Understanding the IRS Basic Rules & Fundamentals of a PFIC
Understanding the IRS Basic Rules & Fundamentals of a PFIC: When a U.S. Person owns a PFIC (Passive Foreign Investment Company), tax deferral rules take a backseat to PFIC Penalty Taxes. Sometimes, it may be difficult to determine if the foreign investment is considered a PFIC, and other times it is easier. We will summarize some of the more common types of foreign companies are considered PFIC.
- 1 What are the Basic Rules of a PFIC?
- 2 Threshold Requirements
- 3 Passive Investments deemed PFIC
- 4 Exceptions , Exclusions, and Limitations
- 5 Out of Compliance – IRS Offshore Disclosure
- 6 Golding & Golding (Board-Certified)
- 7 Recent Golding & Golding Case Highlights
- 8 How to Hire Experienced PFIC Counsel?
- 9 Interested in Learning More about Golding & Golding?
What are the Basic Rules of 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).
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.
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.
Passive Investments deemed 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
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.
Golding & Golding (Board-Certified)
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.
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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 PFIC 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
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