The Problem for US Citizens Managing their Self-Managed Super Funds
Published on November 19, 2024
by Nick Wee
Nick Wee, an IRS Enrolled Agent with 17 years of expat tax experience, specializes in US tax preparation, tax planning, and tax advice for US citizens and Green Card holders living and working in Australia.
Table of Contents
US citizens managing self-managed super funds (SMSFs) in Australia face significant challenges because US tax laws treat SMSFs differently from Australian authorities.
Where does the complexity come from for US citizens with SMSFs?
The complexity comes from the differences between US and Australian tax systems.
In Australia, SMSFs are designed to be tax-advantaged structures to help people save for retirement. However, the US Internal Revenue Service (IRS) views a SMSF as a type of foreign trust, which means US citizens have additional reporting requirements and taxes that make managing an SMSF more complicated.
How are retail funds and SMSFs different for US tax purposes?
Retail super funds are usually treated as employee benefits trusts, where employers contribute money for the purpose of retirement. When you roll over funds from a retail fund to an SMSF or set up a new SMSF, it becomes classified as a “grantor trust” by the IRS.
A grantor trust means that if you, as an individual, put money into a trust that you control and benefit from, you need to report everything on your US tax return. This includes the SMSF’s balance sheet, income, and earnings as if you held these investments in your own name.
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Why does the IRS consider an SMSF a grantor trust?
The IRS considers SMSFs grantor trusts because you control the investments, benefit from their growth, and eventually receive the money in retirement.
Since you have direct control over the assets, the IRS wants to tax any income as they are earned, rather than allowing you to defer the tax until retirement, as is possible under Australian rules.
What are the risks of double taxation?
In Australia, earnings within a SMSF, whether from income, capital gains, or other sources, are taxed at rates of 15% or 30%, depending on the owner’s level of income. However, the IRS may also tax these earnings at US rates, which can be as high as 40.8%.
Since the IRS considers SMSF assets to be held directly in your name, you need to report any income, dividends, or capital gains on your US tax return.
For example, if Australia taxes this income at 15% and the US taxes it at 30%, you may have to pay the difference, leading to a higher overall tax burden.
Why don’t Foreign Tax Credits always help with SMSFs?
Foreign Tax Credits (FTCs) are usually used to avoid double taxation, but they don’t always work well for SMSF income.
This is because the IRS places SMSF income into the “l passive earnings basket,” instead of treating it like regular salary or wages. While retail super fund income is treated like employment benefits for foreign tax credit purposes, SMSFs are not, which means you might not be able to use foreign tax credits to fully offset the US tax owed given the lower Australia tax rate applied to SMSF earnings.
What are the penalties for late filing or non-compliance?
If you fail to file the required forms, like Form 3520 or Form 3520-A, you could face automatic penalties of up to US$10,000 per missed form.
On top of that, the IRS can add penalties of up to 5% of the entire value of the SMSF if you don’t provide the right information on time.
Should US expats avoid SMSFs entirely?
It depends on your individual situation.
SMSFs offer a lot of control and investment flexibility, but the complexities of US tax compliance make them risky for many expats. If you have been away from the US for a long time or are an “accidental American” who didn’t realize the tax implications, you may not see these risks until it’s too late.
For most people, sticking with a retail super fund might be easier and safer, as it simplifies tax filing and reduces the risk of penalties. Retail super funds are treated as employee benefits trusts and don’t usually require the complicated filings that SMSFs have.
Are there scenarios where an SMSF might work for a US expat?
There are some scenarios where an SMSF could work for a US expat. If your investments are focused on high capital growth and you are willing to handle the risk of double taxation, an SMSF might make sense or if you have significant passive foreign tax credits.
Additionally, if you’re considering renouncing your US citizenship, managing a SMSF may become simpler after renunciation, as you would no longer be subject to US tax laws.
If the SMSF investments are straightforward and you have a flexible plan, you might be able to navigate the complexities with the help of a good tax advisor. However, for most people, the compliance requirements are too burdensome and the risks are too high to justify the benefits of an SMSF.
What is the best approach if you are considering an SMSF?
If you’re a US citizen or green card holder thinking about an SMSF, getting professional tax advice is crucial.
A tax advisor who understands both US and Australian tax laws can help you identify potential issues and determine if an SMSF is right for your financial situation. Careful planning can help you avoid unexpected penalties and tax burdens.
For most US expats, taking a cautious approach—like sticking to retail super funds or getting professional advice upfront—is the safest way to manage retirement savings while minimizing the risk of double taxation and IRS penalties.
