Common PFIC Tax & Reporting Issues – Disclosing Foreign Investments
Common PFIC Tax & Reporting Issues – Disclosing Foreign Investments
Over the years, we have spoken with thousands of clients involving a broad range of complex international tax issues. Many of these complex issues involve matters regarding PFIC Reporting and Taxes.
Why are PFICs so hard? That is because the definition of a PFIC (Passive Foreign Investment Company), is in and of itself — very complex. There are various tests a person can use to determine whether they are a PFIC, but just knowing when to identify a potential situation as one in which a PFIC is involved can be somewhat overwhelming and daunting.
This is due to the fact that even the IRS instructions and information regarding a PFIC is less than clear.
Moreover, even the most up-to-date consumer tax software such as TurboTax does not provide any analysis as to whether or not you are the proud owner or investor of a PFIC.
Worse yet, is that even if you find a program or a form to assist you with preparing the basics of the form, it will not provide the Excess Distribution calculation along with it, and the IRS does not provide that information either – although the IRS will expect you to prepare all calculations properly.
What if It is Not Reported Properly?
When a PFIC is not reported properly, there are usually two main components:
First, is preparing and submitting form 8621. While there are no direct monetary damages for not filing a form 8621, the penalty is that the non-filing of Form 8621 means the tax return is not considered complete. As such, the IRS has an extended amount of time to audit you regarding these issues.
Second, and especially in any year that you cash out and presumably receive an excess distribution, you may have not properly reported the tax, interest and penalty sufficient to meet up a PFIC excess distribution equation. Stated differently, you probably did not pay sufficient tax or interest on the money — and now you may be subject to significant taxes, interest, fines and penalties for underreporting.
How Do I know I have a PFIC?
Based on our experience, we have found a sort of commonality between many of our clients who learn for the first time that they are the owner of a PFIC. In order to provide some clarity for you in order to determine whether you may have a PFIC, we will provide you five examples of situations which oftentimes lead to the sobering reality that you invested in a PFIC.
Foreign Mutual Fund
We know, your first question is how can investing in a foreign mutual fund result in you being an owner of a foreign corporation? It’s not that complex (at least from the IRS’ perspective). Chances are the company that owns the mutual fund is a corporation and the funds involved within the mutual funds are also some type of corporation. The fund generates income from passive investments. Therefore, chances are more than 75% of the income within the fund is generated from passive income and/or more than 50% of the assets are passive assets.
Therefore, by owning an interest in a foreign mutual fund, you may be considered an owner of a PFIC.
Foreign Holding Corporation
This is also very common. The example we deal with often is as follows: David owns various stocks throughout Hong Kong, Singapore, and China. Many years ago he realized it would be easier to consolidate all of the investments under one holding company and not in his name. Therefore, prior to 2009 David opened a BVI (prior to 2009 it was easier to keep the shares unregistered) and placed all the investments into the company.
The sole purpose of the BVI is to hold the investments that generate income. All of the income generated is passive income, such as dividends, interest, capital gains, royalties, etc..
As a result, David’s company may be a PFIC.
In many different countries, a trust is the preferred method to hold investments. For example, in New Zealand it is very common to hold all assets and income in a trust, in which the trust files its own tax returns and holds the investments.
Typically, the assets in the trust are going to be income producing, and the assets are also going to be passive assets. In addition, the income is typically going to be passive income.
Therefore, if you have a foreign trust it is important to determine whether more than 50% of the assets or 75% of the income is as a result of passive means. Unlike the above two examples, oftentimes there is a mixture of both active and passive income or active and passive assets within the trust. Thus, a person should not jump to the conclusion that they are subject to PFIC rules – a full analysis should be completed.
Superannuation or Provident Fund
In this type of situation, the investment starts out as an employment retirement vehicle such as an Australian superannuation or Singaporean/Malaysian/Thai Provident Fund.
At some point subsequent to initiation of the fund, the person stops working for the employer. And, there are no employer contributions to the fund. Nevertheless, due to tax breaks the individual may receive in the country (similar to a 401(k) in the United States), they continue to deposit money into the fund.
As a result, the fund becomes primarily funded by the individual than by the employer. Moreover, if the only earnings of the fund are the passive income or passive assets, and the fund meets the other basic requirements of being a foreign corporation, what started out as an employment trust may have been transmuted into a PFIC.
Again, as with the prior example this is a complex analysis and a person should not jump into the deep end and assume it is a PFIC without taking a cross-section evaluation of the assets and income first.
ETFs, Bitcoin, & Other Sophisticated Investments
With the globalization of the US economy and investments in general becoming more complex in nature, there are various types of investments which may otherwise mimic a PFIC. For example, if you are invested in ETFs or similar investments, the IRS would probably make the presumption that is similar to a mutual fund and therefore should be reported as a PFIC (assuming that other qualifications are met).
Moreover, with the increasing popularity of crypto currency and Bitcoin, depending on how these currencies are being held, or if the Bitcoin is being held in a foreign corporation, and the type of income being generated is passive, there is the potential for the IRS to try bootstrap these investments into PFIC territory.
Therefore, if you have these types of investments and they being held in a type of corporation or through a fund, you should speak with an experienced international tax attorney to evaluate whether you may have a PFIC reporting requirement.
Exceptions , Exclusions, and Limitations
As with any type of complex tax situation, there are individuals who have already figured out ways to meet various exceptions, exclusions and other limitations. For example, if you are filing in the year in which it had no excess distributions and the aggregate total of all of your PFIC investments is less than $50,000 (married filing jointly), you may be able to avoid filing the PFIC form 8621 altogether.
Alternatively, depending on which accounting method you want to use, you may want to consider offshore disclosure to go retroactively and make a mark-to-mark election.
Otherwise, you may consider making a late QEF election, but with the understanding that you’re going to have to clean the prior PFIC Taint, which typically involves making excess distribution calculation for previous time period (prior to making the election), that you held the investment (it is even more complex than it sounds),
Out of Compliance – IRS Offshore Disclosure
Offshore Voluntary Disclosure Tax law is very complex. There are many aspects that go into any particular tax calculation, including the legal status, marital status, business status and residence status of the taxpayer.
When Do I Need to Use Voluntary Disclosure?
Voluntary Disclosure is for individuals, estates, and businesses who are out of compliance with the IRS and the Department of Treasury. What does that mean? It means that if you are required to file a U.S. tax return and you don’t do so timely, then you are out of compliance.
If the IRS discovers that you are out of compliance, you may become subject to extensive fines and penalties – ranging from a warning letter all the way up to tax liens, tax levies, seizures, and criminal investigations. To combat this, you can take the proactive approach and submit to Voluntary Disclosure.
Golding & Golding – Offshore Disclosure
At Golding & Golding, we limit our entire practice to offshore disclosure (IRS Voluntary Disclosure of Foreign and U.S. Assets). The term offshore disclosure is a bit of a misnomer, because the term “offshore” generally connotes visions of hiding money in secret places such as the Cayman Islands, Bahamas, Malta, or any other well-known tax haven jurisdiction – but that is not the case.
In fact, any money that is outside of the United States is considered to be offshore; the term offshore is not a bad word. In other words, merely because a person has money offshore (a.k.a. overseas or in a foreign country) does not mean that money is the result of ill-gotten gains or that the money is being “hidden.”
It just means it is not in the United States. Many of our clients have assets and bank accounts in their homeland countries and these are considered offshore assets and offshore bank accounts.
The Devil is in the Details…
If you do have money offshore, then it is very important to ensure that the money has been properly reported to the U.S. government. In addition, it is also very important to ensure that if you are earning any foreign income from that offshore money, that the earnings are being reported on your U.S. tax return.
It does not matter whether your money is in a country that does not tax a particular category of income (for example, many Asian countries do not tax passive income). It also does not matter if you are a dual citizen and/or if that money has already been taxed in the foreign country.
Rather, the default position is that if you are required to file a U.S. tax return and you meet the minimum threshold requirements for filing a U.S. tax return, then you have to include all of your foreign income. If you already paid foreign tax on the income, you may qualify for a Foreign Tax Credit. In addition, if the income is earned income – as opposed to passive income – and you meet either the Bona-Fide Resident Test or Physical-Presence Test, then you may qualify for an exclusion of that income; nevertheless, the money must be included on your tax return.
What if You Never Report the Money?
If you are in the unfortunate position of having foreign money or specified foreign assets that should have been reported to the U.S. government, but which you have not reported — then you are in a bit of a predicament, which you will need to resolve before it is too late.
As we have indicated numerous times on our website, there are very unscrupulous CPAs, Attorneys, Accountants, and Tax Representatives who would like nothing more than to get you to part with all of your money by scaring you into believing you are automatically going to be arrested, jailed, or deported because you have unreported money. While that is most likely not the case (depending on the facts and circumstances of your specific situation), you may be subject to extremely high fines and penalties.
Moreover, if you knowingly or willfully hid your foreign accounts, foreign money, and offshore assets overseas, then you may become subject to even higher fines and penalties…as well as a criminal investigation by the special agents of the IRS and/or DOJ (Department of Justice).
Getting into Compliance
There are five main methods people/businesses use to get into compliance. Four of these methods are perfectly legitimate as long as you meet the requirements for the particular mechanism of disclosure. The fifth alternative, which is called a Quiet Disclosure a.k.a. Silent Disclosure a.k.a. Soft Disclosure, is ill-advised as it is illegal and very well may result in criminal prosecution.
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