- 1 PFIC
- 2 Cryptocurrency & Bitcoin Lawyers Golding & Golding, A PLC
- 3 IRS PFIC Rules
- 4 Disclaimer: Passive Foreign Investments can be Hazardous – Proceed Cautiously
- 5 Introduction to the Concept of Passive Foreign Investment Company
- 6 Step 1 – What is a PFIC?
- 7 Step 2 – Some Examples
- 8 Step 3 – Do You Own One?
- 9 Step 4 – Has the Investment Distributed Income?
- 10 Step 5 – Categorize Each Type of Income
- 11 Step 6 – Do You Meet any Exceptions?
- 12 Step 7 – If No Exceptions, Complete Form 8621
- 13 Step 8 – Consider making an Election (MTM or QEF)
- 14 Step 9 – Take a Deep Breath…
- 15 Step 10 – Don’t Forget all those Pesky other Forms
- 16 Unreported Prior Year Reporting or Income
PFIC (IRS Passive Foreign Investment Reporting Requirements)
The IRS rules involving a PFIC (Passive Foreign Investment Company) are needlessly complex. The analysis requires a detailed evaluation of the offshore investment, including:
- U.S. status of the owner
- Distribution schedule
- Length of investnent
As you settle into TurboTax, you begin searching the IRS website, when 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 realize that PFIC income (dividends or shares of PFIC stock) may each have a separate reporting requirement. The taxation rules are very difficult, and income tax calculations require multiple layers of analysis.
You resign yourself to the fact that this is going to be very hard.
We’re here to help.
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IRS PFIC Rules
The IRS is not a big fan of passive asset foreign investments, and if you own a PFIC, then additional reporting will be necessary.
PFICs are difficult to deconstruct (especially for tax purposes).
PFIC Investments (Passive Foreign Investment Companies) are reported on Form 8621.
TurboTax does not even offer this IRS form, and from the little research you did online, you find the information is dense and confusing.
We’re here to help.
Common Questions we will summarize, include:
- What is the purpose of reporting this type of foreign investment?
- What is it?
- What are Examples of it?
- Do I have one?
- Does the Passive Investment have any income?
- Has the Foreign Investment Distributed any income?
- Do you meet any of the exceptions?
- What if you do not meet any exceptions?
- What form do you use to report the investment with the IRS?
- Can you make an election?
- What to do about prior year unreported filings?
Disclaimer: Passive Foreign Investments 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 — you should use a dually-licensed 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.
Kovel letters can be rejected by the court.
Introduction to the Concept of Passive Foreign Investment Company
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?
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
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 Own One?
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 Investment 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
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 Passive Foreign Investment Company 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 Reporting or Income
If you have unreported prior year 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.
Sean holds a Master's in Tax Law from one of the top Tax LL.M. programs in the country at the University of Denver. He has also earned the prestigious IRS Enrolled Agent credential. Mr. Golding's articles have been referenced in such publications as the Washington Post, Forbes, Nolo, and various Law Journals nationwide.
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