If you are a U.S. expat parent living in Hong Kong, China, or Macau, navigating investment income taxation us expat rules can be challenging. You might be juggling dividends, capital gains, or even passive foreign investment companies (PFICs). On top of that, you want to claim helpful family tax benefits like the Child Tax Credit. Below, you will find a clear overview of how to handle your U.S. tax filing obligations while ensuring you maximize your dependents’ benefits and keep your investments compliant.

Recognize your tax obligations

Even if you live overseas, the IRS still treats your worldwide income as taxable. This includes interest, dividends, capital gains, and other investment income. You may also need to keep an eye on special reporting rules:

  • The Foreign Bank Account Report (FBAR) on FinCEN Form 114 is required if your foreign accounts total more than $10,000 at any time.
  • IRS Form 8938 (FATCA) may apply if you hold substantial foreign financial assets.

If your income – from investments or otherwise – crosses filing thresholds, you must file a U.S. tax return every year. Late or incomplete filings can result in penalties, so it is wise to stay organized and prompt.

Document your dependents properly

As a U.S. citizen or green card holder abroad, you can claim your children as dependents on your tax return, as long as they meet IRS requirements. Generally, each child must:

  • Be your son, daughter, stepchild, foster child, sibling, or other qualifying relative.
  • Live with you for over half the tax year, with some exceptions for U.S. expats.
  • Have a valid Social Security Number (SSN) or an Individual Taxpayer Identification Number (ITIN) if they do not qualify for an SSN.

Be sure to apply for an SSN as early as possible if your child is a U.S. citizen born abroad. If your children do not qualify for SSNs, you may need to obtain ITINs so you can properly list them on your return. Proper documentation can unlock key tax credits and deductions.

Secure your Child Tax Credit

The Child Tax Credit can reduce your overall tax liability by thousands of dollars. To claim it while living abroad:

  1. Verify that each child has a valid SSN.
  2. Confirm that you meet the residency and relationship tests for each dependent.
  3. Calculate your adjusted gross income, factoring in all foreign and U.S. earnings.

If you owe less in taxes than the available credit, you may be able to receive a partial refund back through the Additional Child Tax Credit. The rules around refunds can vary year to year, so be sure to check the latest IRS guidelines before filing.

When you hold foreign mutual funds, exchange-traded funds (ETFs), or other foreign corporations that generate passive income, you may be dealing with PFICs. PFIC classification can trigger higher tax rates plus extra reporting requirements on IRS Form 8621. To avoid harsh consequences:

  • Identify whether your investments meet PFIC definitions, typically if they generate at least 75% passive income or hold at least 50% passive assets.
  • Stay ahead of annual filing requirements on Form 8621.
  • Consider shifting your portfolio to U.S.-based funds if PFIC demands become too burdensome.

To better understand the ins and outs of these rules, you can explore our dedicated resource on PFIC rules for US expats.

Manage dividends and capital gains

For U.S. expat parents, handling dividends and capital gains correctly is crucial. You are subject to:

  • Ordinary income tax rates of 10% to 37% on short-term capital gains (assets held for one year or less).
  • Preferential long-term rates of 0%, 15%, or 20% on capital gains (assets held over one year).
  • Potential net investment income tax of 3.8% for higher earners.
  • Normal U.S. rates on dividends, though some may qualify for lower rates if they are from certain U.S. corporations or qualified foreign companies.

Because local Hong Kong, Chinese, or Macau taxes may also apply, you could face double taxation. One way to reduce this outcome is by using the Foreign Tax Credit. Learn more by reading our overview of US expat tax on dividends if dividends make up a large portion of your family’s passive income.

Using the Foreign Tax Credit

The Foreign Tax Credit (FTC) lets you claim a dollar-for-dollar credit on taxes paid to another country. When it comes to dividends and capital gains:

  • You cannot claim FTC on any income you already chose to exclude under the Foreign Earned Income Exclusion (FEIE).
  • You must file IRS Form 1116 if your foreign taxes exceed certain amounts.

By carefully combining the FEIE (for earned income) and the FTC (for investment income), you may minimize your total U.S. tax bill.

Explore frequently asked questions

Below are some common questions we hear from U.S. expat parents who have overseas investments.

  • Q: Do I still need to file a U.S. return if my employer withholds taxes in Hong Kong or China?
    A: Yes. The U.S. taxes you on worldwide income, so filing a return remains essential for claiming credits or exclusions.
  • Q: Is investment income like dividends or capital gains covered under the FEIE?
    A: No. The FEIE only applies to earned income. Investment income is generally not excluded, so you might rely on the Foreign Tax Credit.
  • Q: Are my children automatically U.S. citizens if they were born overseas?
    A: They can be, depending on circumstances like your own citizenship status and U.S. residency history. Check eligibility so you can get them an SSN or ITIN and claim any applicable tax benefits.
  • Q: Why do some foreign banks close American accounts?
    A: Under FATCA, foreign banks face additional reporting requirements. Some prefer not to deal with U.S. clients, creating a challenge for many expats overseas.
  • Q: How do I handle foreign mutual funds categorized as PFICs?
    A: You might consider divesting or restructuring to U.S.-based accounts. Failing that, you must file Form 8621 and potentially pay higher tax on PFIC income.

Review essential takeaways

  • Worldwide income is always taxable. You are subject to U.S. tax on your global earnings, including investment and passive income.
  • Child Tax Credit can reduce liability. Ensure your dependents meet the eligibility rules and have valid SSNs or ITINs.
  • PFIC rules can be tricky. If you hold foreign mutual funds, check PFIC rules for us expats to stay compliant.
  • Capital gains and dividends matter. Short-term gains are taxed at ordinary income rates, while long-term gains may qualify for lower rates.
  • Foreign Tax Credit can help. Use FTC to offset the taxes you pay abroad, but remember you cannot double-dip on income excluded under the FEIE.

If you need personalized guidance or have questions about claiming your children or navigating the intricacies of FATCA, FBAR, or PFICs, contact American Pacific Tax for compassionate and expert support. We are here to help you stay compliant, lower your overall tax burden, and ensure you receive all the family-related benefits you deserve. Schedule a consultation and let us handle the complexities of your U.S. tax obligations while you focus on what matters most: your family.