As promised last week and on January 28th to the attendees of the Financial Fitness for the New Year Webinar, we are going to provide written answers to the questions we were unable to cover in enough detail after the event. We will answer 10 of those questions in this post.
These questions are very heavily Swiss resident oriented, so they may not be relevant to every reader of the Blog. Having said this, many of the considerations are applicable to Americans with foreign income and assets irrespective of their country of residency.
Are you ready? Here we go:
1. Do 1st and 2nd Pillar retirement pension income qualify for the earned income deduction?
I believe the question being asked here is whether income from Swiss AHV/AVS and Pillar 2 distributions are eligible for the Foreign Earned Income Exclusion or FEIE. The FEIE is a US tax provision that allows a certain amount of earned income, $107,600 in 2020, to be excluded from US taxation if certain conditions are met. The operative word here is EARNED. Pension income, whether from AHV/AVS or Pillar 2, is considered unearned income, and is therefore NOT eligible for the FEIE. Most US expats rely on the FEIE to avoid double taxation, so we will cover the FEIE in detail in our next issue of CBP.
2. How is this income tax otherwise?
AVS/AHV income is fully US taxable. Pillar 2 distributions are US taxable to the extent that the distribution received exceeds “cost basis”.
What is cost basis? The portion of the distribution that was already taxed. Since contributions to Pillar 2s are not deductible for US tax purposes, when a Pillar 2 beneficiary receives a Pillar 2 payment, a portion of that payment is a return of the contributions made into the Pillar 2 while the beneficiary was working. That return of contributions made with after-tax US income is the recipient’s “cost basis” and it is not taxable for US tax purposes.
US tax rules allow a foreign tax credit for the income tax paid in Switzerland on Pillar 1 and 2 distributions received by a Swiss resident that are also taxed in the USA, thus reducing the risk of double taxation. Foreign tax credits can reduce US tax on income already taxed by Switzerland dollar for dollar. Foreign tax credits are also an important tax provision that mitigates the risk of double taxation and is used by many expats, so we will cover in the CBP issue that follows the one about the FEIE.
3. How is Inherited IRA income taxed by the USA and Switzerland?
In the USA, inherited IRA distributions are considered income in respect of a decedent and are taxable to the extent that they exceed the decedent’s cost basis in the original IRA. If the inherited IRA is a Roth IRA, the distributions are usually US tax free. If the inherited IRA was a traditional, rollover, SIMPLE or SEP IRA, unless you have proof that some of the contributions were made by the decedent with after tax dollars, the distributions are generally fully taxable.
The Swiss tax treatment is a little less clear because Swiss tax laws, as you might imagine, do not specifically address inherited IRAs. Each canton, and even sometimes, each cantonal tax office, may take different positions as to how a foreign asset or stream of income should be taxed, and this includes inherited IRA distributions. Since this question can have different answers depending on where you live in Switzerland, my recommendation is to check with your local tax office or with a Swiss tax advisor familiar with your local tax office’s position on the issue.
4. What are the prospects for Residency Based Taxation implementation in the next five years?
The US has always taxed its citizens even when they live outside the country. This causes all kinds of headaches and issues for Americans living overseas. Residency based taxation would solve most of these issues by taxing US citizens only if they live in the USA, as is the norm with almost every other country. US expat advocacy groups continue to advocate for tax reform in this area. I do not believe it is possible to predict what will happen politically from one day to the next, let alone in the next five years, so unfortunately, I cannot make any predictions with regards of the odds of residency-based taxation. It’s difficult to get the attention of Congress about this issue, unfortunately. If you are interested in this issue, the American Expat Financial News Journal is an online publication that is updated daily and is a good source of information about the progress made by these different advocacy organizations working to get RBT through Congress. You can also through it about the different ways in which you can contribute to these efforts.
5. Using Revolut to transfer funds to children studying abroad, are there tax implications?
Revolut is a FinTech company and a Revolut account is considered a foreign financial account subject to reporting on Form FinCEN 114, aka FBAR, and on Form 8938 if the reporting thresholds are met. To the extent that the account has a balance on December 31st, it could also constitute an account subject to Swiss wealth or fortune tax.
Additionally, transfers of cash to adult children are considered gifts or donations both from a US and Swiss perspective. Typically, Switzerland does not tax gifts made from parents to their children, but these gifts have reporting requirements that vary from canton to canton. For US purposes, gifts that exceed $15,000 in total value per child per year are reportable on Form 709 and could potentially be taxable unless they meet a gift tax exemption. For example, medical and educational expenses paid on behalf of children directly to the educational institution or medical provider are gift tax exempt.
So pay attention to the Revolut account balances and to the amounts you gift to your children to ensure that you are complying with both US and Swiss reporting requirements.
6. How is retirement income handled?
This question does not have enough specificity to answer properly. The answer depends on the type of retirement income, the status of the recipient (US citizen or not, living in the USA or abroad), the tax treaty clauses that may apply, the country, canton or province of residency, the cost basis that the recipient may have on the income, the right to foreign tax credits on that income, etc.
One thing that is common irrespective of the type of the details of the retirement income is that the FEIE, as explained above, is not available for retirement income, and that US taxpayers must rely on foreign tax credits to offset double taxation if the income was taxed by a foreign country in addition to being taxed by the USA.
7. How can a US expat invest in US based index funds?
There are several US financial institutions that currently allow US citizens living in Switzerland to open investment accounts and invest in US based ETFs. US mutual funds are typically restricted and/or unavailable to Americans overseas. Many of these US brokers have mobile apps that work in Switzerland and other foreign countries, in addition to their traditional online platforms.
Since the firms available to residents of different countries change regularly based on local regulatory updates and business decisions made by the institutions themselves, a good approach is to reach out to the largest US independent custodians either by phone or email, or online through their websites, to inquire about the possibility and process for opening an account from Switzerland, Portugal or a different country.
8. USD depreciation against the CHF, what are the implications for CHF denominated mortgage holders?
This is an excellent question and answering thoroughly would require its own newsletter issue. Instead, what I am going to do is share a really good but still valid oldie post from my colleague Phil Hodgen, who very simply and clearly explains in his blog, the foreign exchange rate exposure for Americans with foreign mortgages. If you enjoy reading about international tax, you will absolutely love Phil Hodgen’s blog. Feel free to peruse through the different entries. The post about foreign mortgage F/X tax exposure is found here.
9. Are HSA contributions permissible with Swiss health insurance plans?
HSAs, or Health Savings Accounts, are types of US accounts that allow tax advantaged contributions (and investment growth) to save for future health care costs. Distributions from HSAs to pay for qualified health care expenses are not taxable for US tax purposes.
Whether contributions to an HSA are permitted while being a participant on a Swiss health insurance plan or any foreign health insurance plan, depends on whether the specific plan meets the requirement of a high deductible HSA eligible plan in the USA. One way to find out is by asking an attorney to review your policy’s provisions and check if they meet the US requirements. Potentially, an alternative option would be to ask the financial institution that holds your HSA account if you are eligible for making contributions. I do not believe it is possible to open an HSA account from overseas, but if you have experience to the contrary, please let us know!
10. Are employee and employer contributions to Swiss pension plans taxable under the US tax code? Are the gains taxable?
In the same manner that Swiss tax laws do not address the taxation of US retirement accounts, the US tax code does not address the taxation of Swiss pensions plans either. The rules that apply are inferred from US tax provisions aimed at the taxation of various US pension and deferred compensation plans.
The general consensus is that Swiss Pillar 2 generally meet the requirements to be treated as the equivalent of US non-qualified employees trusts, which typically means that contributions, by the employee and the employer, are taxable in the year made, and that the growth in the account is taxable annually if the plan is not discriminatory and the participant is a highly compensated employee.
US citizens need to be careful when making buy-in or buy-back contributions and when rolling over the capital balance in a Pillar 2 account to a Vested Benefits Account, as both events can trigger the loss of the “employees’ trust” character of the account, causing it to become taxable as a foreign grantor trust instead. Foreign grantor trusts are subject to more complex reporting requirements and can be taxed punitively if the account is invested in Swiss funds.
This is all for this issue. We’ll be back in a couple of weeks to discuss the foreign earned income exclusion and later in March to discuss foreign tax credits.
Don’t forget to share this post with your friends and to shoot us an email if you have questions that you believe can also be of interest to other US expats or immigrants, for us to address in future issues of the Blog.
Be safe and stay healthy.
With much love, un abrazo y buena onda,
Marina