What is a PFIC (IRS Summary 2020)
PFIC: Revisiting Passive Foreign Investments: PFIC is 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.
PFIC (Passive Foreign Investment Company)
PFIC involves many different types of foreign passive investments. The first step in evaluating a PFIC for tax and reporting purposes is to be sure you actually have one.
What are the Passive Foreign Investment Company Tests?
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 the PFIC
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 a PFIC
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 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. 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. 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 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.
Golding & Golding (Board-Certified Tax Law Specialist)
We specialize exclusively in international tax, and specifically IRS offshore disclosure.
We have successfully represented clients in more than 1,000 streamlined and voluntary offshore disclosure submissions nationwide and in over 70-different countries. We have represented thousands of individuals and businesses with international tax problems.
We are the “go-to” firm for other Attorneys, CPAs, Enrolled Agents, Accountants, and Financial Professionals across the globe.
- Learn more about the Board-Certified Tax Lawyer Specialist credential
- Learn more about the Enrolled Agent credential
- Learn more about Golding & Golding’s Case Accomplishments
- Learn more about Golding & Golding Testimonials from prior clients
We are the “go-to” firm for other Attorneys, CPAs, Enrolled Agents, Accountants and Financial Professionals worldwide.
Less than 1% of Tax Attorneys Nationwide Are Certified Specialists
Sean M. Golding is one of less than 350 Attorneys (out of more than 200,000 practicing California Attorneys) to earn the Certified Tax Law Specialist credential. The credential is awarded to less than 1% of Attorneys.
Recent Golding & Golding Case Highlights
- We represented a client in an 8-figure disclosure that spanned 7 countries.
- We represented a high-net-worth client to facilitate a complex expatriation with offshore disclosure.
- We represented an overseas family with bringing multiple businesses & personal investments into U.S. tax and offshore compliance.
- We took over a case from a small firm that unsuccessfully submitted multiple clients to IRS Offshore Disclosure.
- We successfully completed several recent disclosures for clients with assets ranging from $50,000 – $7,000,000+.
How to Hire Experienced Offshore Counsel?
Generally, experienced attorneys in this field will have the following credentials/experience:
- Board Certified Tax Law Specialist credential
- Master’s of Tax Law (LL.M.)
- Dually Licensed as an EA (Enrolled Agent) or CPA
- 20-years experience as a practicing attorney
- Extensive litigation, high-stakes audit and trial experience
Beware of inexperienced counsel trying to mislead you about the Streamlined Procedures or Reasonable Cause.
Interested in Learning More about Golding & Golding?
No matter where in the world you reside, our international tax team can get you IRS offshore compliant.
Golding & Golding specializes in FBAR and FATCA. Contact our firm today for assistance with getting compliant.
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. He has also earned the prestigious IRS Enrolled Agent credential. Mr. Golding's articles have been referenced in such publications as the Washington Post, Forbes, Nolo, and various Law Journals nationwide.