Reporting Foreign Mutual Funds IRS Case-Study Example
Contents
Reporting Foreign Mutual Funds
Reporting Foreign Mutual Funds: The U.S Government takes a very heavy hand against taxpayers on issues involving the reporting of foreign mutual funds. This is because the IRS wants to make sure they get their chance to tax the foreign mutual fund in accordance with the PFIC anti-deferral of tax regime.
The Reporting Foreign Mutual Funds rules are complex.
In recent years, the IRS has taken an aggressive approach to foreign accounts compliance — including foreign mutual funds. The investments must be reported each year on various international reporting forms such as Form 8621, FBAR, and FATCA.
In addition, if there were any excess distributions, then there may be very complicated income tax calculations.
The failure to report the form may result in significant offshore fines and penalties.
These penalties can be reduced, avoided or abated using various tax amnesty programs such as FBAR Amnesty.
The tax amnesty programs are collectively referred to as voluntary disclosure.
A Case-Study Example
David is a U.S. Person. He is originally from the U.K., but spent some time in Australia and India before coming to the United States.
Along the way, David decided he wanted try his hand at investing. He attempted his own research and stock investing, but after that failed, he decided to just “invest in funds.”
David purchased 5 different funds, which are all in one account. The value of the account in total hovers around $300,000.
David also have 3 bank accounts with a total of $200,000.
Are Foreign Mutual Funds Listed on the FBAR?
Yes.
The mutual fund account is a “Foreign Financial Account.”
The total value of David’s accounts are $500,000. Therefore, since the total “annual aggregate total” of all the accounts exceeds $10,000 – David reports all the accounts on the FBAR.
What if one of the Foreign Mutual Funds is less than $10,000?
It doesn’t matter. It is not $10,000 per fund, but more than $10,000 in aggregate total of all the accounts. In addition, the mutual funds within the account are not reported separately for the FBAR (different rules apply to reporting on Form 8621), so individual fund value is less important for the FBAR.
Is the Mutual Fund Account Listed on the 8938?
Investment accounts are generally included on Form 8938 (FATCA).
But, foreign mutual funds are treated a bit differently. Each individual fund is included on a separate form 8621. This is so the IRS can track the fund’s individual basis, income, taxes paid, etc.
And, while some people may still list it on Form 8938 as well, it is required to be listed on Form 8621 (unless an exception or exclusion applies)
What Form do I File Instead of the Form 8938?
Form 8621, which is used to report Passive Foreign Investment Companies, including Foreign Mutual Funds.
What is a Form 8621?
Form 8621 is a specialized form used to report passive foreign investments.
Change in PFIC and Foreign Mutual Fund Law (2013 Forward)
Requirements for filing the form changed after 2012. Previously, the form was only filed if income was actually received. Starting in tax year 2013, the form had to be filed by any individual who had a PFIC value (in aggregate) that exceeds the specific exemption/exclusion amounts.
Are there any Exceptions or Exclusions?
The main exception is that if there was no income distributed from the PFIC, and the value in aggregate total of all PFICs is less than $25,000 if the person files single or separate, and $50,000 if the person file jointly – then the form may not need to be filed.
*We want to reiterate that even if the values are below these amounts, if there were distributions, the form must still be filed.
How is Accrued Passive Income from Foreign Mutual Funds Taxed
Generally, taxpayers are required to pay tax on accrued, non-distributed income in overseas accounts (subject to exceptions and limitations such as retirement accruals and subpart F Income). The PFIC is different.
General Example:
David has a 5-year Fixed Deposit overseas. It generated 7% growth. In 2018 he had $100,000 in the account, which generated $7,000.
The $7,000 happens to be tax-free in the country David maintains the investment.
Under U.S. tax law, the $7,000 is taxable as it accrues.
U.S. Taxation of Foreign Mutual Funds
PFIC Taxation will vary based on various factors.
Accrued Growth Within the Fund
You can imagine the PFIC as a box. If nothing comes out of the box (it is growing within the fund), then it is generally not taxable until it is distributed. But once it is distributed, the taxes can be massive.
Distribution Outside of the Fund
Once the money is taken out of the box, it is taxable. This presumes the distribution is not the first year of the PFIC Investment, in which the distribution cannot be considered an Excess Distribution (distinct from the first PFIC distribution, which could be many years into the investment).
The tax rules are detailed and comprehensive. You can see here for an example calculation.
What if the Foreign Mutual Funds are switched Out?
It depends on whether any funds “left the box,” even for a moment. If so, then generally it would be considered a taxable event.
What if the Foreign Mutual Funds are Redeemed?
It depends on whether any funds “left the box,” even for a moment. If so, then generally it would be considered a taxable event.
*Generally, a redemption is a “payout,” and is taxable.
Conclusion
Foreign Mutual Fund taxation and reporting is hard.
Non-Compliance with U.S. Tax Law
Whether it is because you did not you had to report foreign accounts, thought you were below the threshold for filing, did not realize non-bank accounts were required to be reported, and/or have other unreported income, accounts, investments or assets – we can help.
What Can You Do?
Presuming the money was from legal sources, your best options are either the Traditional IRS Voluntary Disclosure Program, or one of the Streamlined Offshore Disclosure Programs.
Golding & Golding: About Our International Tax Law Firm
Golding & Golding specializes exclusively in international tax, and specifically IRS offshore disclosure.
Contact our firm today for assistance.