Understand PFICs in 10 Easy Steps (Passive Foreign Investment Company) - Golding & Golding

Understand PFICs in 10 Easy Steps (Passive Foreign Investment Company) – Golding & Golding

Understand PFICs in 10 Easy Steps (Passive Foreign Investment Company)

It’s Friday night. You finally get the kids to sleep, and work emails out of the way. You and your spouse pour a glass of wine and sit down together, and then remember….

taxes are due.

As you settle into TurboTax, you suddenly remember that Mom over in Australia purchased a bunch of mutual funds in your name (she really hopes dangling those purse strings will lure you and the grandkids back Down Under).

You begin to research the topic more, and resign yourself to the fact that this is going to be very hard. 

TurboTax does not even offer the form, and from the little research you did online, you find the information is dense and confusing.

We’re here to help.

Common PFIC Questions we will summarize, include:

  • What is the purpose of the PFIC?
  • What is a PFIC?
  • What are Examples of PFICs
  • Do I have a PFIC?
  • Does the PFIC have any income?
  • Has the PFIC Distributed any income?
  • Do you meet any of the PFIC exception?
  • What if you do not meet any PFIC exceptions?
  • What form do you use to report PFICs with the IRS?
  • Can you make an election?
  • What to do about prior year unreported PFICs?

Disclaimer: PFICs can be Hazardous – Proceed Cautiously

If you have them, and they are unreported in prior years, you should work with a dually licensed Attorney/Enrolled Agent, or Attorney/CPA to work through it with you.

Since there are legal issues involving PFICs, and there is no Attorney-Client privilege with a CPA or EA unless he or she is also an attorney. 

If you use an Attorney, who refers to a “Kovel Letter,” please refer to this Kovel page summary so that you understand the benefits (and especially the limitations) of a “Kovel Accountant” before divulging confidential information to an Accountant.

Introduction to the Concept of PFIC

You have investments overseas in funds or other “fancy” investments. The IRS wants to tax you on the accrued and non-distributed growth – but it’s too hard for them to track.

The IRS has limited resources. Moreover, foreign companies and funds generally do not issue 1099 or 1099 equivalents, and the IRS has no idea how much the growth really is.

So they take a step back, ramp up enforcement, and figure they’ll get it on the back-end — when the money is distributed from the PFIC.

Step 1 – What is a PFIC?

Passive

Foreign

Investment

Company

Technically, a PFIC occurs when:


“A foreign corporation is a PFIC if it meets either the income or asset test described next.


Income test. 75% or more of the corporation’s gross income for its tax year is passive income (as defined in section 1297(b)).


Asset test. At least 50% of the average percentage of assets (determined under section 1297(e)) held by the foreign corporation during the tax year are assets that produce passive income or that are held for the production of passive income.”


Translated, this means that if you own interest or shares of a foreign corporation, and the corporation is earning almost all of its income from passive means, or more than half of the assets generate passive income, congratulations—you have a PFIC.


**Unlike a CFC or Form 5471, there is no control or minimum share ownership requirement.

Step 2 – Some Examples of PFICs

Now that you know what it is, the question is – do you have one?

Here are some common examples:

  • A BVI that owns real estate and funds used for accumulating passive wealth
  • An S.A. (Sociedad Anonima) that owns investments that issue dividends
  • Ownership of Mutual Funds (and usually other types of investment funds as well)

Step 3 – Do You Have a PFIC?

You study your investments to determine if you have a PFIC. If you own, or have any interest in any of the items listed in Step 2 – chances are you have a PFIC.

*But, keep in mind that if you have a U.S. mutual fund or other fund that owns foreign funds, then generally that is considered a U.S. fund and does not require a PFIC analysis or filing for Form 8621.

Step 4 – Has the PFIC Distributed Income?

This is a very important step!

If the PFICs have accrued income, but none of the income for any of the funds has been distributed, then there may be exceptions that apply,

Step 5 – Categorize Each Type of Income

**STOP

If no income was actually distributed, you may be in luck, and you may be able to side-step form 8621 reporting. BUT, non-distributed, does not mean it was distributed and immediately re-invested – because it was…distributed (even only for a second).

If it remains within the fund, and is reinvested in the fund, you should be in the clear. But you have to confirm for multiple prior years as well.

If income was actually distributed you need to determine

  • What types of income (Dividends, Interest, Capital Gains, etc.)
  • How Much Income of each type of income per year.
  • How many years has income been distributed for

***If Income was actually distributed or recognized — such as dividend, capital gains, or redemptions —  you can refer to our very detailed analysis here (but you should probably not go at this part alone.)

Step 6 – Do You Meet any Exceptions?

There are a few exceptions, with the most notable exception being that if the combined aggregate total of ALL your PFIC is below $25,000 (Single or MFS) or $50,000 (MFJ) and there were no distributions, you may be able to circumvent filing Form 8621.

Please, keep in mind that it is not $25,000 or $50,000 per PFIC.

Step 7 –  If No Exceptions, Complete Form 8621

Form 8621 ranges from not so bad, to absolutely brutal. It all depends on the:

  • Number of PFICs (each one is reported separately)
  • Whether or not income was distributed
  • How many years the income was distributed
  • How many different buckets of income are distributing income

If you do not have any unreported income, and you understand the basics of foreign investments, it may not be that bad.

If you have income, and you have to perform excess distribution calculations – consider contacting a professional.

Step 8 – Consider making an Election (MTM or QEF)

If this is the first year of you having these investment. You have some options.

Who doesn’t like options, right?

Two main types of elections are Qualified Electing Fund (QEF) and Mark-to-Market (MTM). The QEF is difficult to make because it requires cooperation from a foreign corporation – and most of the time, foreign corporations do not want to proactively cooperate with the IRS — unless required.

The MTM is a good election as well, BUT, usually, people do not realize about the election until after the first year has passed.

Trying to go back and make a retroactive/late election is very, very hard.

With prior OVDP, a person could make an MTM election, but OVDP was discontinued on 9.28.2018. The updated program appears to still be “under construction” and whether or not the MTM OVDP option is available, is unclear.

Step 9 – Take a Deep Breath…

Once you determine where you fall on the PFIC spectrum, determine if you want to go at it yourself, or hire a professional.

From what we understand, TurboTax still does not offer the Form 8621 or assistance with it, but maybe that has (or will) change with the updated international tax law.

Step 10 – Don’t Forget all those Pesky other Forms

There are many other forms in which you may have to file, including

  • 5471: Foreign Corporations
  • 8938: Specified Foreign Financial Assets
  • 8865: Foreign Partnerships
  • 3520: Foreign Gifts or Trust Distributions
  • 3520-A: Foreign Trust
  • FBAR: Foreign Account Reporting
  • Step 10: Prior Unreported PFIC Issues

Unreported Prior Year PFIC Reporting or Income

If you have unreported PFIC issues for prior years coming you should not just begin filing forward. Rather, you should take advantage of what the IRS offshore amnesty programs, while they are still available.

Hiring an IRS Amnesty/Voluntary Disclosure Program

Unlike other areas of International Tax, you need a law firm that practices exclusively in the area of IRS Offshore Disclosure, and your attorney should be a Board Certified Tax Law Specialist.

We’re here to help you.

What Type of Attorney Should I Hire?

IRS Voluntary Disclosure is a specialized area of law. An IRS Voluntary Disclosure is a complex undertaking. It requires the coordination of several moving parts, including strategy development, Tax Preparation, Legal Analysis, Negotiation and more.

You should hire a Tax Attorney who has the following credentials:

  • ~20 Years of Private Practice experience representing his/her own clients
  • Experienced in Criminal and Civil Tax Litigation
  • Experienced representing clients in Eggshell and Reverse Eggshell Audits.
  • Advanced Tax Degree (LL.M.)
  • EA (Enrolled Agent) or CPA (Certified Public Accountant)
  • Preferably a Board Certified Tax Law Specialist

What is the Board Certified Tax Law Specialist Credential?

Once an Attorney earns the prestigious Board Certified Tax Law Specialist credential, it proves to the general public that the attorney is dedicated to tax law, and has real tax law practice experience as an Attorney.

Few tax attorneys have passed the tax speciality exam (regarded as one of the most difficult tax exams in the country) — and met the additional education, experience, and recommendation requirements necessary for certification.

Once a person becomes “Board Certified in Tax,” it shows they have met the following requirements:

  • Advanced tax education 
  • Extensive tax law experience
  • Attorney & Judge recommendations for certification

In California for example, there are 200,000 active Attorneys, with tens of thousands of Attorneys practicing in some area of tax — and only 350 Tax Attorneys have successfully earned the designation.

Less than 1% of Attorneys nationwide have earned the credential.

Sean M. Golding, JD, LL.M., EA (Board Certified Tax Law Specialist)

IRS Offshore Disclosure is ALL we do.

Our Managing Partner, Sean M. Golding, JD, LLM, EA  earned an LL.M. (Master’s in Tax Law) from the University of Denver and is also an Enrolled Agent (the highest credential awarded by the IRS, and authorizes him to represent clients nationwide.)

He is a Board Certified Tax Law Specialist.

Mr. Golding and his team have successfully handled several hundred IRS Offshore/Voluntary Disclosure Procedure cases. Whether it is a simple or complex case, safely getting clients into compliance is our passion, and we take it very seriously.

He is frequently called upon to lecture and write on issues involving IRS Voluntary Disclosure.

Tax Law Specialty Firms are Best Prepared to Represent You in Specialized Tax Matters

Unless the firm has 50-100 attorneys, with a $25 million operating budget, a successful boutique tax-law firm will almost always have all of the attorneys in the firm devote the firms’s time, energy, and resources to one specific area of tax.

In other words, all the attorneys in the boutique tax firm practice the same, single area of tax law.

Some common niche areas of tax law include:

  • Tax Litigation
  • Employment Tax
  • Sales Tax
  • Offshore Voluntary Disclosure

For example, in employment tax, all tax attorneys in the firm handle employment tax related cases. In sales tax, all the tax attorneys in the firm handle sales tax. It may be “Sales Tax” in various different fields and industries — but the firm will limit the niche practice to sales tax.

The same is true for Offshore Voluntary Disclosure. If a firm handles Offshore Voluntary Disclosure, then all tax attorneys at the firm should be handling the same area of tax law.

This area of Offshore Disclosure law is constantly evolving, and becoming infinitely more complicated — including highly complex issues involving:

  • FBAR
  • FATCA
  • PFIC
  • CFC
  • International Cryptocurrency
  • J5
  • Increased Schedule B Enforcement (Paul Manafort)
  • Foreign Gifts
  • Foreign Inheritance
  • Foreign Business 
  • Foreign Trusts
  • OVDP
  • IRM
  • SDOP
  • SFOP

If a small firm has attorneys practicing 5-10 different areas of tax law (and even non-tax law related matters) – it can put your case at a severe disadvantage.

Why? Because it is impossible for these types of “general tax firms” to establish set protocols, policies and procedures sufficient to handle all the complexities and nuances for multiple different types of niche tax law areas.

At our tax specialty firm, we handle matters involving Offshore Voluntary Disclosure, and each case is led by one or more highly experienced attorneys.

This guarantees that your case gets the time and dedication it deserves.

Why Do We Care?

Because each month, like clockwork, we get calls from individuals in an utter state of panic, because the “Expert” or “Specialist” who made themselves out to be knowledgeable, has no real knowledge of Offshore Disclosure.

It turns out, the Attorney has never handled a complex Offshore Disclosure.

Oftentimes, Golding & Golding is called upon to fix these messes. Click Here to learn about some of the representative matters we have handled.

Serious Tax Matters; Serious Tax Consequences

Getting hit with an eggshell audit, reverse-eggshell audit, or IRS Special Investigation involving offshore money is serious business – it’s not like getting a traffic ticket or speeding ticket.

The ramifications of serious tax inquiries by the IRS (especially in the area of Offshore Disclosure and Compliance), can result in serious consequences such as monetary fines, penalties and even jail time.

Golding & Golding – Safely Disclose Your Foreign Money

We have successfully handled a diverse range of IRS Voluntary Disclosure and International Tax Investigation/Examination cases involving FBAR, FATCA, and high-stakes matters for clients around the globe (In over 65 countries!)

Whether it is a simple or complex case, safely getting clients into compliance is our passion, and we take it very seriously.

Examples of areas of tax we handle

Who Decides to Disclose Unreported Money?

What Types of Clients Do we Represent?

We represent Attorneys, CPAs, Doctors, Investors, Engineers, Business Owners, Entrepreneurs, Professors, Athletes, Actors, Entry-Level staff, Students, Former/Current IRS Agents and more.

You are not alone, and you are not the only one to find himself or herself in this situation.

Beware of Copycat Law Firms

Unlike other attorneys who call themselves specialists or experts in Voluntary Disclosure but are not “Board Certified,” handle 5-10 different areas of tax law, purchase multiple keyword specific domain names, and even practice outside of tax, we are absolutely dedicated to Offshore Voluntary Disclosure.

*Click here to learn the benefits of retaining a Board Certified Tax Law Specialist with advanced tax credentials.

IRS Penalty List

The following is a list of potential IRS penalties for unreported and undisclosed foreign accounts and assets:

Failure to File

If you do not file by the deadline, you might face a failure-to-file penalty. If you do not pay by the due date, you could face a failure-to-pay penalty. The failure-to-file penalty is generally more than the failure-to-pay penalty.

The penalty for filing late is usually 5 percent of the unpaid taxes for each month or part of a month that a return is late. This penalty will not exceed 25 percent of your unpaid taxes. If you file your return more than 60 days after the due date or extended due date, the minimum penalty is the smaller of $135 or 100 percent of the unpaid tax.

Failure to Pay

f you do not pay your taxes by the due date, you will generally have to pay a failure-to-pay penalty of ½ of 1 percent of your unpaid taxes for each month or part of a month after the due date that the taxes are not paid. This penalty can be as much as 25 percent of your unpaid taxes. If both the failure-to-file penalty and the failure-to-pay penalty apply in any month, the 5 percent failure-to-file penalty is reduced by the failure-to-pay penalty.

However, if you file your return more than 60 days after the due date or extended due date, the minimum penalty is the smaller of $135 or 100 percent of the unpaid tax. You will not have to pay a failure-to-file or failure-to-pay penalty if you can show that you failed to file or pay on time because of reasonable cause and not because of willful neglect.

Civil Tax Fraud

If any part of any underpayment of tax required to be shown on a return is due to fraud, there shall be added to the tax an amount equal to 75 percent of the portion of the underpayment which is attributable to fraud.

A Penalty for failing to file FBARs

The civil penalty for willfully failing to file an FBAR can be as high as the greater of $100,000 or 50 percent of the total balance of the foreign financial account per violation. See 31 U.S.C. § 5321(a)(5). Non-willful violations that the IRS determines were not due to reasonable cause are subject to a $10,000 penalty per violation.

A Penalty for failing to file Form 8938

The penalty for failing to file each one of these information returns is $10,000, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return.

A Penalty for failing to file Form 3520

The penalty for failing to file each one of these information returns, or for filing an incomplete return, is the greater of $10,000 or 35 percent of the gross reportable amount, except for returns reporting gifts, where the penalty is five percent of the gift per month, up to a maximum penalty of 25 percent of the gift.

A Penalty for failing to file Form 3520-A

The penalty for failing to file each one of these information returns or for filing an incomplete return, is the greater of $10,000 or 5 percent of the gross value of trust assets determined to be owned by the United States person.

A Penalty for failing to file Form 5471

The penalty for failing to file each one of these information returns is $10,000, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return.

A Penalty for failing to file Form 5472

The penalty for failing to file each one of these information returns, or to keep certain records regarding reportable transactions, is $10,000, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency.

A Penalty for failing to file Form 926

The penalty for failing to file each one of these information returns is ten percent of the value of the property transferred, up to a maximum of $100,000 per return, with no limit if the failure to report the transfer was intentional.

A Penalty for failing to file Form 8865

Penalties include $10,000 for failure to file each return, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return, and ten percent of the value of any transferred property that is not reported, subject to a $100,000 limit.

Fraud penalties imposed under IRC §§ 6651(f) or 6663

Where an underpayment of tax, or a failure to file a tax return, is due to fraud, the taxpayer is liable for penalties that, although calculated differently, essentially amount to 75 percent of the unpaid tax.

A Penalty for failing to file a tax return imposed under IRC § 6651(a)(1)

Generally, taxpayers are required to file income tax returns. If a taxpayer fails to do so, a penalty of 5 percent of the balance due, plus an additional 5 percent for each month or fraction thereof during which the failure continues may be imposed. The penalty shall not exceed 25 percent.

A Penalty for failing to pay the amount of tax shown on the return under IRC § 6651(a)(2)

If a taxpayer fails to pay the amount of tax shown on the return, he or she may be liable for a penalty of .5 percent of the amount of tax shown on the return, plus an additional .5 percent for each additional month or fraction thereof that the amount remains unpaid, not exceeding 25 percent.

An Accuracy-Related Penalty on underpayments imposed under IRC § 6662

Depending upon which component of the accuracy-related penalty is applicable, a taxpayer may be liable for a 20 percent or 40 percent penalty

Possible Criminal Charges related to tax matters include tax evasion (IRC § 7201)

Filing a false return (IRC § 7206(1)) and failure to file an income tax return (IRC § 7203). Willfully failing to file an FBAR and willfully filing a false FBAR are both violations that are subject to criminal penalties under 31 U.S.C. § 5322.  Additional possible criminal charges include conspiracy to defraud the government with respect to claims (18 U.S.C. § 286) and conspiracy to commit offense or to defraud the United States (18 U.S.C. § 371).

A person convicted of tax evasion

Filing a false return subjects a person to a prison term of up to three years and a fine of up to $250,000. A person who fails to file a tax return is subject to a prison term of up to one year and a fine of up to $100,000. Failing to file an FBAR subjects a person to a prison term of up to ten years and criminal penalties of up to $500,000.  A person convicted of conspiracy to defraud the government with respect to claims is subject to a prison term of up to not more than 10 years or a fine of up to $250,000.  A person convicted of conspiracy to commit offense or to defraud the United States is subject to a prison term of not more than five years and a fine of up to $250,000.

What Should You Do?

Everyone makes mistakes. If at some point that you should have been reporting your foreign income, accounts, assets or investments the prudent and least costly (but most effective) method for getting compliance is through one of the approved IRS offshore voluntary disclosure program.

Be Careful of the IRS

With the introduction and enforcement of FATCA for both Civil and Criminal Penalties, renewed interest in the IRS issuing FBAR Penalties, crackdown on Cryptocurrency (and IRS joining J5), the termination of OVDP, and recent foreign bank settlements with the IRS…there are not many places left to hide.

4 Types of IRS Voluntary Disclosure Programs

There are typically four types of IRS Voluntary Disclosure programs, and they include:

Contact Us Today; Let us Help You.