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The five worst tax traps for Americans living in Denmark

Richard Orange
Richard Orange - [email protected]
The five worst tax traps for Americans living in Denmark
Rasmus Kjærgaard Nielsen, Tax Director at PwC in Denmark, ran The Local through some of the worst tax traps for US citizens. Photo: PwC

Americans who live abroad know all too well they can't escape the clutches of the IRS. But they may not be aware of the painful tax traps specific to Denmark. Rasmus Kjærgaard Nielsen, Tax Director at PwC, explains the worst.

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It is not as if there are no measures to avoid double taxation between Denmark and the US. In theory, if a part of your income is taxed in one country, you should be able to show that in your tax return and receive a tax credit to prevent you from paying tax twice on the full amount.

For Americans resident in Denmark, this will generally mean that the Danish Tax Agency (Skattestyrelsen) has the first right to tax any income generated in Denmark, such as salaries, while the US Internal Revenue Service (IRS) has the first right to income generated in the US, such as dividends from shares in US companies.

If one country has a higher tax rate on a type of income, then it receives any tax left over once the tax credit has been applied.

The problems arise when income – or, in the case of property in Denmark, an asset – is tax-free in one of the countries but not in the other, or when income is taxed annually in one country but only when realised in the other.

Denmark's mark-to-market approach for some investments

A relatively technical but often financially significant difference is the mark-to-market approach Denmark takes to taxing investments such as mutual funds and ETFs .

"One thing that surprises most individuals moving to Denmark from the US is the fact that for a number of investments, we apply a mark-to-market taxation principle," Nielsen told The Local.

This means that instead of being taxed only when you sell the investment, you are taxed on any increase in value between January 1st and December 31st.

This brings what Nielsen calls "a liquidity strain", as people have to pay tax without any additional cash in hand to pay it out of.

It also brings a double taxation issue.

"They might end up paying taxes in the US when they realise the investment, which would then not be possible to offset against any taxes in Denmark, because the taxes have already been paid in the previous years when the investment increased in value," Nielsen explains.

One way around this is to sell any ETFs, mutual funds, or other investments taxed on a mark-to-market basis before moving to Denmark, and instead buy listed shares, for which Denmark only taxes realised profits.

When you do this, it'’s also probably best to go for non-dividend paying shares, as Denmark taxes dividend income at up to an eye-watering 42 percent, compared to 15 percent in the US.

"The reason for that is that if an individual leaves Denmark within seven years of arriving, then no tax would apply to shares taxed on the realisation principle," Nielsen said.

Any longer than seven years, however, they would be covered by Danish exit tax.

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Problems with IRAs

Many US executives who move to Denmark will already have a substantial nest egg — hundreds of thousands or even millions of dollars — saved up for their retirement in an IRA or "Individual Retirement Account".

An IRA generally allows the holder to buy and sell shares and funds without paying capital gains tax annually on any profits, with tax only paid when the money is taken out, usually from the age of 59-and-a-half years old.
For Danish pensions, Denmark generally taxes any realised or unrealised gains (i.e. the increase in value of the savings adjusted for withdrawals and contributions) each year at 15.3 percent.
A similar principle applies for certain non-Danish pensions where value increases on the pension scheme might be taxed at a marginal tax rate of up to 42 percent.

This means there's a real risk of double taxation, with US citizens who pay tax when they withdraw money from the account from the age of 59 and a half, unable to get a tax credit for the tax they already paid on the same gains while they were living in Denmark.

For other types of non-Danish pensions, no taxes would apply on the value increase of the foreign pension.

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READ ALSO: Why it pays to check your preliminary tax return in January

The sheer number of tax-shielded retirement options in the US, with 401(K) plans, Roth IRAs and the hybrid Roth 401k plan, the tax-shielded Health Saving Accounts (HSAs), and more, mean that it can take a specialist to work out how they should be taxed in Denmark.

"It's essentially a matter of determining, 'if this were a Danish scheme, then how would it be taxed?'. So that involves looking into the scheme and asking, 'does this product resemble a Danish pension product? And if so, how would that be treated in accordance with Danish law, and generally, it's possible to place the US pension in one box or another. But there is, of course, an amount of work involved with this."

Whether Denmark's authorities tax gains made by selling shares within an IRA, or gains in assets taxed on a mark-to-market basis, depends largely on whether you have a Roth or a non-Roth IRA, Nielsen said.

You can only pay income which has already been taxed into a Roth IRA, but any gains on assets held in the account are then treated as tax free when they are withdrawn. With a Non-Roth, or traditional IRA, on the other hand, you invest pre-tax earnings and are then taxed on any gains when you withdraw funds on retirement.

"If it's a Roth pension, then generally, the individual would be taxed in Denmark if the value of the pension goes up by more than what's been paid into it during that year.

"And if it's a non-Roth account, then Denmark generally wouldn't tax the annual increases in value. But we would tax any payouts from the pensions when the individual retires -- giving a credit for the taxes paid in the US because the US will still be allowed to tax the payout."

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The property tax mismatch

Unlike the US, Denmark levies an annual tax on the value of any properties held by the taxpayer, wherever they are in the world. Nielsen says that it often comes as "at least a surprise" to US executives when they come to work in Denmark and then realise they need to pay tax on the beachside condo they have back home.

"You pay taxes on a percentage of the value of the property. And that's regardless of the property being located in Denmark or outside of Denmark," Nielsen said. "For foreign property, the value is calculated based on the acquisition price, the acquisition year, and also the relevant OECD index figures for the market development in that specific country."

Up to a value of 9.2m Danish kroner ($1.3m), you pay 0.51 percent of the value of each property annually, and 1.4 percent for anything above that.

"It can end up being quite significant amounts," Nielsen said. "Fortunately, a lot of people coming to Denmark will either have sold the property or rented it out and there is an exemption from the tax for properties that are rented out for at least one year or more."

For countries, such as France and Spain, which also have similar property taxes, you also get a tax credit to prevent double taxation.

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How does Denmark tax LPs and LLCs?

Many US citizens coming to work in Denmark will have a Limited Liability Company or LLC or a Limited Partnership (LP), either for a side business or as an investment vehicle.

In Denmark (unlike in Norway), an LLC is often treated as its own entity, meaning any gains made inside it are not taxed as part of the holder's personal income.

This is generally not the case, however, for an LP.

"The individual holding the LP would be personally taxable on all investments," Nielsen said. "Whether or not that ends up in double taxation, that, of course, depends on the specific situation, but it is definitely an issue."
The Danish tax qualification of LPs and LLCs will always be subject to an individual assessment taking into account, among other things, the structure, the liability and the general functioning of the US entity.

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Denmark often does not recognise trusts

A lot of people in the US might also have trust funds, perhaps as part inheritance from a wealthy relative, as a way of shielding that money from tax.

"In the US, we often see individuals set up a family trust or beneficiary trust for tax purposes," Nielsen explained.
"In Denmark, we generally don't recognise trusts as being their own tax entities. So in a lot of cases, the beneficiaries of those trusts would be regarded as holding the investments or cash held by the trust.
“This means that everything carried out in the trust would essentially be considered as being carried out by the individual who benefits from the trust."

As a result, Americans who come to Denmark risk finding themselves liable for tax on any gains made on investments inside the trust. If the trust has several beneficiaries, it can also be complicated (and expensive) to work out how much is owed.

There is also a risk of double taxation, as beneficiaries of a trust will pay tax on it in the US when they withdraw income, but will not be able to get a tax credit for tax paid on gains in Denmark in previous years.

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Sky high income tax

Of course,the biggest shock of all for US executives coming to Denmark is simply how high income tax can be.

The marginal tax rate is currently 56 percent and that will be going up to 60.5 percent from 2026. For most US individuals, that's a terrifying rate," Nielsen said.

Fortunately, Denmark realises this and has brought in a special expatriate scheme for highly paid international executives and highly skilled researchers, which sees income taxed at about 33 percent.

To qualify in 2024, you need to have a salary over 75,100 kroner ($10,800) a month.
"It generally always makes sense," Nielsen said. "I think I have seen one or two examples in my career where it made better sense for the individual to to use the the ordinary rules. For most people, it's definitely a no-brainer."

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Comments (4)

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Jackson 2024/04/20 22:42
Thanks for this article. Do you know of any solutions for avoiding (or mitigating) double taxation on US Roth IRAs?
Simon 2024/02/21 09:36
Very interesting and informative topic, thanks. A similar tax article for retired Canadians resident in Denmark also would be appreciated. (government pensions, property, investments, RRSPs, inheritance)
Randall 2024/02/17 08:53
Isn’t 9.2m DKK equal to $1.3m USD? Not $132,000 USD.
  • Richard Orange 2024/02/21 11:41
    Yes, you are right. That's been corrected. Thanks for pointing it out.
Lin 2024/02/15 23:15
Does Sweden tax US IRAs similarly? Only on withdrawals from an IRA?
  • Richard Orange 2024/02/16 08:04
    I'm not sure. That's next in my list of articles to do. Should have it done in a couple of weeks.

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