PFIC Distributions – First Year vs. First Distribution (Certified Tax Specialist)
PFIC is an acronym for “Passive Foreign Investment Company.” As far as tax reporting goes, a PFIC is one of the more complicated aspects of international tax. Mainly, because the term PFIC is very nebulous and not properly defined.
Moreover, it is very encompassing, and once you determine whether you may be subject to the complicated tax analysis of a PFIC and Form 8621, you will also come to the conclusion that resources are scant as to how to prepare the Analysis.
PFIC and IRS Guidance
The IRS will not provide you much in the way of directions, and even the instructions are not clear for form 8621.
Moreover, if you have a PFIC and received an excess distribution, then the tax analysis requires the addition of attachments, which are complicated to say the least.
One of the main questions will be (presuming you did not make any election), is whether you are subject to an excess distribution? One main factor in determining whether you are subject to the PFIC excess distribution rules, is whether you are receiving a first year distribution vs. first distribution of the fund.
Distribution in the First Year of the Investment
For the sake of trying to keep you awake (and mildly interested), we are just going to presume that the fund is a PFIC. For example, you purchased the mutual fund worth $500,000, and you purchased the fund in 2018.
In that same year you receive a distribution for $15,000 in dividends. It is the first distribution you have received from the fund, but it was within the first year of the investment.
In other words, you receive the distribution in the investment during the first year you held the investment. In this situation, you would presumably not be subject to the excess distribution rules.
Why is This Not an Excess Distribution?
Because an Excess Distribution means the current year distribution was “in excess” of an equation provided for prior years (usually the average of three prior years multiplied by 1.25) but even if it was less than three years you may still be subject to an excess distribution.
Nevertheless, if you purchase the fund in the current year and received the first distribution from the fund in the current year, then presumably you do not have an excess distribution.
The Fund’s First Distribution (Post-First Year)
This is different. Let’s say for example that you purchase the fund in 2018 for $500,000. Five years later, you receive distributions in the amount of $50,000 as a mix of dividends and capital gains distributions.
In this situation, you would most likely be subject to an excess distribution. Why? Because in the for prior years you received no distribution. Therefore, the current year distribution is in excess of prior years – which was zero.
But I did Not Receive any Prior Distributions?
And that’s the point. The IRS is “upset” that you did not pay any tax on the incremental gains (even if they stayed within the fund), during the prior four years. Therefore, when it’s time to receive the first distribution during the fifth year of this particular fund, the IRS’ position is that you should have been taxed incrementally on the gains for each prior year in which interest/dividends/capital gain had accrued but not been distributed.
And, the IRS is going to take you to task. First, you have to separate each category of income such as capital gains, dividends, and interest. Next, you have to determine the amount of the excess distribution per category, per fund (typically will be the full amount since there were no prior-year distributions and 125% of zero is zero).
Then, you have to pay taxes at the highest allowable OI tax rate (39.6% or 35%) for each year during the five-year period (technically each day of the period), except for the current year in which you are taxed at your progressive tax rate (you do not receive long-term capital gain or dividend treatment).
Of course, you then have to pay interest on top of that.
Prior Year Non-Compliance
If you have had mutual funds or other PFIC in prior years and are not properly in compliance, you should consider getting into compliance through one of the approved IRS offshore voluntary disclosure programs.
The IRS has developed several new ITEG (International Tax Enforcement Groups) designed to go after and penalize individuals who are not in compliance. Moreover, if you are considering OVDP, then you want to keep in mind that the IRS is set to terminate this program on September 28, 2018.
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