Questions about Investing Options and Tax Implications - US Citizen/German Resident

[tatenda]

Hi all and thanks in advance for information and advice. Trying to get some things straight after researching online... it’s a lot and I’m anticipating I may get the response ‘pay a professional to answer these questions!’, which I’ll do if that’s the consensus

• Many recommend opening/maintaining a US based brokerage account with a family member’s address and not disclosing foreign residency. To see what this looked like, I went through the brokerage opening steps with Charles Schwab until I got to accepting the terms and conditions where one disclosure asked me to confirm I was exempt from FACTA (among other things). It seemed like a deal breaker to me to ‘lie’ here and indicate that I’m exempt.

a. Am I overthinking this from a legal perspective? I’d like to be able to utilize this ‘preferred’ option of a US-based brokerage for passive investing purposes but don’t want legal trouble.

b. If this option turns out to be viable and I am able to invest in this taxable account, it’s my understanding the double taxation agreement between the US and Germany (and Germany taxing worldwide income) that I would only owe (the admittedly less favorable) German Capital Gains tax.

• Am I understanding this correctly?
• With a ‘non disclosure’ of German residency, would I have any issues with Charles Schwab communicating US tax documents/liability to the IRS? My understanding is that to stay tax compliant I’d report/pay capital gains, but that I’d avoid US capital gains by claiming the German capital gains paid as a foreign tax credit (I’ve already used the FTC for 2019 and 2020). Basically, am I also understanding this correctly?

My worry is the IRS would be looking for US capital gains paid on this brokerage account—I’m basically looking for confirmation that claiming it as worldwide income/capital gains in Germany and paying the capital gains in Germany keeps me good with the IRS if they see this on my tax returns.

• Another recommended options is IBKR (Interactive Brokers Ireland) who I recently established an account with.

a. Similar questions to above. My understanding is they provide tax forms and information but do not withhold taxes, so—

• When handling capital gains, I would eventually pay the German capital gains ‘manually’ with the help of a German tax consultant. I could then claim Foreign Tax Credit on my US taxes with these capital gains to avoid double taxation. Correct?

b. I am confused with regards to US exchange stocks (eg NYSE) and dividends. I have read that I’d be liable for taxes on the dividends in both the USA and Germany, and that withholding WOULD be involved? Hoping someone can clear this up.

c. Do I need to be especially concerned with converting EUR to USD to buy, for example, NYSE based stocks?

• Last ‘general’ question—does prior year(s) carried over Foreign Tax Credit apply to all income types or just the income type where it was claimed? Since 801 euros of capital gains are tax free in Germany, I’m wondering this since the US would see that same 801 euros as taxable.

Again, thanks in advance and I understand if I’m directed to pay a professional!

 

[stephendisraeli]

@tatenda

Am I understanding this correctly?

The tax treaty between the US and Germany has a so-called savings clause, which basically says that most of the treat does not exist for US citizens and residents with regard to taxation by the US and for German residents with regard to taxation by Germany.

There are only a few provisions untouched by this savings clause. The most useful is the one about "relief from double taxation". It does not remove any tax liabilities, but it allows to use some of the tax amount paid to one country as a credit against the tax liability of the other.

Also note that the treaty does not disarm any tax traps, neither in the US tax code nor in the German tax code (admittedly, the latter has fewer and they are not as readily sprung).

With a ‘non disclosure’ of German residency, would I have any issues with Charles Schwab communicating US tax documents/liability to the IRS?

I would think that you will need to disclose your citizenship to Schwab, at which point they'll know that you fall under FATCA. If you could keep your US citizenship hidden from them (i.e. by having another citizenship), they would treat you like a "foreign" investor, which means automatic withholding tax of 15% (due to the treaty, without a treaty the rate would be 30%) on any realized capital gains. I am not sure how this would work when filing US taxes, as a US tax resident should not be subject to the withholding tax. It sounds messy, as you'd somehow reclaim the wrongly-administered withholding tax and the IRS would know that the brokerage provider doesn't know you're a US tax resident.

When handling capital gains, I would eventually pay the German capital gains ‘manually’ with the help of a German tax consultant. I could then claim Foreign Tax Credit on my US taxes with these capital gains to avoid double taxation. Correct?

Correct. And you are fortunate that Germany changed how it taxes structured investment products in 2018, as before there were fairly harsh tax provisions in place for any such products deemed "intransparent" (think US PFIC rules, just without absurdly complex filing requirements).

 

[tatenda]

@stephendisraeli Thank you so much for the response.

I would think that you will need to disclose your citizenship to Schwab, at which point they'll know that you fall under FATCA.

Did you mean disclose my residency? I am a US citizen/German resident and at this point have no intention of becoming a German citizen.

I am not sure how this would work when filing US taxes, as a US tax resident should not be subject to the withholding tax. It sounds messy, as you'd somehow reclaim the wrongly-administered withholding tax and the IRS would know that the brokerage provider doesn't know you're a US tax resident.

Though this isn't the hypothetical situation i would be in--my hypothetical situation would be Schwab believing I'm a US Citizen and Resident, but I think a similar complication applies. If I had a brokerage I was trading on, I believe Germany would consider that 'worldwide income' and want to apply capital gains for me to pay. However, I'm thinking Charles Schwab (or any US brokerage) would withhold and send the IRS my assumed US tax liability.

What puzzles is me is that searching Reddit and the web is that many recommend that if you can 'get away with this', e.g. the brokerage doesn't find out you are a foreign resident and freeze/close your accounts, that it is the best option. If people are doing this, I am guessing they are not reporting the capital gains to Germany (or wherever their other foreign tax residency is), which to me seems to be straight up tax evasion (on the German side of the equation).

The 'correct' process seems awfully complicated and relates to your comment--paying German Capital Gains on the US based Schwab trades as 'global income', then reclaiming the withheld 'US Taxes' that Schwab automatically send to the IRS because I'd be claiming that I did not owe them due to applying the Foreign Tax Credit and avoiding double taxation (German tax rates are higher). I'm just assuming this is 'correct'. I could very well be overlooking something. This very situation (all FATCA related) is exactly why the brokerages don't want to mess with Expats. It brings me back to my original question--would this even be legal? Schwab asks you to indicate in agreeing to their disclosures that you are exempt from FATCA. I don't even know if it's possible to present to a German tax advisor the necessary paperwork to show what you owe in German Capital Gains taxes on a US Brokerage.

I am sticking with Interactive Brokers for now, but I am still generally curious why people are suggesting 'getting away a US brokerage using a stateside address' when it seems like the end result is tax evasion in the foreign country you are residing in. I wonder how these people are paying the capital gains/taxes.

Still hoping someone can provide some clarity on the following:

If anyone can generally make sense of the sense/logic/process of maintaining a US brokerage with a US address while a foreign resident!

b. I am confused with regards to US exchange stocks (eg NYSE) and dividends. I have read that I’d be liable for taxes on the dividends in both the USA and Germany, and that withholding WOULD be involved? Hoping someone can clear this up.

c. Do I need to be especially concerned with converting EUR to USD to buy, for example, NYSE based stocks?

• Last ‘general’ question—does prior year(s) carried over Foreign Tax Credit apply to all income types or just the income type where it was claimed? Since 801 euros of capital gains are tax free in Germany, I’m wondering this since the US would see that same 801 euros as taxable.

To clarify this last one, could the FTC carryover from previous years (all from wages paid by my employer) be applied to foreign capital gains in subsequent/future years, or does it have to be again applied to wages from my employer?

 

[stephendisraeli]

@tatenda

Did you mean disclose my residency?

Ah, sorry. I got confused about the process, and that the question was about pretending to have US residency while having actual residency elsewhere. FATCA applies to accounts that US tax residents hold in non-US countries, so I am not sure why a US-based brokerage provider would ask about this. Maybe they mean the reciprocal information exchange that is usually part of tax compliance treaties? Under the treaty, US financial institutions would need to report accounts and balances of residents of Germany to the German authorities, but as far as I have heard, the US has not implemented the provisions of the treaty in actual law yet (unlike Germany, which does have legislation implementing the treaty on its side).

Though this isn't the hypothetical situation i would be in

Yes, I was assuming the wrong premises earlier. Apologies, I had not had enough coffee yet.

However, I'm thinking Charles Schwab (or any US brokerage) would withhold and send the IRS my assumed US tax liability.

I am not sure if this is how it works when a US-based financial institution is dealing with what they believe to be US tax residents. At least they will provide you with the information you need to file US taxes. Automatic withholding definitely happens if the account owner is not a US tax resident - the regular withholding tax rate is 30%, but for a resident of Germany it is 15% due to the tax treaty.

On the other hand, this is basically how things work in Germany. A German financial instution will automatically withhold the 26.something percent of all capital gains after the tax-exempt 801 € are reached. When you file your taxes, the tax on capital gains can be adjusted downwards if your marginal income tax rate is below 25% - basically, capital gains are taxed at the lower value of 25% and your marginal income tax rate. It gets a bit more complicated for funds, as a certain percentage of the gains of a fund are tax-free, depending on the type of funds. 30% for funds investing in stocks, while the tax-free percentage can reach 80% for funds investing in real estate.

The 'correct' process seems awfully complicated

It's probably still less complicated than dealing with form 8621.

I don't even know if it's possible to present to a German tax advisor the necessary paperwork to show what you owe in German Capital Gains taxes on a US Brokerage.

That should be possible, but it requires a bit more manual record keeping than for a brokerage account based in Germany where most things are taken care of by the brokerage provider. The tax advisor will need the market prices of the shares at the beginning and the end of the year, and a list of dispositions, acquisitions and distributions. The process is, very roughly, similar to doing mark-to-market for PFIC shares, so no "internal" financial information about the fund is needed other than what it invests in (for determining the tax-free share). It is the same process for all funds regardless of their domicile, so unlike the dreaded US PFIC rules, it will not lead to adverse outcomes based on fund domiciles.

 

[trantrang2461]

@tatenda

My understanding is that to stay tax compliant I’d report/pay capital gains, but that I’d avoid US capital gains by claiming the German capital gains paid as a foreign tax credit (I’ve already used the FTC for 2019 and 2020). Basically, am I also understanding this correctly?

Yes this is totally legal and expected that this is what you would do, the IRS will not be upset about this

When handling capital gains, I would eventually pay the German capital gains ‘manually’ with the help of a German tax consultant. I could then claim Foreign Tax Credit on my US taxes with these capital gains to avoid double taxation. Correct?

Correct