The US is one of the few countries in the world that taxes all citizens and permanent residents no matter where they live in the world. Since we still have our green cards and want to be on best behavior, this means we need to file.
I learned yesterday that under no circumstances you should own non-US mutual funds if you have to file taxes as a resident. Even a simple money market fund can get you in serious trouble.
Take this scenario:
You put your life savings into a Euro money market fund that gives you around 2% interest per year. Great, so you just declare your 2% interest as income and you're done, right?
Wrong! You have just bought a PFIC (Passive Foreign Investment Company) and ruined your life. (I prefer to call them PFUCKs).
First, if you don't mention the PFUCK on your tax return, nothing much happens until you sell it. At that point, all hell breaks loose. Not only do you have to pay 4% per year penalty interest, you also have to value your shares in US Dollars (both at the start and end dates whatever the exchange rates were), and any currency difference is treated as regular income (and you don't get to count anything if its a loss).
There is also the option to mention the PFUCK on your tax return and do Mark-To-Market accounting, but currency movements can really screw you over, especially this year, when the Euro peaked around Dec 31st. The third option, known as QEF doesn't generally work in Europe since no funds will give you the accounting information necessary.
On the other hand, if you just stick to certificates of deposit, you get your steady interest payments, can apply Spanish taxes against your US taxes, and live stress free.