As the world becomes more interconnected, families are embracing the opportunities that come with global mobility, leading more Americans to explore their options overseas.
This trend, which gained momentum when personal travel was restricted during the pandemic, shows no signs of slowing, as adult children and grandchildren venture abroad for education, work and other reasons. The allure of golden visas, tax savings and concerns over geopolitical events are just a few factors driving overseas relocation.
As a result, families with global exposure — in terms of assets, family members and investments — are becoming increasingly common.
But a move abroad can be a more complicated adventure for U.S. citizens compared to noncitizens. The United States is one of only two countries that require its citizens to pay taxes on their worldwide income and assets, regardless of where they actually live. In contrast, most countries tax individuals based primarily on their place of residence, with citizenship being irrelevant.
In effect, this means that U.S. citizens who live outside the country are often subject to tax on the same income or assets in more than one jurisdiction. They are taxed by their country of residence because they are residents and by the U.S. because they are citizens — creating a complex and potentially frustrating situation for those seeking to establish a new life abroad.
Avoiding double taxation
To mitigate the risk of double taxation, the U.S. has entered into treaties with several countries. These treaties are essentially agreements between the U.S. and those other nations on how residents of foreign countries will be taxed. Such treaties often reduce or even exempt certain items of income from taxation in one of the jurisdictions.
In the absence of a treaty, the U.S. may give credit for foreign taxes paid by U.S. citizens on foreign income. As a result, U.S. citizens living abroad typically do not pay taxes twice — but they are subject to the higher tax rate of the two countries. Treaty provisions or internal tax laws — in cases where no treaty exists — dictate the allocation of total tax paid between the two nations.
Notably, treaties and credits for foreign taxes solely impact federal taxes. They do not address state and local taxes or other taxes, like the net investment income tax (NIIT) or annual wealth taxes that some countries impose on their residents.
What’s more, U.S. citizens living abroad must comply with U.S. reporting requirements and adhere to the anti-deferral rules applicable to U,S, taxpayers, wherever they reside. This can pose a challenge for local advisers abroad who handle the management of U.S. taxpayers’ investments, due to unfamiliarity with U.S. regulations.
For example, a U.S. citizen investing in a foreign exchange-traded fund or other foreign fund will be treated as owning a passive foreign investment company (PFIC). Owning a PFIC triggers increased annual reporting obligations and can result in significant adverse, and sometimes punitive, consequences involving U.S. income taxes. As a result, managing investments for U.S. citizens living abroad can be a nuanced process that requires specialized knowledge and expertise.
Yet another potential challenge that U.S. citizens may face involves their estate plans. U.S. estate plans often use trusts to reduce the impact of U.S. transfer taxes. However, trusts are not as widely recognized in many countries, and in some cases, they are not even considered legal entities.
This lack of familiarity may mean that local laws are ill-equipped to handle trusts, leading to distorted or downright adverse tax consequences for the grantor and/or the beneficiaries of these common U.S. estate planning structures. That’s why it’s vital for U.S. citizens moving abroad to ensure that their estate plans are structured appropriately and comply with local laws.
A checklist for global relocators
To illustrate some of the issues that may crop up for Americans relocating abroad, let’s revisit Alex and Yasmin, a U.S. citizen couple currently living in New York — a state with a high income tax. Recall from our previous efforts helping the couple navigate the tax asymmetry in their mixed-citizenship marriage and determine how best to inherit wealth from Yasmin’s father, that the pair own a successful business and have amassed sufficient wealth to live a comfortable lifestyle.
Yasmin’s father, who was not a U.S. citizen, funded a trust for Yasmin’s benefit with a $5 million gift. When he passed away, he also bequeathed an additional $10 million to the trust, naming Yasmin as the sole beneficiary, with the remainder passing to her three children upon Yasmin’s death.
Two of Alex and Yasmin’s now-grown children live abroad. Their eldest daughter lives in Spain with her Spanish citizen husband and their two young children, while their middle son lives and works in the UK. Their youngest daughter is a graduate student in New York.
Since none of their kids is interested in continuing the family business, the couple is entertaining a lucrative offer to sell. Afterward, they are considering retiring and moving to Spain, where they can be closer to their grandchildren, while still spending some time in New York. Retiring to sunny Spain sounds very appealing, though Yasmin and Alex would do well to explore some key issues:
Tax considerations
- Ensure that ties are sufficiently cut so that the state of New York doesn’t tax their income as residents.
- Determine how the Spain-U.S. income tax treaty will affect their worldwide taxation. Could any structures beneficial for property ownership in Spain alleviate their Spanish tax burden?
- Ascertain whether additional taxes are imposed on residents who are not covered by the treaty. For example, Spain imposes annual wealth taxes with differing rates depending on the location of your residence.
- Confirm that U.S. retirement accounts will still be recognized and enjoy the same tax deferral under the treaty.
Investment considerations
- Continue working with their U.S. investment adviser to ensure no investments are made in PFICs.
- Report annually any bank or other financial accounts that Alex and Yasmin open outside the U.S. on their foreign bank account report (FBAR).
- Revisit fixed-income exposure and adjust accordingly if the benefits of investing in tax-exempt bonds (i.e., municipal bonds) disappear.
Estate planning/marital rights considerations
- Obtain local legal advice on forced heirship rules to determine whether Spain is one of the countries that has some heirship rights that supersede taxpayer control. If such rules apply — and are inconsistent with the couple’s testamentary wishes — explore ways to circumvent them if possible.
- Review matrimonial documents, such as pre- and postnuptial arrangements, through the lens of Spain’s laws.
- Determine whether Yasmin, as sole current beneficiary of her trust, will be treated as the “owner” of the trust’s assets for Spanish income tax purposes, now that Yasmin’s father is no longer alive. If so, Yasmin may be subject to Spanish income taxes on trust income (both ordinary and capital gains) even if she has not received any trust distributions. Since the trust is a separate taxpayer from Yasmin in the U.S., this may give rise to some challenges that are not necessarily resolved by the treaty. Yasmin should seek advice from tax counsel on how the trust would be taxed before moving.
- Ask Spanish counsel to review the couple’s U.S. wills to ensure that provisions remain in effect, given Spanish residence.
- Draft a local will, even if not required, to facilitate the disposition of locally owned real estate upon death.
Navigating the complexities of global mobility
As global mobility becomes more prevalent — and more Americans consider relocating abroad — the list of “what to know before you go” becomes more urgent. Double taxation is a real risk, and treaties are only a partial solution. They do not address state and local taxes or other taxes like the net investment income tax or annual wealth taxes. Nor do they ensure trust structures continue to be recognized across borders.
Managing investments and estate planning for U.S. citizens living abroad can be complex, requiring specialized knowledge and expertise. It’s crucial for U.S. citizens who plan to move abroad to weigh all these considerations and seek both local and U.S. advice before fully committing to the dream of overseas living.