Foreign Trust PFIC – Offshore Investments | IRS Foreign Trust PFIC
Oftentimes, when you are researching international tax and the IRS, you may see two complex offshore terms merged together into one. One common example of this, is when you see the term “foreign trust” and the term “PFIC.”
While there may be some similarities and overlap between the two terms, it is important to note the differences for each concept — as well as the different reporting requirements for each form(s).
A foreign trust is a trust that is generally created outside of the U.S., or subject to a foreign country’s laws — and/or with a Foreign Trustee.
For example, if you are a U.S. person in Hong Kong and you create a Hong Kong trust is subject to Hong Kong jurisdiction — then the baseline position would be that it is a Hong Kong trust, and therefore a foreign trust.
Reporting a Foreign Trust
A Foreign Trust is reported annually to the IRS on Form 3520-A. it requires a significant amount of information about the trust, the trustees, and the beneficiaries.
In addition, the IRS requires that you summarize the assets.
Moreover, if you do not have a U.S. agent designated on behalf of the trust, the the IRS may also require the filer to provide substantial amount of documentation regarding the trust.
Foreign Trust Penalties
The form 3520-A — along with form 5471 (which is used to report foreign corporations) — are two of the more common IRS forms which are heavily penalized by the IRS, when person does not file them accurately or timely.
A PFIC is a Passive Foreign Investment Company. There are many different examples of a PFIC, but two them more common examples that we come across in our practice are:
- Foreign Holding Companies
- Mutual Funds
Is a PFIC a Foreign Trust?
Not by definition it is not. In other words, just because you have a PFIC does not mean that your foreign investment is subject to the foreign trust rules.
There are numerous instances in which a foreign trust may include various investments, and one or more of those investments may include a PFIC — but the reporting requirements are distinct (even if they sometimes overlap)
IRS PFIC Reporting
Generally, unless the PFIC is excluded from reporting or meets one of the exceptions to reporting, the U.S. owner of PFIC files an annual form 8621.
The form is different then Form 3520-A. If there are no excess distributions, then the 8621 form is not the most difficult form to prepare.
But, if there are excess distributions, multiple categories of income, foreign tax credits, etc. the reporting can get very onerous and burdensome.
Form 8621 Penalties
Typically, if a person does not file the form 8621 — and it is discovered by the IRS — the penalty for the unfiled Form 8621 is that the tax return does not close.
In other words, while the general statute of limitations for the IRS audit or examine a tax return is 3-to-6 years, with an unfiled form 8621, the tax return may stay open in perpetuity — which is very dangerous, as the IRS continues to increase penalties for noncompliance with offshore reporting requirements.
Getting Into IRS Offshore Compliance
It is human nature to want to avoid making a proactive submission to a government agency such as the IRS before the IRS ever discovers the non-compliance. But, typically that is best path forward.
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