# Yet another Australian superannuation thread



## AmerInSyd

I've been reading a lot of threads about this, and am getting more and more confused.

It seems the consensus is that Australian super is treated like an ordinary account by the IRS, so both employer and employee contributions should be reported as earnings, and the 15% contributions tax can be claimed as a tax credit.

There seems to be more disagreement about how to deal with investment earnings in the super account, with some people saying to report it and some saying to treat it as an unrealized capital gain (which would then presumably accrue tax on withdrawal). However if the earnings are not reported then how do you fill out the FBAR for the super account? Among those who say to report it, some say it is a PFIC and some say it is a trust, which apparently have very different tax implications. 

There are thousands of people with the exact same issue every year, why are there no official rules about this???

If I report the investment earnings, is it as "passive category income" on the 1116?

Anyway, my main question is that I would like to get a foreign tax credit for the taxes already paid to Australia on the investment earnings, since I should have a right not to be double taxed on the same income. It seems that the standard tax on super earnings is 15%, although it may depend on the length of holding. However this is paid by the super fund before crediting the earnings to my account, and does not appear on my statement. I have e-mailed my super to ask for a statement of taxes paid on earnings, but I'm sure they don't keep track of this for individual accounts, since the taxes are probably paid on a large scale. So how do I estimate the tax paid for the foreign tax credit?

Finally, if I declare all the contributions and earnings on my US tax return every year, then distributions at the end should be tax-free since it is just like taking money from a post-tax account, is that right? I am worried that down the road the IRS will decide that super should be taxed on the back-end and come for another bite at the apple, is this a concern?


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## BBCWatcher

There are official rules, but there are also a variety of Australian superannuation arrangements.

In my view (and in others') there doesn't seem to be any particular controversy that Australian superannuation accounts are organized as foreign trusts. Consequently they would be reportable via IRS Form 3520/3520-A and, for that matter, FinCEN Form 114. That appears to be clear cut, at least to me.

Where there's some variability is in what the accounts hold. Often, typically, Australian superannuation accounts are invested in foreign unit trusts a.k.a. mutual funds. Thus they hold PFICs, so you'll have IRS Form 8621 to contend with. However, that's not an absolute _given_, hence there's no absolute answer to that question. Obviously if you can direct the investments such that you avoid PFICs, that'd be ideal.

You're on the right track for determining the foreign tax paid. That's a common issue. Japan, for example, withholds income tax on bank interest. Most banks don't report that tax separately and just report after-tax interest, but it's a uniform, level rate of tax. Thus it's easy to calculate. If you know what the rate of tax is because it's published somewhere -- in the employer's general benefits brochure, for example -- then you don't need a separate statement. Just hang onto a copy of the brochure (or whatever) in your personal files.

Interest and dividends on the account will be U.S. taxable in each year paid (IRS Form 1040 Schedule B). Capital gains...it depends. If they're capital gains from PFICs then you'll want to make "mark to market" elections and pay the U.S. income tax on the unrealized gains along the way. In that case when you withdraw yes, you'll only pay U.S. capital gains tax on the final increment of gains for a partial year. If they're not PFICs then you treat the gains conventionally, with tax owed when the gains are realized.

That's probably your fundamental source of confusion, whether the investments are PFICs or not. That's just situational. Often yes, sometimes no. To the extent you control how the funds are invested you can probably avoid PFIC complications if you wish.

There might be other opinions of the "aggressive tax stance" nature that are probably not well grounded in the actual tax code (and tax treaty), but I'd say what I wrote above adheres to the letter of the code/treaty.


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## AmerInSyd

Thanks for the reply.

Regarding the PFIC issue, I have seen some people argue that superannuation should be considered as an employee trust subject to 402(b), and then the employee is not required to file 8621. For example, the discussion Tax Blog: PFIC Attribution Through Foreign Pensions (I can't post the link since I'm new here)

and particularly the conclusion "Thus, no Form 8621 would be necessary for a foreign pension fund that is treated as an employees' trust, regardless of whether the pension was covered by a treaty." (though they are not talking specifically about Australian superannuation). This also would depend on the super fund; mine is an industry fund for university employees.


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## BBCWatcher

I agree with that "it depends" caveat. As I understand it, Australian superannuation accounts are structured in various ways, and the devil(s) is(are) in the details.

For more background reading -- and, brace yourself, there's a lot of detail -- try this article. That article may give you some ability to go beyond the "normal" depending on what sort of account(s) you've got.


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## Bevdeforges

The IRS never seems to issue any advice or "rules" on foreign stuff - with the possible exception of Canada, I suppose because it's right next door.

What you have to do is to find a logical and reasonable approach to fitting something "exotic" like the Australian Superannuation funds into the US tax structure. What does it most resemble? And can you somehow shoe-horn it into the rules for whatever that is? Unfortunately, the IRA rules call specifically for US recognize funds and a few other details so that you can't really claim that your foreign retirement plan is "just like" an IRA and go that way. But honestly, that's what the high-priced tax advisors do, too - find a position they can defend if questioned, and basically hope that they aren't questioned.
Cheers,
Bev


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## AmerInSyd

So as indicated above, I think that at least for some super funds, one can make a case that they should be treated as non-discriminatory employee trusts, in which case only the contributions are taxable each year and the growth is only taxable upon withdrawal. Then the employee does not have to deal with 8621 or 3520.

But anyway, I ran some numbers just for fun. Employee X is 25 years old and makes AUD $100,000 (about USD $75,000) per year, in today's dollars, for 30 years. His employer contributes 12% of salary annually to his super (which will be the mandatory contribution amount in a few years). Employee X makes no voluntary contributions. Let's suppose that the super fund produces a annual nominal rate of return of 8% including 3% inflation, for a real return of 5%. This is perhaps somewhat optimistic (or pessimistic, as we shall see), but not wildly so. Then at the end of 30 years, Employee X is still 5-10 years from reaching the preservation age (which the government has talked about moving to 65), and has no access to his super.

His super is now worth over 800,000 in today's dollars, and growing by well over $60,000 a year, not including contributions. Assuming the super growth is treated under PFIC rules and taxed at a rate of 39.6%, at this point his annual US tax bill is more than $26,000, in addition to his Australia tax bill, for a total tax bill of well over $50,000.

Let's say the fund goes on a massive tear, and returns 16% one year, which many funds did in 2007. Then lucky Employee X gets to take home about $20,000 of his $100,000 salary that year.

If one assumes a smaller real return and/or lower inflation, then the situation gets a little better but is still pretty bad. (For example if one assumes only a 3% annual real return and a low 2% annual inflation, then after 30 years the super will only cost Employee X an extra $12,000 per year in taxes.)

What these calculations seem to indicate is that if one's super is treated as PFIC, then an average long-term career in Australia is untenable for a US citizen unless he can somehow manage to make sure that his super performs poorly. (And simply investing directly in bonds or stocks is not always an option; I don't think that's possible in my super.)

Maybe someone can find a mistake in my calculations, but it looks ominous.


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## AmerInSyd

PS I realized that I forgot to deduct taxes and fees from the employer super contributions, so the American tax bills are maybe 20% less than I estimated. On the other hand, some employers contribute 17% to employee super, so the American tax bills would be over 40% worse than I estimated. In the bad year (16% nominal gain) Employee X's take home salary would be less than AUD $15,000.


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## BBCWatcher

I see a mistake.

An individual earning US$75,000 (plus these PFIC gains) is not in the 39.6% top marginal tax bracket. With a "mark to market" approach on his PFICs (what you're describing) and at that income level his PFIC gains would be taxed at a blend of the 25% and 28% marginal tax rates -- entirely at the 25% rate in the early years, with some the dollars eventually taxed at 28%. But he doesn't get past the 28% bracket in this scenario. The 28% bracket tops out at US$189,300 (tax year 2015) for a single filer, and that's AGI so figure about $200,000 in gross total income. The bracket limits are increased with inflation, so he'd find it very hard to catch up from this income level in this scenario.

You could also run variations with Married Filing Jointly and Married Filing Separately. The tax rates are lower in a MFJ scenario (assuming a spouse with low or zero income) and a bit higher in the MFS scenario. In MFS he still wouldn't get past the 33% bracket, and it'd only be the out years when he gets a few dollars into that bracket (and perhaps zero).


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## maz57

Ugly numbers; that makes that $2350 to renounce US citizenship look like a bargain. If the Aussy dollar goes on a tear it could be even more painful. (To be fair, it could also improve the picture if the exchange rate went the other way.)

To address the question about AU tax paid on the super: Would it be possible to calculate backward from the annual incremental gain to arrive at an estimate for the tax paid? The IRS won't need official statements because they don't compute in the IRS system anyway. They'll just have to take your word for it.


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## AmerInSyd

Ok thanks, I ran the numbers again for a salary of AUD 112,000 with a 17% employer contribution rate, assuming zero voluntary contributions (this is very close to the situation of *someone I know*), and with a made-to-market tax rate of 25%. No other income or assets.

At the end of 30 years, Employee X is now getting hit with a US tax bill of more than AUD $20,000 per year, on top of his Australian tax bill. In a big year of nominal 16% growth, more than $40000, which when added to his Australian tax bill, leaves him with a take home pay of AUD $40,000.

If the big year occured after 35 years and he is still not retired (remember the age to acces super is projected to be 65), then his take home pay that year would be about $24,000 out of his $112,000 salary. If he has the temerity to work for 40 years (maybe he started at 20 and is still 5 years away from super access), then then by end he will now be taking home only about AUD $40,000 in an average year, and when the stock market has the big year 16% nominal growth, then his take home pay for the year will be a grand total of around $4,000 (actually it would probably be much less, possibly negative, since at this point his "income" is well over $200,000).

So to summarize, for Employee X with a salary of USD $85,000, 17% employer contributions (which is standard in higher education), and no voluntary contributions, with super making a 5% real return (which many funds aim for), his average combined tax rate after 40 years, assuming 3% inflation at that time, will have risen to well over 60% of his salary, and could rise to over 100% in a year with a market boom. 

On the other hand, an Australian making the same salary has a tax rate of about 26% of salary, and an American making the same salary with a similar retirement savings profile (say 17% employer contributions to 401(k) and no voluntary contributions) has a tax rate of around 20% of his salary (including FICA).

By the end of his 40 year career career, the American living in Australia is paying on average nearly 50% more per year in taxes than the American and Australian combined, and in some years may be hit with a tax bill that his larger than his gross salary. He also won't necessarily have any more retirement savings than either of them.


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## AmerInSyd

One more thing, if I understand things correctly, then if the super is considered an employee trust, then the accrued benefit is not necessarily regarded as passive income but rather as compensation. It is certainly passive income for the trust itself, but not necessarily for the employee beneficary. See the discussion here about the Opaque doctrine: International Tax Blog: PFIC Attribution Through Foreign Pensions.

f that's correct, then there is a question about whether the earnings should be declared annualy or upon withdrawal. From a tax point of view, it might even be better to declare them annually, at least in the beginning. 

In the scenario above, if you conisder the accrued benefit to be general category income (i.e. compensation), then the tax credit for Australian income taxes applies. Because the Australian effective rate is higher there will be no tax due as long as the growth is relatively small. At a certain point the US effective tax rate will pass the Australian effective tax rate once growth is added in, since Australia taxes growth at a much lower level. But the difference in effective rates should be small for a while, and you can use the FEIE to exclude the salary portion, so in the end all you're paying is the difference in overall effecttive rates, which may just be a few percent most of the time, on the unearned portion of the income. At the very end, the difference in effective rates will grow a bit, as well as the amount of unearned income, so there would probably still be a few sizable payments towards the end.

On the other hand, this may be a much better outcome that deferring the growth, because now you've built up a 100% cost basis without paying a huge amount of tax, and the distributions should be tax free.

An interesting question here is regarding credits for Australia's taxation for growth, It seems logistically difficult to claim since there don't seem to be any records of the amount. On the other hand, in the PFIC situation, it certainly seems to me that one should be able to claim such credits.

In the employee trust situation, if you are regarding the trust as the one generating the passive income, which is actually what's taxed, then it seems harder to justifiy a tax credit for you accrued benefit, though I'm not sure.

Anyway, I'm not a lawyer or an accountant, so don't take any advice from me,but these are some thoughts based on what I've been reading.


I'll just add, without wanting to start another war on "fairness", that the PFIC outcome is absurd and can't possibly be what the US and Australian governments want. I would guess that if enough people get caught up in this some solution will eventually be worked out (though who knows how many people could get caught in a mess in the meantime.


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## AmerInSyd

Wel, maybe I was wrong. It could be that even under an employee trust scenario the accrued benefit may be considered passive income. Maybe someone else could way in.

If the income from the accrued benefit in an employee trust is deferred, it is taxed as an annuity upon distribution, which indeed seems to be considered passive income. On the other hand, I read somewhere that in a certain case involving "highly compensated employees", the accrued benefit was declared annually and considered as wages.


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## BBCWatcher

AmerInSyd said:


> In the scenario above, if you conisder the accrued benefit to be general category income (i.e. compensation), then the tax credit for Australian income taxes applies. Because the Australian effective rate is higher there will be no tax due as long as the growth is relatively small.... But the difference in effective rates should be small for a while, and you can use the FEIE to exclude the salary portion....


Or, better yet, don't take the FEIE and instead accumulate excess FTCs, spending down those excess FTCs if the U.S. rate ever passes the Australian rate.

For the record, I happen to think well-regulated foreign accounts such as Australian superannuation accounts probably ought to be exempted from foreign trust and PFIC complications, at least as long as such accounts don't total up to something "big" -- $1 million or more (2015 dollars), let's say. (No foreign equivalents to Mitt Romney with $100+ million IRAs, please.) I also think only _real_ interest, dividends, and gains ought to be taxed (at ordinary income tax rates), meaning only amounts received above the U.S. Consumer Price Index would be taxable. Finally, at least as a general principle I'd be in favor of extending a bit of foreign exclusion to foreign passive income, even if it meant losing some of the exclusion for foreign earned income and (in particular) housing.


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## AmerInSyd

maz57 said:


> Ugly numbers; that makes that $2350 to renounce US citizenship look like a bargain. If the Aussy dollar goes on a tear it could be even more painful. (To be fair, it could also improve the picture if the exchange rate went the other way.)
> 
> To address the question about AU tax paid on the super: Would it be possible to calculate backward from the annual incremental gain to arrive at an estimate for the tax paid? The IRS won't need official statements because they don't compute in the IRS system anyway. They'll just have to take your word for it.


Well, all the things I've read say that the basic tax on investment earnings in super is 15%, but sometimes 10% for long term capital gains, and there are some dividend related credits which I don't really understand.

But there are some things I don't understand. 

1) When is this 15% applied? Every year to the change in the balance of the funds? Whenever some event occurs like interest or dividends or trading? 

2) I don't know how to parse "usually 15%, but sometimes 10% or less". How am I supposed to know what percentage of my earnings are taxed at 15% and what percentages at different amounts?

I've e-mailed my super asking from some tax info but haven't heard back yet. I think probably the fund has a bunch of subfunds which each pay taxes, and then amounts are allocated to individual account based on the funds' after-tax balances. In principle it should be possible to reverse engineer the tax attributed to each individual account holder by looking at what funds are associated to each account in what percentages and then checking the taxes on those accounts, but of course the holdings are constantly changing with new contributions coming in so it might be complicated. I'm sure the super funds have neither the software in place nor the inclination to divide up the taxes by account.


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## TaxWonder

So it sounds like the FBARs, amended returns, and 3520 are required for Australian Superannuations. But just so I'm clear -- are Superannuations subject to the 5% miscellaneous offshore penalty on form 14654 if I'm doing a streamlined domestic offshore disclosure?


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