FBAR, PFIC and Other Four-Letter Tax Words U.S. Expats Should Know

Life as an expat in Hong Kong has all sorts of “get out of jail free” benefits – especially when it comes to family obligations.  But there is one family member American expats can’t avoid: Uncle Sam.  If you’re new to filing taxes abroad, here is a list of some four-letter terms and associated tips you should know.

FEIE:  The U.S. is one of two countries in the world[1] that taxes its citizens (or other “connected persons”) on their worldwide income, regardless of where they reside.  News to you? Rather than hurl expletives, get familiar with this four-letter word: FEIE, which stands for Foreign Earned Income Exclusion.  For the 2018 tax year, you can exclude up to USD103,900 of earned income from U.S. tax, subject to certain restrictions.  The FEIE for the 2019 tax year is USD105,900.  In addition, U.S. expats residing in Hong Kong can exclude certain housing costs (notably rent) up to a maximum of USD114,300 (again, subject to certain restrictions).

In order to qualify for the FEIE, you must have been out of the U.S. for a total of 330 days over a 12-month period or deemed a “bona fide resident” of a foreign country.  Don’t fret if you don’t satisfy either requirement, as partial exclusions may be possible.

Additional exclusions: If the FEIE and housing-related deductions don’t fully offset your U.S. taxable income, you may be able to use the income taxes you pay in Hong Kong as an itemized deduction or a foreign tax credit when filing your U.S. taxes.  Make sure to explore what option would be best for you with your tax advisor.

FBAR: FBAR refers to Reports of Foreign Bank and Financial Accounts. An FBAR must be filed if the total amount of your financial interests in or signature authority over financial accounts maintained outside the U.S.  exceed USD10,000 at any point during the tax year and regardless of whether any of the accounts produce any income.  Failure to report in any applicable year can incur some pretty hefty penalties or even jail.  Still not convinced?  Google it.

The filing deadline for FBAR is April 15 (although it can be extended in certain cases) and can be done electronically here: https://bsaefiling.fincen.treas.gov/main.html

Shameless Plug #1: At MASECO Asia, our clients’ assets are domiciled in the U.S., and are therefore not subject to FBAR filing.  This can help reduce the reporting burden during tax time.

PFIC:  I leave you with one more four-letter tax word: Passive-Foreign-Investment-Company (PFIC).  PFICs encompass pooled investments (e.g., mutual funds, ETFs, hedge funds, insurance products) domiciled outside the U.S.  Why care?  Well, Uncle Sam really cares. In his effort to disincentivize investing offshore, PFICs are subject to some rather punitive tax rates.

Take for example a mutual fund that invests in European stocks but is domiciled in the U.S.  Long-term capital gains from this product are taxed at 0%, 15%, or 20%, depending on your tax bracket and filing status.  Now suppose that same European stock mutual fund is instead domiciled in Hong Kong.  Those same capital gains would be taxed at the highest current federal tax rate of 37%.  The PFIC story gets even uglier when considering the taxation of distributions and compounded interest charges on deferred gains.  The good news is that there are several different accounting treatment options (and hence taxation outcomes) for PFICs.

Shameless Plug #2:  MASECO Asia investment portfolios are PFIC-free, lending to a more tax-efficient wealth solution versus for U.S. expats versus other providers.

Need more advice?  Although we are not expert tax advisors, we are expert tax advisor referrers!  Please don’t hesitate to contact us for direction.

[1] Fun fact: the other country is Eritrea, located in East Africa.

The Government Shutdown: There’s more at stake than just a wall

When the President of the United States opted not to sign into law a bipartisan bill to fund several government agencies (a bill which was overwhelmingly supported in both the House of Representatives and the Senate), the US Government entered a partial shutdown at midnight on the 22nd of December.    A government shutdown isn’t a unique event anymore.  Shutdowns go all the way back to President Carter, and the only period in which there wasn’t a shutdown was during the George W Bush Administration. Now in its third week, the current shutdown is the longest in US history.

What is the real impact of a shutdown from an economic perspective?

Let’s start with the actual employees that are impacted by the shutdown. The current shutdown impacts roughly 800,000 federal employees comprised of nine federal departments:

  1. Department of Treasury
  2. Department of Agriculture
  3. Homeland Security Department
  4. Department of the Interior
  5. Department of State
  6. Department of Housing and Urban Development
  7. Department of Transportation
  8. Department of Commerce
  9. Department of Justice

Many of these employees, such as the Transportation Security Administration, will have to work without pay. These are the individuals that help protect the US and travellers to the US at airports around the country.  So how does this impact them?  According to Northwestern Mutual’s 2017 Planning and Progress Study[1], roughly 70% of US workers  live pay check-to-pay check.  This statistic inevitably includes a (significant) portion of the TSA workers.  Credit card bills, mortgages, utilities, rents, etc. are likely to become delinquent due to the cash flow constraints of these workers.  And these are just some of the knock-on effects.  In some states, the federal government is the major employer.  In cases such, there is a further erosion of the supporting community, such as restaurants, shops and banks, as patronage will be lower due to the federal workers having limited resources to put back into local commerce.

There are also more macro-related issues surrounding shutdowns. In the US, for instance, interest rates have been rising due primarily to the strong economy and the increasing level of inflation.  This has already made borrowing money more expensive with regard to mortgage repayments (those that have a variability aspect to them), consumer debt, auto leasing, etc.  The shutdown exacerbates the situation by making the economy more unstable.  The US hasn’t been in a recession since June 2009, which marked the end of the Great Recession or better known as the Global Financial Crisis.  Shocks to the economic system such as a government shutdown could be a catalyst for propelling the US into a correction or recession. We saw some of these fears play out in the US stock market in late December/early January.

Credit concerns are another aspect to the government shutdown. According to Standard & Poor’s, the US credit rating stands at AA+.  Both Moody’s and Fitch have the US at Aaa and AAA respectively.  A protracted shutdown could lead to a downgrade of that rating.  If that happens, interest rates will rise, bond debt will worsen, and the dollar could potentially see a real weakening against the global market basket of currencies.  This would result in a higher cost for imports.

Investing globally will help soften the blow of any negative impacts from the government shutdown. But, as the old adage goes “When General Motors sneezes, the stock market catches a cold.”  Now simply replace General Motors with the United States and the stock market with the global economy, and you have a recipe that isn’t very appealing.

[1] https://news.northwesternmutual.com/planning-and-progress-2017

Demystifying Social Security

Social Security benefits form a bedrock of retirement income for tens of millions of Americans. And yet, many would agree that the program is mired with unnecessary complexity which makes claiming benefits confusing.  My intent is to use this blog post to help demystify some of the confusing elements of the Social Security retirement benefit.

First, a bit of background and historical context. The Old Age, Survivors, and Disability Insurance (OASDI) program, better known as Social Security, was enacted by Congress in 1935 to help Americans suffering in the wake of the Great Depression. Originally intended as a retirement income program, Social Security expanded over time to include disability benefits and family/survivor benefits in the event of premature death.  Social Security is designed as a pay-as-you-go program which means that the benefits of current retirees are funded by the current contributions of today’s workforce through FICA and self-employment taxes.  As long as an individual accrues 40 credits (done over 10 years in most cases) of eligible employment, they have an entitlement to Social Security income (SSI) benefits.

To determine an individual’s benefit entitlement, the highest 35 years of earnings are averaged (and adjusted for inflation) to arrive at the primary insurance amount (PIA). The PIA is the benefit an individual will receive at their normal retirement age (i.e., 66 or 67, depending on your year of birth). An individual can elect to begin Social Security benefits as early as age 62 or as late as age 70.  The PIA is adjusted up or down depending on when benefits commence.  For individuals or couples with sufficient assets or other pensions, it is often advantageous to delay drawing on Social Security until age 70 because for each year you wait, the benefit increases by approximately 8%.  This is essentially an 8% return backed by the US government.  A strategy involving delaying the onset of Social Security will likely necessity earlier distributions from other retirement assets, but with proper planning, this can be easily managed.

Even if you never worked outside the home, if you are married you may still have an entitlement to a spousal benefit. If both spouses have their own work history, the lower-earning spouse has the option to claim based on his/her own earnings history or take the spousal benefit from the partner, if higher.  However, the timing of making a claim can impact the total benefit payment and the amount of the benefit subject to tax.  In 2018, if a married couple has more than $44,000 in provisional income[1], they will pay tax on 85% of their SSI benefit.  Moreover, if you or your spouse have earnings from a pension a job that wasn’t covered by Social Security (e.g., a state pension from work abroad), you may be affected by the Windfall Elimination Provision (WEP) or the Government Pension Offset (GPO).  These are more nuanced topics that may require the assistance of your accountant.

A key challenge facing Social Security is an aging population. Americans are living longer, meaning they will be drawing on their benefits for a greater number of years.  At age 65, the average man can expect to live another 19 years, while the average woman can expect to live another 22 years[2]. Despite this fact and the incentive of an increased benefit associated with deferring to claim until a later age, approximately 40% of retirees claim their benefit at age 62 or shortly thereafter, resulting in a permanently reduced benefit[3].  We have a tendency to underestimate our life expectancy, but a real crisis could emerge if you outlive your life expectancy and prematurely deplete your assets.  If you begin drawing at 62, the benefit can be reduced by as much as 25% from your PIA or full-retirement benefit.  This is significant for a few reasons:

  1. If your spouse is claiming a benefit based on your benefit (as opposed to his or her own work history), the spousal benefit will also be reduced.
  2. You will have to supplement to a larger degree with other assets to fill the gap in your retirement income, likely resulting in greater depletion of your total wealth over time
  3. If you are still working at age 62, you may be subject to a further benefit reduction due if you breach the annual earnings limit (currently approx. $17,000 in 2018).
  4. Taxes can be imposed on as much as 85% of your Social Security benefit resulting in the need to further subsidize with other assets.

The decision of when to start Social Security requires a thorough break-even analysis of one’s retirement cash flow, including a consideration for longevity, taxes, inflation, and an assumed rate of return on investment assets. If an individual lives into her mid-80s, she is generally better off delaying the commencement of benefits. The above factors considered, there are often strong reasons to elect to claim early benefits, especially if cash flow is a concern immediately upon retiring.  Some argue that Social Security’s solvency or legislative changes could affect future benefits.  This is a valid concern but given how many Americans are reliant upon Social Security income, it is unlikely to see the program materially depleted as it would be very unpopular politically.  It is probable that we will see a restructuring of benefit calculations in order to deal with the growing population of retirees.

To learn more about SSI, visit www.ssa.gov or talk directly with your financial advisor.


[1] https://www.ssa.gov/planners/taxes.html

[2] “Calculators: Life Expectancy,” Social Security (2017), https://www.ssa.gov/planners/lifeexpectancy.html.

[3] “Social Security in the New Retirement,” Financial Engines, January 2016.

What’s Going on in Emerging Markets?

After 2017, a year in which emerging markets gained more than 35%, investors are very concerned about the performance in 2018. Year-to-date, emerging markets are down nearly 8%.  If valuations in the space are at multi-decade lows, what can explain this seeming discrepancy?  It turns out there are several factors contributing to weak performance so far this year.  First, although it is easy to assume it has little effect, the US dollar has strengthened significantly in 2018.  In local EM currency terms, the dollar has rallied nearly 10% in some instances (compared to 4% in dollar terms)[1].  Some of these countries (e.g., Turkey, Argentina, and others) are actually seeing bear market territory for their securities in US dollar terms.  Emerging markets tend to underperform historically when the US dollar gains strength.

The next factor is the move towards protectionist policies on an international scale, and in particular, by the US. Further exacerbating the situation, Trump, has instituted a non-systematic trade war with multiple countries, some of which are emerging market economies.  As an example, Trump has targeted Turkey which is a key EM economy and is intricately connected to many other emerging market economies in the vicinity.  The threat of tariffs has had a detrimental impact on EM economies that sell to the US (i.e., EM exports will decrease causing an increase in unemployment in these countries).

A third factor is the rebound in commodities, particularly oil. If you look at current oil prices (Brent, WTI) compared to last year over the same time, oil has moved nearly 50% higher.  This has a more negative impact on emerging markets because it makes manufacturing costs higher.

Although the above points paint a not-so-rosy outlook on emerging markets as an asset class, many emerging market economies have improved their current account deficits and strengthened their overall financial position. It is also important to view EM in a worldwide context.  From a CAPE (cyclically adjusted price earnings) perspective, emerging market countries are poised to outpace the rest of the world over the next 10 to 15 years.  The United States has had its longest bull market in history, and prices haven’t yet receded.  The last recession in the US ended in June 2009.  This means the US is on its nearly 37th quarter (111th month) without a recession.  With the average economic cycle lasting between 5 – 7 years, the US is poised not only for a recession, but its equity market has and continues to be highly, if not, fully valued with a CAPE near 40%.

From a long-term investment view, attempting to call the top of the US market (or the low of emerging markets, for that matter) is a fool’s errand, likely amounting to nothing more than a blip over the long haul. As history and academia teach us, it’s very important to never attempt to time markets; it is a losing proposition. Where we are in the current business cycle is no different.  Emerging markets remain an important part of a global asset allocation strategy, but investors must expect higher than average volatility in this asset class since it is less stable than other developed markets.

[1] http://www.morningstar.co.uk/uk/news/170562/2018-a-very-tough-year-for-emerging-markets.aspx/


Junk Boating and Investing

Ahh, Hong Kong summer…hot, sweaty and gross, just the way we hate it. But at least we can all find refuge on a junk boat. Well, sort of. There are many factors that contribute to your experience at sea on one of these 6-hour(!) outings. Some factors you can control (e.g., who you invite, how much you drink), some you try to control (who other people invite, how much your spouse drinks), and some you can’t possibly control – notably the weather. It’s how you handle the uncontrollable factors that makes all the difference. Case in point: my most recent junk boat trip one rainy, rocky, T1 Saturday in July.

As a co-host of the junk boat, I wanted everyone to have a fabulous time, despite the Gilligan’s Island/S.S. Minnow conditions. But what I observed – in my cheap prosecco haze – is that it really wasn’t the weather that mattered. It was an individual’s attitude towards the weather that was make-or-break…much like an investor’s reaction to a bout of market volatility. Two archetypes unfolded:

1) The Panic Seller: Riddled with nausea, this guest wants off the boat NOW. He/she is fixated on the waves and is antisocial at best. As far as he/she is concerned, it is a day lost at sea.

2) The Big Picture Thinker: This more seasoned junk boater knows the key to avoiding motion sickness is to focus his/her gaze on the horizon. 15-foot waves? Pff – this too shall pass.

And so it did. By the afternoon, the floaties were floating and the free flow was flowing. Even the Panic Sellers found something to talk about other than the shortcomings of the Hong Kong Observatory.

As investors, we should all aspire to be Big Picture Thinkers. When markets are choppy, it’s my job as a wealth manager to convince you to stay invested and avoid selling at the wrong time. This means shifting your gaze from daily market fluctuations (waves) to a much longer-term perspective (horizon).

Take the performance of the global equity market since January 2000 for example¹ . If you focus solely on the monthly fluctuations (waves), you would be hard-pressed to stay invested during the rough times, as seen in the chart on the top.

The other (better) way, is to focus on how much your wealth can grow if you stay invested, as shown in the ‘horizon’ chart on the bottom. Ten thousand dollars invested in global equities since January 2000 would have more than doubled by the end of July 2018. Better yet, if you stick with this discipline, you will have a guaranteed source of bragging rights for many junk boat seasons to come!


The Waves

The Horizon


¹ MSCI All Country World Index (USD, net div). Source: Dimensional Fund Advisors.

Simplifying US Tax Payments

Make Paying Your US Taxes Easier

It’s no secret that being a US taxpayer is onerous, especially for those living abroad. Preparing returns, filing supplemental schedules, and completing FBARs is tedious and complicated.  For many overseas taxpayers, the headache doesn’t end when the return is submitted. The “simple” exercise of remitting US tax payments can be challenging.  Often, this involves converting foreign currency, wiring funds to a US account, and/or posting checks from overseas (and hoping they aren’t lost in the mail).

Electronic Federal Tax Payment System®

The Electronic Federal Tax Payment System® (EFTPS) tax payment service is provided free by the U.S. Department of the Treasury. It enables US taxpayers to pay their federal taxes online, and this includes estimated payments. Businesses can also enroll for the service. The user completes an enrollment process and links their EFTPS account to a US bank account. Once enrolled, the user can access the site to make one-off payments, schedule estimates, and view payment history.

By using this service, taxpayers can reduce the risk of lost or mismatched payments and confirm when their payment has settled. For those who find there is nothing easy about US taxes, this just might make your life a little easier!

If you are a US taxpayer who has struggled with the logistical challenges of paying taxes while overseas, visit https://www.eftps.gov/eftps/ to enroll.

ETFs May Not Be What You Bargained For

In a prior blog post, I discussed the performance hurdle that fund costs impose for actively managed strategies, making the case for lower cost solutions. Was this a plug for pure ETF portfolios? Hardly. Yes, ETFs have low direct costs, but there are notable caveats and indirect costs associated with ETF investing.

Pick an ETF, any ETF? The popularity of ETFs was borne out of investor demand for a simple, low-cost way to gain broad exposure to a chosen asset class. But the investor experience can vary widely within seemingly similar ETFs, with a key differentiator being the underlying indexes that the ETFs attempt to track. Suppose an investor has to choose between two US small cap growth ETFs, one that tracks the MSCI US Small Cap Growth Index and the other that tracks the Russell 2000 Growth Index. Despite its apparent randomness, this choice may offer significantly different outcomes, especially over the longer term. Over the 25-year period ending March 2018, the MSCI US Small Cap Growth Index returned an annualized 10.5%, while the Russell 2000 Growth Index returned an annualized 8.1%. The disparity likely stems from differences in index inclusion criteria and how and when indexes are rebalanced (more on this below).

My Money’s on the Women

The recent Time’s Up and #MeToo movements have given me reason to reflect on the role of gender in the financial industry. When it comes to investing, common stereotypes plague women. For example, we’re too conservative or don’t understand enough about investments. We don’t save enough. We start too late. We lack confidence. I often (though not universally) see this in my own interactions with clients, especially married couples. Wives tend to defer to their husbands when it comes to making investment decisions and trust in the husband’s experience and decision-making. This is not a judgment, just an observation.

Is There Still Value in Pursuing Value?

The year 2017 tested the patience of US value investors. While US value stocks returned a decent 13.66% (as measured by the Russell 1000 Value index), they were overshadowed by the phenomenal 30.21% return of US growth stocks (as measured by the Russell 1000 Growth index) – an underperformance of 16.55%. This negative value premium marked the fifth worst year since 1979 and pulled the five-year rolling premium into negative territory. Ouch.

The pain for US value investors has persisted into 2018, with US value stocks underperforming US growth stocks by 6.01% 1. Despite this seemingly relentless underperformance, we believe there is still value in pursuing value for the long-term investor. Here’s why:

We have seen this movie before. Even over extended periods, underperformance of the value premium (or any other return premium) is not unusual. For example, over the 10-year period ending in March 2000, US value stocks underperformed US growth stocks by 5.61% per year (on an annualized basis). But this underperformance quickly reversed course. By the end of February 2001, US value stocks had outperformed US growth stocks over the previous one-, three-, five-, 10-, and 20-year periods.2
Return premia are nearly impossible to predict and relative performance can change rapidly. This underscores the need for discipline in an investment strategy.

Value rewards long-term investors. Empirical evidence dating back to 1926 shows that US value stocks typically beat US growth stocks, with the odds of outperformance increasing as the time period lengthens, as illustrated in the chart below3. For example, US value stocks beat US growth stocks in 61% of the 1-year rolling periods since 1926, while over the 15-year rolling periods the odds of outperformance increased to 94%. Similar track records have been exhibited in other markets, with value beating growth in developed ex-US markets in 95% of 10-year rolling periods since 19754. In emerging markets, value beat growth in 86% of 10-year rolling periods since 19895.


Beware the allure of growth trends. We’ll admit it: value investing can seem boring compared to its trendier growth counterpart. Take the popularity of FAANG (Facebook, Apple, Amazon, Netflix and Google’s parent Alphabet) stocks. FAANG investors were undoubtedly well-rewarded last year, receiving a simple average of 49% (versus the S&P 500 at 22%); but merely latching on to the latest investment catchphrase does not an investment strategy make. Sure, the FAANGs do have their merits, but investors should not allow their allure to result in an overly tech-concentrated portfolio (remember the dot-com bubble?). Broad diversification across sectors and markets is a much more prudent investment strategy.

Bottom Line: Discipline and diversification are the name of the game. While there is empirical evidence to support our expectation that value stocks will outperform growth stocks over longer periods, there will be periods of underperformance. Discipline and diversification across multiple sources of return premia will lead to a more positive investment experience.

1 Year-to-date total return of Russell 1000 Value index and Russell 1000 Growth index as of market close, 9 March, 2018.
2 Source: Dimensional Fund Advisors LP; total returns quoted are for the Russell 1000 Value and Russell 1000 Growth indexes.
3 Source: Dimensional Fund Advisors LP; Value is Fama/French US Value Research index. Growth is Fama/French US Growth Research index. There are 919 overlapping 15-year periods, 979 overlapping 10-year periods, 1,039 overlapping 5-year periods, and 1,087 overlapping 1-year periods.
4 Source: Dimensional Fund Advisors LP for the period ending December 31, 2017.
5 Ibid.

The Economics of Tariffs

Recently, President Trump unilaterally decided that the US is going to institute tariffs on both steel and aluminium. Tariffs have been used in the past by previous administrations and, indeed, other countries around the world. Tariffs, or customs duties, are taxes on imported products, usually in an ad valorem form, levied as a percentage increase on the price of the imported product. Tariffs are one of the oldest and most pervasive forms of protection and barrier to trade.

Who benefits from such a tax? In this case, steel and aluminium manufacturers. Who loses? Everyone else. In the US, the working population is estimated to be around 145 million. How many workers are employed in the steel and aluminium industry? That number is about 200 thousand. Doing the math, this tax will favour roughly 0.14% of the overall labour force. So, Trump is taxing the users of these materials whilst protecting those who manufacture the products.

Who pays for these taxes imposed on exporting countries? Everyone. Meaning, a 25% increase in steel imports will mean that consumers in the US will pay an additional 25% on steel inputs. That means new cars, beer, watches, household appliances, etc., will be more expensive. Why would a country assess such a punitive additional cost to consumers? In this writer’s humble opinion, for optics to look tough to the voting population (if the country is somewhat democratic). Anyone who has a rudimentary understanding of economics will likely agree that tariffs are generally bad for the economy. Furthermore, there is a strong likelihood of retaliation from exporting countries which could trigger a costly trade war. Europe, for example, has promised to put tariffs on Harley Davidsons, bourbon and blue jeans. These are specifically targeted at the home states of particular members of the US Congress.

As an investor, do tariffs impact your portfolio? Yes. It’s unlikely that increased costs, i.e., tariffs, will not have a negative impact on an investable portfolio. The US accounts for nearly 25% of world gross domestic product (GDP), which means the impacts of these increased expenses will spread throughout much of the world. In turn, these increased prices will have knock-on effects on businesses worldwide. Taxes are ultimately paid for by consumers as businesses pass these costs into their end products (goods and services).

What should an investor do? The primary defence against specific political risk, such as tariffs, is to make sure your portfolio is diversified geographically, as well as amongst sectors and industries. This will help mitigate the risk from any government or region as best one can.