PFIC Tax Treatment – 5 Examples of U.S. Tax on Foreign Investments
- 1 PFIC Tax Treatment
- 2 What if It is Not Reported Properly?
- 3 How Do I know I have a PFIC?
- 4 Exceptions , Exclusions, and Limitations
- 5 What are the Options to Reduce or Avoid Penalties?
- 6 We Specialize in Safely Disclosing Foreign Money
- 7 Who Decides to Disclose Unreported Money?
- 8 Sean M. Golding, JD, LL.M., EA (Board Certified Tax Law Specialist)
- 9 Beware of Copycat Law Firms
- 10 4 Types of IRS Voluntary Disclosure Programs
- 11 How to Retain Experienced Counsel?
PFIC Tax Treatment – 5 Examples of U.S. Tax on 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.
PFIC Tax Treatment
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).
What are the Options to Reduce or Avoid Penalties?
In order to avoid severe IRS penalties, the US government has created a program entitled IRS offshore voluntary 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.
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.
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.
4 Types of IRS Voluntary Disclosure Programs
There are typically four types of IRS Voluntary Disclosure programs, and they include:
- Traditional (IRM) IRS Voluntary Disclosure Program
- Streamlined Domestic Offshore Procedures (SDOP)
- Streamlined Foreign Offshore Procedures (SFOP)
- Reasonable Cause (RC)
How to Retain Experienced Counsel?
Our clients have asked up to prepare an Offshore Disclosure Attorney Fee Summary Guide for you to help separate fact from fiction when selecting an attorney.
Contact Us Today; Let us Help You.
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.)