In my last monthly update post I alluded to the fact that our less than stellar savings rate for the month was because we had to write the IRS a large check. Large enough to buy a car. A new car, not a used one.

Mr. BITA and I are both W-2 employees. We have no side hustles or rental income. We do receive bonuses and have RSUs and ESPPs and I did make estimated payments to our friendly neighborhood tax collectors every quarter of 2017. How then did we end up with such a sizeable surprise bill come tax time?

 

The thing that threw our calculations all out of whack were our foreign assets and foreign income.

 

The BITAs’ Portfolio Overseas

I immigrated to this country when I was nearly 30 years old. From ages 21 to 29 I worked as a software developer in India. I saved a modest amount in those years and when I moved to the U.S. I left my savings in India, and there they stay to this day. I haven’t sent additional money back home; I just left my original savings to grow. We are invested in various mutual funds and in a handful of Indian equities.

 

I’ve written before about neglecting to declare our Indian stash correctly to the IRS, the saga of having to beg forgiveness under the Streamlined Domestic Offshore Procedures program, and coughing up over $12,000 to the IRS to fix the issue.

 

While I handle our U.S. investments myself (yay for index funds and Vanguard!), in India our money is managed by a financial advisor. There are two salient points about my financial advisor that are important for the rest of this sad story:

• My financial advisor has the power to transact on my behalf. He can buy and sell as he sees fit.
• My financial advisor very rarely generates short or long term capital gains on my behalf. He holds most positions for a large number of years. This is one of the reasons that I only owed the IRS about $12,000 in the disclosure mentioned above – I had had much growth but very few realized gains in all the years that I had messed up my tax filing.

 

Foreign Income and U.S. Taxes

Cut to 2017. For the first time in known history my financial advisor in India made a large number of moves. He generated short term (a few) and long term (quite a bit more) capital gains. Everything was reinvested – he was rebalancing my portfolio.

 

I made an assumption here:

I assumed that I would be paying taxes on these gains on my Indian tax return. I would then declare the gains on my U.S. tax return and also claim the foreign tax credit. Ta-da!

This assumption, as it turns out, was complete horseshit.

Because of my non-resident status in India, I was not taxed on my long term capital gains there. All my long term capital gains were tax exempt in India. That meant that I owed the IRS money, and, to add insult to injury, I also owed a penalty for not paying estimated taxes on time.

Bummer.

It gets worse.

 

The Curse of Form 8621

Let me start by stating that I fucking hate form 8621. It is an infected cankle of a form.

I filed our taxes myself. I breezed through form 1040, schedules A, B and D. I valiantly waded through form 1116 (foreign tax credit). I could complete 2441 in my sleep. Even 6251 (good old AMT) hardly made me break a sweat. I filled out multiple copies of 8606 and bravely tackled 8938 (Statement of Specified Foreign Financial Assets). But 8621 brought me to my fucking knees.

Form 8621 is the pithily named Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund. For your viewing pleasure, here are some poetic extractions from the instructions on how to fill this beast:

“If the stock is owned indirectly through foreign entities, see Regulations section 1.1296-1(d)(2).”

So off we toodle obediently to 1296 etc.

“In the case of section 1296 stock that a United States person is treated as owning through certain foreign entities pursuant to paragraph (e) of this section, the basis adjustments under paragraph (d)(1) of this section shall apply to such stock in the hands of the foreign entity actually holding such stock, but only for purposes of determining the subsequent treatment under chapter 1 of the Internal Revenue Code of the United States person with respect to such stock.”

 

And so we go, down the rabbit hole of another forty sections trying to decipher this gobbledygook. This is what hell must be like. One is doomed to spend one’s days reciting section 1.1296-1 for all eternity.

 

What was the bottom line though? It turns out that I had to report all my Indian mutual funds on this form, and, here is the truly juicy bit – pay tax on unrealized gains.

Let me say that again.

I owed income tax, at my marginal tax rate, on all UNREALIZED gains.

 

I had to take the value of those mutual funds at the end of 2016 and compare that to the value of the funds at the end of 2017. The difference was to be reported on line 21 of form 1040 as “other income”.

In 2017 our mutual funds gained 41%. Our marginal tax rate is very high. Motherfucker.

 

Being taxed on actual income is one thing, but being taxed on paper gains was a punch to the gut.

 

Bring Out the Tiny Violins and Serenade the Whiny Brat

I get it. I get it. These are good problems to have. More taxes implies more money. These problems aren’t even first world problems. They are the problems of the super duper privileged with a cherry on top.

But privilege or not, having to unexpectedly cough up a car-equivalent for the IRS put a ding in our savings rate for March, and will have an effect on how much we can save in April too. We reached deep into our emergency fund, and now need to replenish it. I also need to figure out what I need to do about those mutual funds in the long run – I cannot abide a long term relationship with that bastard of a form, 8621.

Tags: taxes