Index Funds for US Expats are OK, right?

[expat2011]

Hey there RetireJapan. Stupid question for you, but I just wanted to double-check something. My income is earned in Japan and I file the Foreign Earned Income Exclusion every year. I can still use this income to invest in US index funds with US investment firms, right?

[TokyoWart]

Hey there RetireJapan. Stupid question for you, but I just wanted to double-check something. My income is earned in Japan and I file the Foreign Earned Income Exclusion every year. I can still use this income to invest in US index funds with US investment firms, right?

As long as you have those accounts at the US investment firms that shouldn't be a problem. Two things to keep in mind:

1. If you are trying to fund a US IRA account you need to have earned income to do so. If the Foreign Earned Income Exclusion eats up your entire income you will have no "earned" income to count and won't qualify for a US IRA contribution. You could still invest money in a taxable account.

2. If you are considered a tax resident of Japan (generally 5 years after moving here) Japan will tax you on worldwide income including any dividends or capital gains you make in those US accounts. They'll expect you to do a 確定申告 (kakutei shinkoku, or individual tax return) to report those gains.

[expat2011]

TokyoWart, thanks very much for this information. That was actually my next question- what kind of tax obligation do I have in Japan for my US investments? Your answer was very helpful: "If you are considered a tax resident of Japan (generally 5 years after moving here) Japan will tax you on worldwide income including any dividends or capital gains you make in those US accounts. They'll expect you to do a 確定申告 (kakutei shinkoku, or individual tax return) to report those gains."

I am very concerned about this, mostly because I am afraid of double taxation destroying the value of my investments to begin with. With paying taxes in both the US and Japan, isn't it possible that I may actually *lose* money even when I've gained interest? Do I get to deduct the US taxes I've already paid and just pay the remainder to Japan?

Keep in mind I am, right now, just reinvesting my dividends. Does that change anything? Maybe I only have to pay taxes when I sell?

I am also afraid of the tax office not understanding what they're looking at. I assume I have to turn in some kind of documentation, like a 1099. What if I try to pay taxes on my dividends, but they misunderstand what the document is and, say, try to make me pay taxes on purchases or something? Maybe I am being paranoid, but how complicated is the form? Have you ever had to file, and have you ever had any problems?

Even after years of investing and properly filing the Japanese taxes, will I run into additional taxes when I finally withdraw the money from my accounts to fund my retirement?

Your answer was a big step in me understanding what I'm supposed to do, but I still have so many questions/much anxiety. Please let me know if you are able to provide any additional information.

[TokyoWart]

With paying taxes in both the US and Japan, isn't it possible that I may actually *lose* money even when I've gained interest? Do I get to deduct the US taxes I've already paid and just pay the remainder to Japan?

My experience is that you will pay around a 10% additional tax on the dividends and capital gains in your US accounts to the Japanese tax authorities.

Keep in mind I am, right now, just reinvesting my dividends. Does that change anything? Maybe I only have to pay taxes when I sell?

No, reinvesting the dividends does not change how the tax is calculated.

I assume I have to turn in some kind of documentation, like a 1099. What if I try to pay taxes on my dividends, but they misunderstand what the document is and, say, try to make me pay taxes on purchases or something?

I strongly recommend using the 1099 form (the same portion of the form which is submitted to the US IRS) to calculate the tax liability because it is relatively simple and focuses on your taxable activity. In my case I give it to my 税理士 (tax accountant) and they don't actually submit the 1099 with the Japanese tax return but do use the information. When I have been audited, the Japan tax authorities are happy with the 1099 as evidence and they understand the form pretty well. They do not tax you on purchases.

Maybe I am being paranoid, but how complicated is the form? Have you ever had to file, and have you ever had any problems?

My accountant uses the 分離課税用 to report that foreign income and reports the dividends and capital gains on the "third form" (第三表). There are entries in two polaces for capital gains/sales (上場株式等の譲渡) and also in two places for dividends (上場株式等の配当等). A separate part of that form calculates the tax (for dividends on my form last year the exact calculation was right around 14% but this varies depending on other aspects of your return).

Then you can also claim some foreign tax credit on the 外国税額控除に関する明細書 for the taxes you paid on those dividends in the US. That form assumes you paid 10% in dividend tax in the US (because of the Japan-US tax treaty it's set at 10%, the actual amount you paid is never considered). It then includes that amount along with other US taxes you paid on your Japanese income to come up with a pro-rated calculation of your actual foreign tax credit (it's never really been that full 10% for me, usually quite a bit less).

No question that this is complicated. You can take your forms to the local tax office and they will get someone to help but they themselves are not that certain of the calculations (I did this for several years but then when I was audited they disagreed with the advice I had received from the same office). This is why I now use an experienced Japanese tax accountant.

[expat2011]

TokyoWart, thanks again for this detailed response.

So in the beginning you were just taking your info to city hall, but they audited you based on the documents they prepared? That's crazy.

"Getting audited" sounds really scary, but I assume all you really do is provide a bunch of official forms like bank statements and 1099s. Is that correct? Nobody arrests you unless you don't comply, right?

Even with the additional taxes, it sounds like index funds with a US firm are still a solid solution for US citizens. I don't really want to invest with a Japanese firm because my Japanese is not detailed enough to totally understand what I'm reading, and then I'd have to file additional taxes with the US.

I absolutely would like my Japanese taxes professionally prepared, for peace of mind, for knowing they were done right the first time, and for having a professional who is familiar with my situation in the event I am audited. How would you recommend I begin my search? My Japanese is solid enough to explain my situation, and I also have my Japanese wife who can help, so it's not necessary for the tax representative to speak English.

How much has the professional service been costing you?

Also, I am not even sure if I have to begin filing my overseas investments yet (I've been here for about 3 years), but I assume the professional will tell me what's necessary.

Thank you again for your help.

[TokyoWart]

Also, I am not even sure if I have to begin filing my overseas investments yet (I've been here for about 3 years), but I assume the professional will tell me what's necessary.

This is the most important point so I'll answer it first. Most foreigners are not counted as tax residents until they've been here for 5 years. When you aren't counted as a tax resident in Japan you are not taxed on this worldwide investment income so you don't have to worry about the complicated filing for those foreign accounts. My wife is not Japanese so I am not 100% sure this will also be true for you if you are here on a spousal visa.

"Getting audited" sounds really scary, but I assume all you really do is provide a bunch of official forms like bank statements and 1099s. Is that correct? Nobody arrests you unless you don't comply, right?

It is not pleasant. My experience was being audited for three-year blocks of time twice in a row (e.g. 20010-2012 audited in 2013, 2013-2015 audited in 2016). They invite you to the tax office for interviews, ask questions and request documents and then have you file revised returns for the three audited years. In my experience the first experience made conclusions which were completely countered on the next audit (which was more detailed and confrontational) and that is why I currently use a somewhat expensive firm who can push back in disagreements with the tax office (which is not always correct in what they claim). I don't think my experience was typical because the classification for my employment is unusual and comes with some unusual (and unfavorable) tax handling in Japan.

I absolutely would like my Japanese taxes professionally prepared, for peace of mind, for knowing they were done right the first time, and for having a professional who is familiar with my situation in the event I am audited. How would you recommend I begin my search? My Japanese is solid enough to explain my situation, and I also have my Japanese wife who can help, so it's not necessary for the tax representative to speak English.

It was hard for me to locate a really competent tax professional who could handle reporting of foreigners' overseas assets and returns. After my first audit I did a Google search and found someone who seemed good but actually did not understand all of the issues involved and was not helpful during the audit of the returns he had prepared. The more expensive firm I use now was introduced to me and is paid for by my employer because my situation is complicated by my work classification. The tax accountant I had identified on my own cost 160,000 yen but I think that was at the upper end of his usual client charge because I have several foreign and Japanese accounts and pay lots of taxes. I don't pay the current firm I am using but I'll bet it's several times that because my situation is unusually complicated and they have a fancy office. During my tax accountant journey I used Kaori Fuchi's firm once. Her firm is not cheap but struck me as competent and probably cheaper than my current employer-provided service:

https://www.kaori-fuchi.com/en/

If your yearly US (or non-Japan) dividend income is below 2 million yen and your foreign (non-Japan) assets are below 50 million I would probably stick with the local tax office because you are below the threshold of returns that they will be trying to hit hard with audits.

[RetireJapan]

Most foreigners are not counted as tax residents until they've been here for 5 years. When you aren't counted as a tax resident in Japan you are not taxed on this worldwide investment income so you don't have to worry about the complicated filing for those foreign accounts. My wife is not Japanese so I am not 100% sure this will also be true for you if you are here on a spousal visa.

My understanding is that everyone becomes permanently resident for tax purposes (liable to file worldwide income) after five years residence.

Spouse visa and PR make you liable for inheritance and gift tax worldwide, otherwise they kick in after 10 years residence for other visa holders.

[expat2011]

Hello TokyoWart and RetireJapan. Thanks very much for your help. My US investments are less than the thresholds TokyoWart mentioned, and they are really simple, just one index fund from one investment firm (it's a target-date fund). So the 1099 should be pretty straightforward. It sounds like I will try city hall first and see how it goes.

Thank you again for your help!