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Just Learned You Have a PFIC? (Don't Worry, It's Really Not That Bad) - Golding & Golding

Just Learned You Have a PFIC? (Don’t Worry, It’s Really Not That Bad) – Board Certified Tax Specialist

How to Report a PFIC (Passive Foreign Investment Company) to IRS: A  U.S shareholder with ownership of Passive Investments such as investment funds, holding corporations, ETFs, and mutual funds may have to file an annual Form 8621 — Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund)

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PFIC

PFIC is one of the most dreaded acronyms in IRS Tax Law.  A PFIC is a Passive Foreign Investment Company and the reason it is so “Feared” is because of how the IRS taxes a PFIC.

Key issues involving PFICs will generally include:

  • QEF Elections
  • Mark-to-Market Elections
  • Form 8621
  • Excess Distributions
  • PFIC Reporting
  • PFIC Tax Calculations

Passive Foreign Investment Company

The following is a PFIC Summary Review Guide, explaining the basics of Passive Foreign Investment Companies.

PFIC – Form 8621 Basics

Determining whether a business is a PFIC is a multi-step process. It involves a comprehensive analysis of the type of investment, and it may include many different types of assets, such as a Foreign Mutual Fund, Investment Fund, or holding company — such as a BVI.

For some types of investments, it will require a deep analysis into the type of assets, income and holding periods of the underlying company (including subsidiaries or sister corporations) to  determine if it is a PFIC, but that is just the start.

PFIC Analysis

If the initial analysis reveals a PFIC, and presuming no elections were made, the tax situation will be exacerbated ten-fold (either now or in the future) for any year in which an excess distribution has been issued. In other words, PFICs are no fun; moreover, under current IRS rules and guidelines PFICs are not very profitable either.

In addition, the failure to properly report a PFIC to the U.S. Government on forms such as an FBAR (Report of Foreign Bank and Financial Accounts), FATCA Form 8938 (Statement of Specified Foreign Assets) or IRS Form 8621 (Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund) may result in significant fines and penalties as well.

*While there is no direct 8621 monetary penalty, it flows through Form 8938, which can issue up to $60,000 in penalties.

What is a PFIC?

A PFIC is a Passive Foreign Investment Company.  It is a company that generally operates overseas (offshore, foreign country, abroad) and generates a majority of its income through passive means, and/or has a majority of its assets as passive assets. In other words, the monies being generated are through passive means as opposed to active means.

For example, if David has a company in Hong Kong which he uses to consult, and all of the money earned is through his active consulting with other businesses, then that is an active type of company and would not be subject (other factors pending) to treatment as a PFIC — since David generates his income through active means.

Alternatively, if David operates a holding company overseas (including Foreign Mutual Funds or possibly Foreign Insurance Companies) in which all the money earned is through the payment of dividends, interest or capital gains to the Holding Company that “holds” the investments, that would most likely be a passive company. Why? Because the money being earned is not as a result of David working, but rather as a result of the investments earning money (not to be confused with David operating as a trader or investment analyst and charging for his investment knowledge and services).

IRS Definition of PFIC

As defined by the IRS: A foreign corporation is a PFIC if it meets either the income or asset test described below.

Income test

75% or more of the corporation’s gross income for its taxable year is passive income (as defined in section 1297(b)).

Asset test

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.

Basis for measuring assets.   When determining PFIC status using the asset test, a foreign corporation may use adjusted basis if:

  1. The corporation is not publicly traded for the taxable year and
  2. The corporation is (a) a controlled foreign corporation within the meaning of section 957 (CFC) or (b) makes an election to use adjusted basis.

Publicly traded corporations must use fair market value when determining PFIC status using the asset test.

Look-thru rule

When determining if a foreign corporation that owns at least 25% (by value) of another corporation is a PFIC, the foreign corporation is treated as if it held a proportionate share of the assets and received directly its proportionate share of the income of the 25%-or-more owned corporation.

CFC overlap rule

A 10% U.S. shareholder (defined in section 951(b)) that includes in income its pro rata share of subpart F income for stock of a CFC that is also a PFIC generally will not be subject to the PFIC provisions for the same stock during the qualified portion of the shareholder’s holding period of the stock in the PFIC. This exception does not apply to option holders. For more information, see section 1297(d).

PFIC and Foreign Mutual Fund Classifications

As the United States continues cracking down on offshore tax havens and unreported foreign income, the Internal Revenue Service has expanded the definition of a PFIC. Unfortunately, the expanded definition of a PFIC now includes all foreign mutual funds. Thus, by simply purchasing and owning a foreign mutual fund (even though you do not own any actual Company or Corporation, or hold the funds in a foreign holding company or BVI for example) you are setting yourself up for having to comply with IRS PFIC Rules — namely form 8621.

While the simple reporting of a PFIC is not necessarily a big deal (aside from the fact that you were probably hoping to keep your foreign investment below the IRS radar), the reporting and taxation of excess distributions can be very intense. If you want to better understand Excess Distributions, we have prepared a comprehensive analysis/calculation in a separate article which you can find by clicking here.

Briefly, an excess distribution is generally when the current year distribution (excluding the first year of the investment when a distribution is made in  the first year) is more than 125% of the average of distributions of the three (3) prior years. It is important to distinguish between a first-year distribution and the “first distribution.” If you receive a distribution in the first year, then it is not an excess distribution because it is not an excess of any “prior year” distributions.

In sharp contrast, if the investment has been held for the last 10 years, and the 10th year was the first distribution you receive, then by definition is going to be considered an excess distribution because the average of the three prior years is zero. Therefore, any distribution is going to be more than 125% of the prior years.

Form 8621 and Filing Exceptions

In years in which you do not have to calculate an excess distribution, IRS reporting form 8621 is not so bad. The form is filed as an alternative to FATCA form 8938 (you do not have the file both forms annually — just one form). Moreover, if you happen to fall below the exemption amount ($25,000 single or $50,000 MFJ in total of foreign mutual funds, not per mutual fund) then you may be able to avoid filing the form altogether(depending on whether you have other assets or accounts — and what the value of them is. There are also some more technical exceptions/exclusions that go beyond the scope of the article.

If you do happen to have an excess distribution, the calculations are complex. You would need to know the basis of he value of the investment when you first received it, the value of the dividend for distribution when you received it, and the prior-year distributions.

PFIC Elections

In order to avoid the harsh tax liability of having excess distribution, the IRS does allow the owners of foreign PFIC to make certain elections to reduce or minimize tax liability. Most people do not make these elections, because it is difficult to get the foreign investment fund to comply, in addition to the fact that most individuals do not want the information reported to the IRS – aka “Why they made the foreign investment to begin with”

Essentially, there are two types of elections that can be made: Qualified Elective Fund or Mark-To-Market. Each election comes with its own set of pros and cons, and before making any such election you should speak with a qualified international tax lawyer to evaluate the facts and circumstances of your case, along with whether you have been in compliance with reporting responsibilities of having a PFIC in prior years.

FBAR

An FBAR is a “Report of Foreign Bank and Financial Account” Form. It is required to be filed electronically with the Department of Treasury by any U.S. taxpayer who has an annual aggregate total of more than $10,000 overseas at any given time, in any given year. The hardest part about filing the FBAR is usually determining what accounts are required to be disclosed; the IRS and DOT do not make it easy.

*Foreign Mutual Funds should be reported on an FBAR.

U.S. Fund with Foreign Accounts

Generally, almost any foreign “account” has to be reported on the FBAR. There are exceptions, but the exceptions are limited. Conversely, ownership of certain foreign corporate and partnership interests, generally do not need to be reported on an FBAR (as opposed to an 8938 and/or foreign accounts held in the name of the foreign business).

For example, if you own a foreign corporate or partnership interest, you may still have to report the information about accounts owned by the foreign corporation on an FBAR (ex, you own the company and/or have signature authority as an employee), but that is determined on a case-by-case basis in accordance with the type of foreign business, ownership percentage, and whether the entity is “disregarded.”

We Specialize in Safely Disclosing Foreign Money

We have successfully handled a diverse range of IRS Voluntary Disclosure and International Tax Investigation/Examination cases involving FBAR, FATCA, and high-stakes matters for clients around the globe (In over 65 countries!)

Whether it is a simple or complex case, safely getting clients into compliance is our passion, and we take it very seriously.

Examples of areas of tax we handle

Who Decides to Disclose Unreported Money?

What Types of Clients Do we Represent?

We represent Attorneys, CPAs, Doctors, Investors, Engineers, Business Owners, Entrepreneurs, Professors, Athletes, Actors, Entry-Level staff, Students, Former/Current IRS Agents and more.

You are not alone, and you are not the only one to find himself or herself in this situation.

Sean M. Golding, JD, LL.M., EA (Board Certified Tax Law Specialist)

Our Managing Partner, Sean M. Golding, JD, LLM, EA  earned an LL.M. (Master’s in Tax Law) from the University of Denver and is also an Enrolled Agent (the highest credential awarded by the IRS, and authorizes him to represent clients nationwide.)

Mr. Golding and his team have successfully handled several hundred IRS Offshore/Voluntary Disclosure Procedure cases. Whether it is a simple or complex case, safely getting clients into compliance is our passion, and we take it very seriously.

He is frequently called upon to lecture and write on issues involving IRS Voluntary Disclosure.

Less than 1% of Tax Attorneys Nationwide are Board Certified Tax Law Specialists 

The Board Certified Tax Law Specialist exam is offered in many states, and is widely regarded as one of (if not) the hardest tax exam given in the United States for practicing Attorneys. Certification also requires the completion of significant ethics and experience requirements.

In California alone, out of more than 200,000 practicing attorneys (with thousands of attorneys practicing in some area of tax law), less than 350 attorneys are Board Certified Tax Law Specialists.

Beware of Copycat Law Firms

Unlike other attorneys who call themselves specialists or experts in Voluntary Disclosure but are not “Board Certified,” handle 5-10 different areas of tax law, purchase multiple keyword specific domain names, and even practice outside of tax, we are absolutely dedicated to Offshore Voluntary Disclosure.

*Click here to learn the benefits of retaining a Board Certified Tax Law Specialist with advanced tax credentials.

IRS Penalty List

The following is a list of potential IRS penalties for unreported and undisclosed foreign accounts and assets:

Failure to File

If you do not file by the deadline, you might face a failure-to-file penalty. If you do not pay by the due date, you could face a failure-to-pay penalty. The failure-to-file penalty is generally more than the failure-to-pay penalty.

The penalty for filing late is usually 5 percent of the unpaid taxes for each month or part of a month that a return is late. This penalty will not exceed 25 percent of your unpaid taxes. If you file your return more than 60 days after the due date or extended due date, the minimum penalty is the smaller of $135 or 100 percent of the unpaid tax.

Failure to Pay

f you do not pay your taxes by the due date, you will generally have to pay a failure-to-pay penalty of ½ of 1 percent of your unpaid taxes for each month or part of a month after the due date that the taxes are not paid. This penalty can be as much as 25 percent of your unpaid taxes. If both the failure-to-file penalty and the failure-to-pay penalty apply in any month, the 5 percent failure-to-file penalty is reduced by the failure-to-pay penalty.

However, if you file your return more than 60 days after the due date or extended due date, the minimum penalty is the smaller of $135 or 100 percent of the unpaid tax. You will not have to pay a failure-to-file or failure-to-pay penalty if you can show that you failed to file or pay on time because of reasonable cause and not because of willful neglect.

Civil Tax Fraud

If any part of any underpayment of tax required to be shown on a return is due to fraud, there shall be added to the tax an amount equal to 75 percent of the portion of the underpayment which is attributable to fraud.

A Penalty for failing to file FBARs

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.

A Penalty for failing to file Form 8938

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

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

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

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

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

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

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.

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

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

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.

What Should You Do?

Everyone makes mistakes. If at some point that you should have been reporting your foreign income, accounts, assets or investments the prudent and least costly (but most effective) method for getting compliance is through one of the approved IRS offshore voluntary disclosure program.

Be Careful of the IRS

With the introduction and enforcement of FATCA for both Civil and Criminal Penalties, renewed interest in the IRS issuing FBAR Penalties, crackdown on Cryptocurrency (and IRS joining J5), the termination of OVDP, and recent foreign bank settlements with the IRS…there are not many places left to hide.

4 Types of IRS Voluntary Disclosure Programs

There are typically four types of IRS Voluntary Disclosure programs, and they include:

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International Tax Lawyers - Golding & Golding, A PLC

International Tax Lawyers - Golding & Golding, A PLC

Golding & Golding: Our International Tax Lawyers practice exclusively in the area of IRS Offshore & Voluntary Disclosure. We represent clients in 70 different countries. Managing Partner, Sean M. Golding, JD, LL.M., EA and his team have represented thousands of clients in all aspects of IRS offshore disclosure and compliance during his 20-year career as an Attorney. Mr. Golding's articles have been referenced in such publications as the Washington Post, Forbes, Nolo and various Law Journals nationwide.

Sean holds a Master's in Tax Law from one of the top Tax LL.M. programs in the country at the University of Denver, and has also earned the prestigious Enrolled Agent credential. Mr. Golding is also a Board Certified Tax Law Specialist Attorney (A designation earned by Less than 1% of Attorneys nationwide.)
International Tax Lawyers - Golding & Golding, A PLC