PFIC Tax & Reporting
What is a PFIC? When it comes to international tax and offshore compliance, foreign investments in general are very complicated. The term PFIC an IRS acronym that refers to Passive Foreign Investment Companies. The acronym can be misleading to U.S. taxpayers, because it gives the impression that PFIC only refers to companies.
While technically this may be true, it does not put people on proper notice that their ownership or interest in foreign mutual funds and other funds is also taxable and reportable as a PFIC.
Moreover, with the Internal Revenue Service taking an aggressive position towards offshore enforcement and foreign accounts compliance, it is important to properly report these types of passive investment companies.
The failure to properly report and disclose PFIC on a tax return form 8621 and/or make the proper QEF or MTM election as well as report on the FBAR — could lead to significant offshore fines and penalties.
We will summarize what is a PFIC, and how it is taxed and reported.
Passive Foreign Investment Companies
There are two main tests to determine if a person has a PFIC. There is the Asset Test and the Income Test.
As provided by the IRS:
“A foreign corporation is a PFIC if it meets either the income or asset test described next.
75% or more of the corporation’s gross income for its tax year is passive income (as defined in section 1297(b)).
At least 50% of the average percentage of assets (determined under section 1297(e)) held by the foreign corporation during the tax year are assets that produce passive income or that are held for the production of passive income.”
Taxation and Reporting
If a person has a PFIC, they must carefully assess the situation to determine whether they also have a tax and/or reporting requirement.
Since 2013, the reporting rules have changed.
Under the new revised rules, once a person has a PFIC, they are required to report the value and other identifying information on a form 8621 (unless exempt or excluded).
*Previously, most reporting was only required in years there was an excess distribution.
How to Report
The PFIC must be reported using form 8621 and (sometimes) the FBAR, unless it meets one of the exceptions or limitations.
There may be other reporting forms as well, depending on the type of PFIC, such as 3520-A, 5471, and 8938.
The form 8621 is the most important form. It Is the most important form, because this form was created specifically for PFIC tax and reporting. Form 8621 is filed at the same time that a person follows their tax returns.
When a person has multiple PFICs (such as multiple mutual funds), each fund is reported separately.
Because it is important to obtain an accurate adjusted basis of each PFIC.
Therefore, when a person sells or otherwise relinquishes, switches out or redeems the investment – there will be an accurate basis for income purposes.
When it comes to Form 8621, some of the key requirements include:
- Date Acquired
- Income Earned
- Excess Distributions
FBAR (FinCEN Form 114)
The FBAR is used to report foreign financial accounts. The biggest issue with the FBAR are the sheer penalties associated with non-compliance.
Some PFICs may qualify for FBAR reporting — such as mutual funds or other investment funds.
Other PFICs, such as a holding company, BVI, Sociedad Anonima, Hong Kong or Australian PVT Ltd., are not reported on the FBAR, but may have other reporting requirements.
Exceptions and Exemptions
There are various exceptions and exemptions to reporting if a person meets the requirements. The two main exceptions, include:
Exception for $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. 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 Indirect value 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. 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.
If a person has income from a PFIC, and the income is distributed, there are tax consequences. The extent of the taxes, and penalty tax for excess distribution will vary based on the type of PFIC, distributions, excess distributions, etc.
What if I have an Excess Distribution?
What a person has an excess distribution, they must perform a very detailed and comprehensive tax analysis computation. Most tax software programs do not provide PFIC information, and most and do not even provide a copy of the form 8621.
Learn more about performing the excess distribution calculation.
What if I Never Reported the PFIC or Paid U.S. Tax?
Now that OVDP has ended, making a late MTM or QEF election is much more complicated.
If you never filed a form 8621 in the year it was required to be filed, there is no direct monetary penalty. But, the tax return remains open indefinitely for audit or examination. This may not seem like a huge problem at first, but if you are out of compliance for other issues such as FBAR or FATCA – which carry very hefty penalties – you may be inadvertently extending the statute of limitations indefinitely, for years to come.
With talks about the IRS ending the Streamlined Procedures, if you are out of compliance, you may want to speak with a specialist to consider your options.
Golding & Golding: About Our International Tax Law Firm
Golding & Golding specializes exclusively in international tax, and specifically IRS offshore disclosure.
We are the “go-to” firm for other Attorneys, CPAs, Enrolled Agents, Accountants, and Financial Professionals across the globe. Our attorneys have worked with thousands of clients on offshore disclosure matters, including FATCA & FBAR.
Each case is led by a Board-Certified Tax Law Specialist with 20 years of experience, and the entire matter (tax and legal) is handled by our team, in-house.
*Please beware of copycat tax and law firms misleading the public about their credentials and experience.
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How to Hire Experienced Offshore Counsel?
Generally, experienced attorneys in this field will have the following credentials/experience:
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