U.S. Taxation of Foreign Mutual Funds and IRS Tax Treatment

U.S. Taxation of Foreign Mutual Funds and IRS Tax Treatment

U.S. Taxation of Foreign Mutual Funds

U.S. Taxation of a PFIC: A PFIC is a Passive Foreign Investment Company. It is codified under 26 U.S.C. section 1291 et seq. The goal of the PFIC regime is anti-deferral of tax on certain investment income from overseas. In general, the U.S. taxation of Foreign Mutual Funds is complicated because they are considered PFIC.

Even if a Taxpayer has fractional ownership, the PFIC rules kick in unless there is applicable exception, exclusion or limitation.

This makes it unnecessarily difficult for taxpayers to realize they may even have a PFIC, or that it is reportable and taxable. 

Also, with the IRS taking an aggressive position on matters involving foreign accounts compliance — which includes investment accounts — taxpayer compliance is crucial.

Important Tax Tips for Taxpayers with Foreign Mutual Funds

Here are some important tips for Taxpayers with foreign mutual funds who are subject to U.S. tax:

Growth within the PFIC

Generally, the growth within the PFIC is generally not taxable when it is growing within the fund.  In other words, if it is a foreign mutual fund for example that is accruing income, then the general rule is that the growth is not taxed.

First Year Distribution

Practice Pointer: A first-year distribution is not taxed as an excess distribution in the first year of the investment. For example, Melissa buys a foreign mutual fund on 2/1/2019. It distributes a dividend on 11/10/2019. This is not an excess distribution, because it is in the first year of the investment. Therefore, it is not “in excess” of any other prior year non-distribution.

Subsequent Distributions

Subsequent distributions are complicated. The distributions will be taxed as either a distribution or excess distribution. If it is a distribution, it is taxed at a regular rate. When it is an excess distribution it is taxed at the highest tax rate for all prior years (plus interest). The current year is taxed at the Taxpayer’s current progressive rate.

Excess Distributions

Excess Distributions are very complicated.

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