Not All Foreign Insurance Investments are PFIC, A Primer

Not All Foreign Insurance Investments are PFIC, A Primer

Not All Foreign Insurance Investments are PFIC

IRS Form 8621 is a complicated tax form that is used to report Passive Foreign Investment Companies. While the direct goal of the US government in creating this foreign tax form was not to require individuals to report foreign mutual funds and ETFs, unfortunately, these types of investments get stuck in the PFIC matrix. In other words, when a person is considered a US person for tax purposes and they have investments in a foreign mutual fund or ETF, they are typically required to file Form 8621 to report these foreign funds. The question then becomes whether foreign mutual funds or ETFs contained in a foreign life insurance policy are reportable as well for PFIC purposes. Unfortunately, there is a lot of ambiguity and misinformation online, so let’s walk through the basics.

Is Life Insurance a PFIC?

The first question is to consider whether you are dealing with a PFIC or not — and there are several layers to the analysis. The first issue is whether the insurance company and/or the policy is considered a PFIC. Then, the next issue is to determine whether the investment held within the policy at the life insurance company is considered PFIC. Oftentimes, a life insurance company is not considered a PFIC. That is because for the company and/or the policy to be deemed a PFIC — in addition to other requirements — either 75% of the gross income of the corporation is passive or 50% of the assets are passive (there are various exceptions, exclusions, and limitations to these rules). In other words, if investments are only one part of the company or the policy and overall, less than 75% of the gross income is passive or a majority of the assets are not passive, then the life insurance company and/or policy is not a PFIC.

Is the Investment Even a Mutual Fund or ETF?

The next consideration is whether the holding within the life insurance policy is a mutual fund or an ETF. Assuming the other qualifications are met, the reason why foreign mutual funds and ETFs are considered eligible for PFIC treatment is that they are each a self-contained corporation – in other words, each individual fund typically has its own entity, management, etc. (this does not directly impact the investor). Thus, if the fund is not an incorporated mutual fund or ETF but just a mirror fund — which is a group investments designed to mimic a mutual fund or ETF available on the open market – and the company/policy is not a PFIC then the fund may not be considered the PFIC in the first place. As provided by the IRS below:

When to Report PFIC?

Generally, a U.S. person that is a direct or indirect shareholder of a PFIC must file Form 8621 for each tax year under the following five circumstances if the U.S. person:

1. 1. 1. Receives certain direct or indirect distributions from a PFIC,

      2. Recognizes gain on a direct or indirect disposition of PFIC stock,

      3. Is reporting information with respect to a Qualified Electing Fund (QEF) or section 1296 mark-to-market election,

      4. Is making an election reportable in Part II of the form, or

      5. Is required to file an annual report pursuant to section 1298(f). See the Part I instructions, later, for more information regarding the person that must file pursuant to section 1298(f).

The majority of individuals who have to file a Form 8621 do so because they have to file an annual report subject to 1298(f).

26 U.S.C. 1298(f)

(f) Reporting requirement

• • • Except as otherwise provided by the Secretary, each United States person who is a shareholder of a passive foreign investment company shall file an annual report containing such information

Exceptions to Filing Form 8621

For individuals who only have to file a PFIC form 8621 because they fall under 1298(f), it is important that they are also aware of the potential exceptions, because taxpayers who do not have to file Form 8621 should not do so. As further provided by the IRS:

Exceptions to Filing Part I

A shareholder is exempt from completing Part I if it meets one of the exceptions described below. Special rules for estates and trusts. Certain U.S. grantors and beneficiaries of estates and trusts may qualify for an exception to filing Part I.

• • • A U.S. grantor of a domestic grantor trust is not required to complete Part I if the trust is a domestic liquidating trust or a widely held fixed investment trust, as described in Regulations section 1.1298-1(b)(3)(i). In these circumstances, the domestic grantor trust is required to complete Part I.

    • In certain situations, a shareholder who is a member or beneficiary of (or participant in) an arrangement treated as a foreign pension fund under a U.S. income tax treaty that owns an interest in a PFIC is not required to complete Part I with respect to the PFIC. See Regulations section 1.1298-1(c)(4).

    • A U.S. beneficiary of a foreign nongrantor trust or foreign estate is not required to complete Part I with respect to the stock of the PFIC that is owned by the trust or estate unless it has made a QEF or section 1296 mark-to-market election, received an excess distribution, or recognized gain treated as an excess distribution with respect to the stock of the PFIC. See Regulations section 1.1298-1(b)(3)(ii). Exempt organizations. In general, if a shareholder of a PFIC is a tax-exempt organization, the shareholder is required to complete Part I only if income derived with respect to the PFIC stock would be taxable to the shareholder under subchapter F. See Regulations section 1.1298-1(c)(1).

Exception if Aggregate value of Shareholder’s PFIC stock is $25,000 or less.

• • • “A shareholder is not required to complete Part I with respect to a specific section 1291 fund if the shareholder meets the $25,000 exception on the last day of the shareholder’s tax year and the shareholder does not receive an excess distribution from, or recognize gain on the sale or disposition of the stock of, the section 1291 fund. For purposes of determining whether a shareholder satisfies the $25,000 threshold, the shareholder takes into account all PFIC stock (QEFs, section 1291 funds, and PFIC stock subject to a section 1296 mark-to-market election) owned directly or indirectly other than PFIC stock owned through another U.S. person or PFIC stock owned through another PFIC. Shareholders filing a joint return have a combined threshold of $50,000 instead of $25,000 for purposes of this exception. For more information, see Regulations section 1.1298-1(c) (2).”

Exception if the value of Shareholder’s indirect PFIC stock is $5,000 or less.

• • • “A shareholder is not required to complete Part I with respect to indirect ownership of a specific section 1291 fund if the shareholder meets the $5,000 exception with respect to the section 1291 fund on the last day of the shareholder’s tax year and the shareholder does not receive an excess distribution from, or recognize gain on the sale or disposition of the stock of, the section 1291 fund. For purposes of determining whether a shareholder satisfies the $5,000 threshold, the shareholder takes into account only the value of the shareholder’s proportionate share of the section 1291 fund. For more information, see Regulations section 1.1298-1(c) (2).”

Late Filing Penalties May be Reduced or Avoided

For Taxpayers who did not timely file their FBAR and/or other international information-related reporting forms, the IRS has developed many different offshore amnesty programs to assist Taxpayers with safely getting into compliance. These programs may reduce or even eliminate international reporting penalties.

Late-Filing Disclosure Options

If a Taxpayer is out of compliance, there are various international offshore tax amnesty programs that they can apply to safely get into compliance. Depending on the specific facts and circumstances of the Taxpayers’ noncompliance, they can determine which program will work best for them.

*Below please find separate links to each program with extensive details about the reporting requirements and examples.

Streamlined Filing Compliance Procedures (SFCP, Non-Willful)

The Streamlined Filing Compliance Procedures is one of the most common programs used by Taxpayers who are non-willful and qualify for either the Streamlined Domestic Offshore Procedures or Streamlined Foreign Offshore Procedures.

Streamlined Domestic Offshore Procedures (SDOP, Non-Willful)

Taxpayers who are considered U.S. residents and file timely tax returns each year but fail to report foreign income and/or assets may consider the Streamlined Domestic Offshore Procedures.

Streamlined Foreign Offshore Procedures (SFOP, Non-Willful)

Taxpayers who are foreign residents may consider the Streamlined Foreign Offshore Procedures which is typically the preferred program of the two streamlined procedures. That is because under this program Taxpayers can file original returns and the 5% title 26 miscellaneous offshore penalty is waived.

Delinquent FBAR Submission Procedures (DFSP, Non-Willful/Reasonable Cause)

Taxpayers who only missed the FBAR reporting and do not have any unreported income or other international information reporting forms to file may consider the Delinquent FBAR Submission Procedures — which may include a penalty waiver.

Delinquent International Information Returns Submission Procedures (DIIRSP, Reasonable Cause)

Taxpayers who have undisclosed foreign accounts and assets beyond just the FBAR — but have no unreported income — may consider the Delinquent International Information Return Submission Procedures. Before November 2020, the IRS was more inclined to issue a penalty waiver, but since then this type of delinquency procedure submission has morphed into a reasonable cause request to waive or abate penalties.

IRS Voluntary Disclosure Procedures (VDP, Willful)

For Taxpayers who are considered willful, the IRS offers a separate program referred to as the IRS Voluntary Disclosure Program (VDP). This program is used by Taxpayers to disclose both unreported domestic and offshore assets and income (before 2018, there was a separate program that only dealt with offshore assets (OVDP), but that program merged back into the traditional voluntary disclosure program (VDP).

Quiet Disclosure

Quiet disclosure is when a Taxpayer submits information to the IRS regarding the undisclosed foreign accounts, assets, and income but they do not go through one of the approved offshore disclosure programs. This is illegal and the IRS has indicated they have every intention of investigating Taxpayers who they discover intentionally sought to file delinquent forms to avoid the penalty instead of submitting to one of the approved methods identified above.

Current Year vs. Prior Year Non-Compliance

Once a Taxpayer missed the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, Taxpayers should consider speaking with a Board-Certified Tax Law Specialist who specializes exclusively in these types of offshore disclosure matters.

Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)

In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful Taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties. 

Need Help Finding an Experienced Offshore Tax Attorney?

When it comes to hiring an experienced international tax attorney to represent you for unreported foreign and offshore account reporting, it can become overwhelming for Taxpayers trying to trek through all the false information and nonsense they will find in their online research. There are only a handful of attorneys worldwide who are Board-Certified Tax Specialists and who specialize exclusively in offshore disclosure and international tax amnesty reporting. 

*This resource may help Taxpayers seeking to hire offshore tax counsel: How to Hire an Offshore Disclosure Lawyer.

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure. 

Contact our firm today for assistance.