Tax on foreign income

86 posts in this topic

On 4/28/2019, 1:18:49, Straightpoop said:

@PandaMunich  @NikoNiko

 

Perhaps I can clarify the confusion about US income tax reporting to holders of US mutual funds.

 

Whether or not passively (e.g. ETF) or actively managed, the vast majority of such funds qualify as "Regulated Investment Companies".  This is an important qualification because otherwise the fund would be subject to US taxation at the corporate level and if/when "distributions" were made to shareholders such distributions would be taxed again to the individual shareholders.

 

"RIC" status allows the fund to escape taxation at the corporate/fund level and "pass through" its earnings to its shareholders.

 

However, in order to qualify for this "pass-through" treatment a US mutual fund must distribute (Ausschütten) at least 90% of its income annually.  "Income" includes net gains and losses realized from the sale of securities held inside the fund.

 

This is the main reason why foreign mutual funds that have not qualified as RICs are given such unfavorable tax treatment in the US. Most countries do not have the requirement to distribute 90% of income, i.e. they allow "Thesaurierung" or internal reinvestment of income.  Germany's recent reform of fund taxation is designed to place some limits on the tax deferral opportunities offered by such "Thesaurierende Fonds".  

 

Since the income realized inside a US RIC is "passed through" in the distribution to shareholders, that income retains its "character" in the hands of the shareholder recipient.  This is very important to the US shareholder because that distribution can be taxed very differently depending on the "character" of its components.

 

Consequently, when a shareholder receives a distribution during the year, the fund will issue a 1099-DIV in which the distribution is broken down into the various character components, e.g. ordinary dividends, qualified dividends, net short-term gains (included in "ordinary dividends"), long-term "capital gains" (AKA as "capital gain distributions"). Additional information on the 1099-DIV will include such exotica as "unrecaptured section1250 gain", Section 1202 gain, 28% gains (from sale of "collectibles"), foreign taxes paid, cash and non-cash liquidation distributions (i.e. non-taxable return of capital), etc.

 

 

How all this gets reported on the German return is not always clear.

 

The brutally simple approach is to treat the entire value of the US fund "distribution" as a foreign Kapitalertrag that was not subjected to 25% Abgeltungssteuer withholding.  In most cases that will produce the correct result.  However, what if the fund distribution includes a non-taxable "return of capital"?  Return of capital (e.g. this year's distribution from Deutsche Telekom) is not taxable but - just like in the US - results in a reduction of the shareholder's cost basis for determining gain/loss on a future sale.

 

And what about the foreign tax credit for US taxes paid on that distribution?

 

And the foreign (i.e. non US) taxes reportedly withheld on that distribution?

 

The credit (up to 15% by treaty) is allowed only on US source "dividends" ACTUALLY PAID.  Is the interest component of the RIC distribution (e.g. from a bond fund) a "dividend" or "interest" for purposes of computing the German foreign tax credit?  Is any amount of US taxes actually paid on the "capital gain" or "interest" portion of the distribution eligible for the German foreign tax credit? Under the treaty Germany has the exclusive right to tax interest and gains so there should be no German foreign tax credit allowable for this portion - but only if you are required to break out the various components of the US RIC distribution on the German tax return. And what about the non-US foreign taxes withheld on the foreign dividends your US "international fund" paid you?

 

Are you required to break all this out on your German return?  Can you do so voluntarily? I just don't know.

 

And then there is the problem of proving to the Finanzamt exactly how much US taxes you really ACTUALLY paid on the dividend portion of those distributions.  Assuming you ACTUALLY PAID anything this proof will involve sharing the worksheet for your US return entitled "Qualified Dividends and Capital Gains Worksheet".

 

Nasty, huh?

 

PS

 

Fund distributions (US and foreign) that are "automatically reinvested" by using the distribution to purchase additional fund shares must not be confused with internal fund income that is reinvested within the fund (i.e. thesauriert). I cannot tell you how often I have had to explain to US fund shareholders that just because they automatically reinvested their distributions does not mean they had no taxable income.

 

 

 

Thank you so much for your comprehensive answer, @Straightpoop. It is starting to make more sense to me, though of course there are still some things I don't fully get. And maybe no one understands! For my situation, I think a lot of those exceptions about foreign taxes and other distributions either don't affect me at all or play a very small role (for example, my foreign tax paid amounts are very small, like 40 euros total) so don't want to go any further into that and at this point just don't have the energy to invest more time into it.

 

My plan:

The "Total Ordinary Dividends" go on line 4 of KAP-INV. I looked up the exact date of when the dividends were distributed and will use the monthly exchange rates to convert the USD to Euros. I will ignore the foreign tax paid even though there might be some chance it makes my tax liability lower. This was relatively easy to do.

The "Total Capital Gains Distributions" will be treated like I actually sold something and received the profits. That means I will put the total amount in lines 9 and 38. Since the mutual funds were bought before 2009, I will also put the amount in lines 10 and 39. To convert from USD to Euros, I'm once again using the monthly exchange rates. I am running into an issue now while using the program ElsterFormular. It keeps asking me to fill out lines 31 to 37 for each individual fund in order to calculate line 38. The distributions aren't exactly coming from selling shares in the mutual funds so those lines don't make sense for my situations. I have all the calculations and fund information in a spreadsheet I can attach and would prefer to do that. Maybe I just have to do it on paper instead so I can ignore those lines for my calculation, or another program allows me to do it differently.

 

Past years:

Also, how did this work differently in the past? 

My understanding is:
The dividend rules have been this way for a while.
For mutual funds purchased after 2009, capital gains had to be reported and 25 percent tax paid on them when they were sold. But starting in some year, the gains from every year have to be reported. Is 2018 the first year this is the case or also in 2017?

For mutual funds purchased before 2009, no taxes on capital gains had to be paid. But did the sale still have to be reported? Then starting this year (or was it 2017?), the gains have to be reported every year. But for these, you get the first 100,000 euros of income without tax. Where do you put this calculation to show that the amount is still below 100,000?


 

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On 4.5.2019, 14:17:48, NikoNiko said:

My plan:

The "Total Ordinary Dividends" go on line 4 of KAP-INV. I looked up the exact date of when the dividends were distributed and will use the monthly exchange rates to convert the USD to Euros. I will ignore the foreign tax paid even though there might be some chance it makes my tax liability lower. This was relatively easy to do.

The "Total Capital Gains Distributions" will be treated like I actually sold something and received the profits. That means I will put the total amount in lines 9 and 38. Since the mutual funds were bought before 2009, I will also put the amount in lines 10 and 39. To convert from USD to Euros, I'm once again using the monthly exchange rates. I am running into an issue now while using the program ElsterFormular. It keeps asking me to fill out lines 31 to 37 for each individual fund in order to calculate line 38. The distributions aren't exactly coming from selling shares in the mutual funds so those lines don't make sense for my situations. I have all the calculations and fund information in a spreadsheet I can attach and would prefer to do that. Maybe I just have to do it on paper instead so I can ignore those lines for my calculation, or another program allows me to do it differently.

 

@NikoNiko

 

After reading your "plan" it is not clear to me that you have fully grasped the difference between a "capital gain distribution" of profits realized from within and distributed by a fund and a capital gain realized on the sale of the fund shares themselves.

 

That is the reason you are having such difficulty figuring the instructions for Lines 31-37.  They apply only to sellers of fund shares.  You did not sell any fund shares yet under your "plan" you insist on breaking out the "capital gain" portion of your distribution and entering it on Line 9 where it is not supposed to go. Line 9 (and subsequent detailing in lines 31-37) is reserved for the reporting of the sale of fund shares.

 

To uncomplicate your life and your German tax return just follow the instructions and - after converting to EUR - put 100% of the amounts distributed to you from your fund - INCLUDING the "capital gain" portion - as reported on the 1099-DIV on the line in KAP-INV that is intended for it to go:  Line 4 (for a stock fund).

 

As far as those foreign taxes you paid are concerned you can forget about reporting them on your German return. Note that KAP-INV has no line to report any such creditable foreign taxes withheld on your fund distribution.  Reason:  beginning 1.1.2018 they are no longer creditable if withheld on a FUND distribution.  Punkt. Ende. Full Stop. or in plain New York English:  Fuggedaboudit.

 

Summary:

 

Stick the EURO value of 100% of the value of 100% of your US stock fund distribution on Line 4 Anlage KAP-INV

 

Now you're done. 

 

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On 1.5.2019, 10:40:05, Hulie said:

 

@Straightpoop the income code in block 1 is 01; 3a exemption code 05, there is nothing in 7a. The only thing I have there is gross income in block 2. I am planning to ignore it this year then. In any case the income is less than 850eur. Thank you very much for your help!

 

@Hulie

 

The reporting on Form 1042-S appears to be inconsistent with what one would expect for T-Bill ownership.

The 01 income code is "interest", i.e. an amount actually paid and credited - not an allocable amount of Original Issue Discount.  If you did not actually receive any such interest then this characterization of income code is incorrect.

 

The 05 exemption code is the "portfolio interest exemption under IRC".  This means that your interest is exempt from US taxation under domestic US tax law, i.e. you don't need to claim the benefits of a tax treaty to obtain exemption.

 

If, as you say, the amount (together with any other Kapitalerträge) adds up to less than your German annual Freibetrag of €801 then you should have no problems:  just ignore the whole thing.

 

However . . . .

 

The brokerage or whoever the withholding agent is may not be competent in correctly meeting its information reporting requirements (not an unusual circumstance, by the way).

 

This is a case of "no harm, no foul" but be advised: theoretically speaking, the amounts shown on Form 1042-S are made accessible by the IRS to the German government or the government of whichever country you gave as your country of residence on Form W-8BEN.  Some day - perhaps years from now - the FA may ultimately learn of the "interest" reported on this form in the year 2018 and may ask you to explain yourself.

 

So . . .

 

If you find time weighing heavily on your hands, you may want to write your broker/withholding agent and ask for an explanation of what appears to have been an incorrectly prepared Form 1042-S.

 

On the other hand, if you have a life . . . .

 

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I am a bit confused about which form to use to declare my foreign income. I worked in Sweden for 3 months last year, before moving to Germany. I thought I was supposed to declare my swedish salaries using form N-AUS, but that does not seem to be the case, according to what I read here. Any clues where I can declare that?

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Thanks! You're a life saver! I was trying to find this information online for several days now...

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