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Personal Finance for Expats

The Difference Between Tax Evasion and Tax Avoidance

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To build upon the previous article (on myths about investing offshore), I wanted to briefly explain the difference between tax evasion and tax avoidance, in particular because there is so much confusion around this topic.

Institutions such as banks, investment firms, and insurance companies might not be required to report their clients’ assets or income to foreign governments or foreign tax authorities. However, depending on where you are resident and what passport you hold, not reporting your foreign assets or income may be considered a crime in your home country or country of residence.

For example, for Americans, purchasing foreign funds and not reporting the capital gains to the Internal Revenue Service (IRS) would be considered tax evasion. Additionally, opening an offshore bank account and not reporting it to the Department of the Treasury (either through the IRS and/or the Financial Crimes Enforcement Network), might constitute tax evasion, depending on whether the balances of the accounts exceed the threshold for filing.

However, deciding to hold on to a foreign investment for longer than one year before selling it in order to pay the lower long-term capital gains tax is an example of tax avoidance and is perfectly legal. Also, taking advantage of various tax credits that are available in order to directly reduce your tax liability is an example of tax avoidance.

Therefore, tax avoidance is the act of minimizing your tax burden through legal means, and tax evasion is the illegal act of not claiming your assets, under-reporting income, or overstating deductions in order to reduce your tax burden.

It goes without saying that one should never resort to tax evasion, as the penalties are harsh and include heavy fines and possibly even a prison sentence.

Before investing offshore, it is wise to enlist the services of a tax advisor experienced with foreign taxation, just to ensure that you are fully compliant with the tax laws in your country of citizenship/residence.

Myths About Investing Offshore, Part 1

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Despite the fact that many people have little or no idea about the benefits of investing offshore, almost all of them have heard horror stories and are swept up by a constant stream of negativity around this topic.

There are various reasons for that, and what I shall do now is discuss a few myths regarding offshore investments. One thing to understand is, most of what you have probably heard about investing offshore is just plain false.

So let’s tackle this topic with an open mind and see what is really going on.

MYTH: People who invest offshore are looking to evade taxes.

FACT: The vast majority of individuals who invest offshore include expatriates who already live in high-tax areas such as the European Union and North America, and pay their taxes responsibly. When they invest offshore, they are seeking higher returns, without any intention of evading taxes.

Some people who invest offshore already live in low-tax areas, or are non-resident for work-related reasons, and are just looking to earn higher returns. A desire to improve one’s life through investing responsibly and successfully is the main reason people invest offshore, and not because they want to evade taxes.

MYTH: Only criminals, drug lords, and terrorists put their money offshore.

FACT: Again, the vast majority of people investing offshore are people like you and I. They only wish for higher returns, more privacy, and a reasonable alternative to the high taxation that may exist in their country of residence, by investing in a legal and responsible manner.

I believe one of the reasons such myths are spread is because domestic banks and financial institutions want you to keep your money with them, for their own financial gain. Banks want you to keep your money domestically, since it helps eliminate competition.

MYTH: If I already have money invested in my country of residence, there’s no need to go offshore.

FACT: Practicing financial diversity is crucial. Having access to top offshore funds, superb asset protection, potentially high returns, tax efficiency, and flexibility are a few of the reasons why it makes sense to invest offshore.

MYTH: Offshore banks and financial companies cannot be trusted.

FACT: Most of the largest banks and financial institutions in the world are located offshore, and many have received the highest ratings from independent rating agencies such as Standard & Poor’s and Moody’s.

MYTH: Americans can never enjoy the benefits of investing offshore.

FACT: While it is true that Americans are taxed on worldwide income, and that major low-tax districts are being pressured into sharing information with the U.S. authorities, the fact remains that investing offshore can still be a beneficial option for Americans.

Depending on where you live, as an American, you too can have access to offshore investments. The higher returns, flexibility, diversification of investment options, and privacy make investing offshore appealing even to Americans, despite the fact that there are additional reporting requirements in the U.S.

One thing for Americans to be wary of, however, is that certain offshore investments may be considered a passive foreign investment company (PFIC). If that is the case, the are stringent compliance and reporting requirements around this, not to mention tax implications. In such scenarios, it’s best to engage the services of a tax advisor, particularly one that is knowledgeable about foreign taxation.

MYTH: Investing offshore is only for the extremely wealthy.

FACT: While it is true that many offshore investments do require high initial amounts, the opposite is also true. There are investments out there that let you start saving for as little as $150 per month. This is an amount that nearly anyone living in a modern, developed country can comfortably put away, so it makes no sense to put off saving.

There are other myths out there, perpetuated by the media and even family and friends, but the main point to consider is this: people just like you are investing offshore and reaping the benefits of their decision. Why shouldn’t you also?

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