Introduction to PFIC Rules & What it Means to Own a PFIC - Golding & Golding

Introduction to PFIC Rules & What it Means to Own a PFIC – Golding & Golding

Introduction to PFIC Rules & What it Means to Own a PFIC

When a tax professional tells you that you may what the IRS has deemed a PFIC (Passive Foreign Investment Company), unfortunately that is not a good thing. It may be good for the IRS (they get more of your tax money), but for you, it is not a great result.

Common PFIC Questions:

  • What is a PFIC?
  • What are Examples of PFIC?
  • Do I have a PFIC
  • What are the taxes I owe?
  • Can I avoid Penalties

Rather, with a PFIC, the IRS is penalizing you because of the nature of your fancy foreign investment. While you may be able to make certain MTM or QEF elections, overall, most people would to try to avoid a PFIC (or at least execute proper tax planning at the outset).

PFIC

A PFIC is a Passive Foreign Investment Company. And, just knowing whether or not you have a PFIC can be an overwhelming task. That is because, oftentimes, items such as a Foreign Mutual Fund, Foreign Life Insurance Policy or even ETFs and other investments held in a personal corporation may be considered a PFIC.

Therefore, the purpose of this article is to provide you various examples of when your own investment may be considered a PFIC.

Passive Foreign Investment Company

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.

Foreign Trust

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

 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.

Examples of areas of tax we handle

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.

*Click here to learn the benefits of retaining a Board Certified Tax Law Specialist with advanced tax credentials.

IRS Penalty List

The following is a list of potential IRS penalties for unreported and undisclosed foreign accounts and assets:

Failure to File

If you do not file by the deadline, you might face a failure-to-file penalty. If you do not pay by the due date, you could face a failure-to-pay penalty. The failure-to-file penalty is generally more than the failure-to-pay penalty.

The penalty for filing late is usually 5 percent of the unpaid taxes for each month or part of a month that a return is late. This penalty will not exceed 25 percent of your unpaid taxes. If you file your return more than 60 days after the due date or extended due date, the minimum penalty is the smaller of $135 or 100 percent of the unpaid tax.

Failure to Pay

f you do not pay your taxes by the due date, you will generally have to pay a failure-to-pay penalty of ½ of 1 percent of your unpaid taxes for each month or part of a month after the due date that the taxes are not paid. This penalty can be as much as 25 percent of your unpaid taxes. If both the failure-to-file penalty and the failure-to-pay penalty apply in any month, the 5 percent failure-to-file penalty is reduced by the failure-to-pay penalty.

However, if you file your return more than 60 days after the due date or extended due date, the minimum penalty is the smaller of $135 or 100 percent of the unpaid tax. You will not have to pay a failure-to-file or failure-to-pay penalty if you can show that you failed to file or pay on time because of reasonable cause and not because of willful neglect.

Civil Tax Fraud

If any part of any underpayment of tax required to be shown on a return is due to fraud, there shall be added to the tax an amount equal to 75 percent of the portion of the underpayment which is attributable to fraud.

A Penalty for failing to file FBARs

The civil penalty for willfully failing to file an FBAR can be as high as the greater of $100,000 or 50 percent of the total balance of the foreign financial account per violation. See 31 U.S.C. § 5321(a)(5). Non-willful violations that the IRS determines were not due to reasonable cause are subject to a $10,000 penalty per violation.

A Penalty for failing to file Form 8938

The penalty for failing to file each one of these information returns is $10,000, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return.

A Penalty for failing to file Form 3520

The penalty for failing to file each one of these information returns, or for filing an incomplete return, is the greater of $10,000 or 35 percent of the gross reportable amount, except for returns reporting gifts, where the penalty is five percent of the gift per month, up to a maximum penalty of 25 percent of the gift.

A Penalty for failing to file Form 3520-A

The penalty for failing to file each one of these information returns or for filing an incomplete return, is the greater of $10,000 or 5 percent of the gross value of trust assets determined to be owned by the United States person.

A Penalty for failing to file Form 5471

The penalty for failing to file each one of these information returns is $10,000, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return.

A Penalty for failing to file Form 5472

The penalty for failing to file each one of these information returns, or to keep certain records regarding reportable transactions, is $10,000, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency.

A Penalty for failing to file Form 926

The penalty for failing to file each one of these information returns is ten percent of the value of the property transferred, up to a maximum of $100,000 per return, with no limit if the failure to report the transfer was intentional.

A Penalty for failing to file Form 8865

Penalties include $10,000 for failure to file each return, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return, and ten percent of the value of any transferred property that is not reported, subject to a $100,000 limit.

Fraud penalties imposed under IRC §§ 6651(f) or 6663

Where an underpayment of tax, or a failure to file a tax return, is due to fraud, the taxpayer is liable for penalties that, although calculated differently, essentially amount to 75 percent of the unpaid tax.

A Penalty for failing to file a tax return imposed under IRC § 6651(a)(1)

Generally, taxpayers are required to file income tax returns. If a taxpayer fails to do so, a penalty of 5 percent of the balance due, plus an additional 5 percent for each month or fraction thereof during which the failure continues may be imposed. The penalty shall not exceed 25 percent.

A Penalty for failing to pay the amount of tax shown on the return under IRC § 6651(a)(2)

If a taxpayer fails to pay the amount of tax shown on the return, he or she may be liable for a penalty of .5 percent of the amount of tax shown on the return, plus an additional .5 percent for each additional month or fraction thereof that the amount remains unpaid, not exceeding 25 percent.

An Accuracy-Related Penalty on underpayments imposed under IRC § 6662

Depending upon which component of the accuracy-related penalty is applicable, a taxpayer may be liable for a 20 percent or 40 percent penalty

Possible Criminal Charges related to tax matters include tax evasion (IRC § 7201)

Filing a false return (IRC § 7206(1)) and failure to file an income tax return (IRC § 7203). Willfully failing to file an FBAR and willfully filing a false FBAR are both violations that are subject to criminal penalties under 31 U.S.C. § 5322.  Additional possible criminal charges include conspiracy to defraud the government with respect to claims (18 U.S.C. § 286) and conspiracy to commit offense or to defraud the United States (18 U.S.C. § 371).

A person convicted of tax evasion

Filing a false return subjects a person to a prison term of up to three years and a fine of up to $250,000. A person who fails to file a tax return is subject to a prison term of up to one year and a fine of up to $100,000. Failing to file an FBAR subjects a person to a prison term of up to ten years and criminal penalties of up to $500,000.  A person convicted of conspiracy to defraud the government with respect to claims is subject to a prison term of up to not more than 10 years or a fine of up to $250,000.  A person convicted of conspiracy to commit offense or to defraud the United States is subject to a prison term of not more than five years and a fine of up to $250,000.

What Should You Do?

Everyone makes mistakes. If at some point that you should have been reporting your foreign income, accounts, assets or investments the prudent and least costly (but most effective) method for getting compliance is through one of the approved IRS offshore voluntary disclosure program.

Be Careful of the IRS

With the introduction and enforcement of FATCA for both Civil and Criminal Penalties, renewed interest in the IRS issuing FBAR Penalties, crackdown on Cryptocurrency (and IRS joining J5), the termination of OVDP, and recent foreign bank settlements with the IRS…there are not many places left to hide.

4 Types of IRS Voluntary Disclosure Programs

There are typically four types of IRS Voluntary Disclosure programs, and they include:

Contact Us Today; Let us Help You.