Form 8621 Instructions – Summarizing The Basics to IRS Reporting
IRS Form 8621 Instructions are a tough nut to crack (so you can just imagine the difficulty in preparing the actual form).
The 8621 form is technically called “Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund” and is used in situations in which a person has a PFIC (Passive Foreign Investment Company).
The failure to file this form may carry one of the stiffest penalties possible – an incomplete tax return, which means that the IRS could feasibly audit the return forever. That leaves your return subject to a number of different penalties.
As you can imagine, there is some major complexity with form 8621. This is not a guide and we highly recommend that you do not rely upon it in preparing your own form (Read: it is one of those forms in which you should have a tax practitioner prepare for you).
Do You Have a PFIC?
A PFIC is a Passive Foreign Investment Company, which doesn’t mean much to you outside of the fact that if you have a PFIC and meet the threshold requirement, you have to report it.
What is a PFIC?
A foreign corporation is a PFIC if it meets either the income or asset test described below:
75% or more of the corporation’s gross income for its taxable year is passive income (as defined in section 1297(b)).
Example: If you have a foreign corporation which earns all of its income from investments such as investing in stocks, securities, ETF’s, etc. and the income is all generated as a result of passive means, then it would be considered a PFIC under the income tax. To contrast this, if you own your own consulting firm that is a corporation and you earn all of the income due to your consulting skills, then you are earning “earned income” and would probably be able to sidestep the PFIC moniker – absent other facts.
At least 50% of the average percentage of assets (determined under section 1297(e)) held by the foreign corporation during the taxable year are assets that produce passive income or that are held for the production of passive income.
Example: You have a foreign corporation that does little more than hold foreign real estate which generates passive income. The rental income is passive income and the assets within the corporation that are generating passive income are at least 50% of the assets (in this example, all of the real estate held in the Corporation is used to generate passive income). This would probably be a PFIC, because at least 50% of the assets are being used to generate passive income.
What is the Threshold for Reporting?
Back in 2012, the rules changed and all PFICs have to be reported each year when the threshold requirement is met – whether or not any income was distributed. There are minimum threshold requirements, which will vary depending on whether the person is filing single or married filing separate versus jointly.
The person who is single or married filing separate has to file form 8621 in any year that their total number of PFICs exceed $25,000. Therefore, if you have one PFIC worth $50,000 or eight PFICs worth $5,000 each, these would meet the threshold requirements under either alternative and all PFICs would have to be reported.
But for example, if a person only had one PFIC and it was only worth $19,000, then generally, unless there were distributions, it may not have to be reported.
The same concept goes for individuals filing married filing jointly, if combined they have more than $50,000 in PFIC ownership
How Do I Report The PFIC?
Step 1: How Many PFICs Do You Have?
Determine the total number of PFICs and what the total value is in the year. You are permitted to use any reasonable exchange rate, but most people use either the published Department of the Treasury exchange rates or the published IRS exchange rates – both of which are available online.
Step 2: Determine the PFIC Values
Confirm that you exceed the threshold requirements for filing. If you are below the threshold requirements for filing, then confirm that you did not receive any distributions from the PFIC. If you received the distributions, then you have to file the form irrespective of whether you are below the $25,000 or jointly below the $50,000 threshold requirement.
Step 3: Basic Filer Information
Complete the top portion of page 1, which request basic information such as:
- Name of the Shareholder
- Filing Year Of The Shareholder
- Type Of Shareholder
- Name And Address Of The PFIC
Step 4: Summarizing the PFIC
The next step gets a little more complicated. The person is required to provide a basic summary of the annual information required on form 8621. This typically includes:
- Describing each class of shares held by the shareholder
- the date the shares were acquired during taxable year
- the number of shares owned at the end of the year
- the value of the shares
- and whether there were any excess distributions or gain
Step 5: What is an Excess Distribution?
In a prior article, we detailed the Excess Distribution for our readers. Essentially, even if a person falls below the $25,000/$50,000 PFIC reporting threshold, if there were any “Excess Distributions” the taxpayer would still have to report the PFIC.
Here is an except from the article:
Let’s take Matthew. Matthew is originally from India but now resides in the United States. With the help of his father back in India, Matthew invested $200,000 in foreign mutual funds. For many years, there have been no distributions such as dividends or interest from the foreign mutual fund. In addition, Matthew has not sold any shares of the fund and never made any U.S. Tax elections.
Fast-forward to five years later and Matthew received a large distribution. It was a $20,000 dividend distribution, and the first and only distribution he has received from the foreign mutual fund.
The following is a breakdown of the tax analysis for this distribution:
– Is it an Excess Distribution? Yes. Even though this was the first distribution from the foreign mutual fund, it is not the first year of the investment (in which there cannot be an excess distribution because it is not in “excess” of any prior year distribution).
– What is an Excess Distribution? An excess distribution is the catalyst that sparks this complex tax analysis. Essentially, an excess distribution is a distribution in the current year, which exceeds 125% of the average of the three prior years. In this particular scenario, there were no prior distributions and this is not the first year of the investment, therefore it is an excess distribution.
– How do I analyze the distribution for tax purposes? Unfortunately, you know it’s going to be difficult when programs such as TurboTax do not even carry the form, your CPA never heard of the form, and the instructions themselves tell you to basically use a separate statement to determine the annual tax liability for prior years and literally block out the section of the 8621 form itself. See below for a numerical analysis.
– Why the Additional Tax? The IRS wants payback for the time your Foreign Mutual Fund was sitting overseas and growing – but not being taxed. Had the investment been in a U.S. mutual fund, it would’ve been distributed annually (even if immediately reinvested) and you would have been taxed (albeit at a lower tax rate). This is the IRS’ opportunity to get that money back from you.
– It Sounds Bad? It is. The IRS is going to tax you for each year you held the investment and the IRS is going to tax you at the highest ordinary income tax rate available each year for the portion of the investment earnings allocated for that year (even if you are not in the highest tax bracket). In addition, the IRS is going to tack on interest for the unpaid allocations that you didn’t pay timely, in accordance with the amount of tax allocated for each tax year of total tax amount, even though the tax amount is only being determined for the first time right now with this initial distribution…simple, right?
Step 6: So, You Want to make a Late Election
Making a late election is very difficult. In fact, it is nearly impossible because of the threshold requirements a person has to show. With that said, each individual’s facts and circumstances are different and sometimes a person for example may have relied upon a professional who told them they did not qualify as a PFIC. Years later, they may come to learn that they did qualify and therefore may be able to make the Late Election.
For most individuals, in order to make the late election, they will have to enter the traditional OVDP (presuming that they have undisclosed foreign income, assets, investments, etc.).
Never Filed the Form – Offshore Voluntary Disclosure
If you have never filed this form previously, then you’re out of compliance. In addition, chances are there are probably other forms you’ve not filed as well. Many of these other forms carry very stiff fines and penalties for not reporting them.
If a person wants to get into compliance and is considering making a late election, they would almost always have to submit to the traditional OVDP (as of November 2017, the Streamlined Program does not permit a person to make a late PFIC).
When a person has unreported PFIC issues, they are typically at risk for other related penalties as well.
The following is a summary of penalties as published by the IRS on their own website:
A penalty for failing to file FBARs. United States citizens, residents and certain other persons must annually report their direct or indirect financial interest in, or signature authority (or other authority that is comparable to signature authority) over, a financial account that is maintained with a financial institution located in a foreign country if, for any calendar year, the aggregate value of all foreign financial accounts exceeded $10,000 at any time during the year. 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.
Beginning with the 2011 tax year, a penalty for failing to file Form 8938 reporting the taxpayer’s interest in certain foreign financial assets, including financial accounts, certain foreign securities, and interests in foreign entities, as required by IRC § 6038D. 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, Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts. Taxpayers must also report various transactions involving foreign trusts, including creation of a foreign trust by a United States person, transfers of property from a United States person to a foreign trust and receipt of distributions from foreign trusts under IRC § 6048. This return also reports the receipt of gifts from foreign entities under IRC § 6039F. 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, Information Return of Foreign Trust With a U.S. Owner. Taxpayers must also report ownership interests in foreign trusts, by United States persons with various interests in and powers over those trusts under IRC § 6048(b). 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, Information Return of U.S. Persons with Respect to Certain Foreign Corporations. Certain United States persons who are officers, directors or shareholders in certain foreign corporations (including International Business Corporations) are required to report information under IRC §§ 6035, 6038 and 6046. 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, Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business. Taxpayers may be required to report transactions between a 25 percent foreign-owned domestic corporation or a foreign corporation engaged in a trade or business in the United States and a related party as required by IRC §§ 6038A and 6038C. 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, Return by a U.S. Transferor of Property to a Foreign Corporation. Taxpayers are required to report transfers of property to foreign corporations and other information under IRC § 6038B. 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, Return of U.S. Persons With Respect to Certain Foreign Partnerships. United States persons with certain interests in foreign partnerships use this form to report interests in and transactions of the foreign partnerships, transfers of property to the foreign partnerships, and acquisitions, dispositions and changes in foreign partnership interests under IRC §§ 6038, 6038B, and 6046A. 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.
Underpayment & Fraud Penalties
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.
Even Criminal Charges are Possible…
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 is subject to a prison term of up to five years and a fine of up to $250,000. 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.