attention needs to be paid to the specific tax implications of foreign pension plans for US citizens. Contributing to US retirement accounts like IRAs and 401(k)s while living abroad requires strategic planning. If an expat resides in a country with higher tax rates than the US, contributions may not be deductible, leading to double taxation. Conversely, in low-tax countries, IRA contributions can be highly beneficial for reducing the overall tax burden.

Currency fluctuations pose a significant risk for expats earning a foreign salary but planning for retirement in the US. Matching future expenses with investments denominated in the right currency is crucial. For example, an expat planning retirement in the US should prioritize investments tied to the US dollar to mitigate currency risk.

The complexities extend beyond investment choices. US citizens remain subject to US estate tax, even after passing away abroad. While increased exemptions have lessened this concern for some, understanding the interplay between US estate tax and local inheritance laws in the expat’s country of residence is essential. Revisiting and updating estate plans after moving abroad is highly recommended to avoid unintended consequences. Additionally, for American expats married to non-US citizens, careful planning around investment titling, spousal structuring, and estate planning is necessary. While certain tax advantages might exist by shifting assets to a non-resident alien (NRA) spouse, limitations like the non-applicability of the unlimited marital deduction to NRA spouses must be considered.

US citizenship adds a layer of complexity to global investment strategies for American expats.  Understanding the interplay between citizenship-based taxation, FATCA regulations, and specific investment vehicles like PFICs is crucial.  Furthermore, navigating foreign currency fluctuations, estate planning considerations, and the dual tax obligations of the US and the host country requires a tailored approach. Consulting with investment management experts and tax professionals is highly recommended to develop a comprehensive and compliant investment strategy that maximizes returns and minimizes tax burdens.

EQBAC is an investment management platform, through which investors can gain investment management solutions with the freedom to choose where, when, and how they want to trade. Our seamless, intelligent, and secure platform provides single-view access to global markets and investment opportunities. Fortunately, solutions and resources exist to help US expat investors navigate these complexities. With EQBAC, US clients can now invest in certain global assets, offering greater diversification potential within a compliant framework. Contact your advisor today to learn more about EQBAC’s offerings.

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