Why Foreign Mutual Funds, Unit Trusts and ETFs are PFICs?
Some U.S. taxpayers who invest in foreign assets will acquire foreign mutual funds and ETFs as part of their portfolio. These are referred to as ‘pooled funds, ’ and pooled fund investments have become much more prevalent in the past 20 years because they allow taxpayers to purchase a larger share of the market without having the hassle of going through and purchasing 50 or 100 different companies. But if the taxpayer is a U.S. person and the investment is a foreign mutual fund, ETF, or unit trust, the taxpayer may have inadvertently invested in a PFIC (Passive Foreign Investment Company). Investing in a PFIC comes with several additional IRS international information reporting form requirements and tax obligations, which oftentimes can make the investment not worth the headache that it takes to maintain the investment for U.S. tax and reporting purposes. Let’s take a brief introduction as to why foreign mutual funds and ETFs are PFICs.
First, What is a PFIC?
A PFIC is a Passive Foreign Investment Company, and they come in many different shapes and sizes — but for many individual taxpayer investors, the reason why they own a PFIC is that they own a mutual fund, ETF, or Unit Trust. Each one of these types of investments is typically a self-incorporated entity — or formed as a trust — and generates most of its money through passive income earnings. As a result, they are by default considered PFICs even though the taxpayer never intended to invest in a PFIC and simply acquired foreign pooled funds – even if they owned the investment before they became a U.S. person for tax purposes.
What is a Mutual Fund?
A mutual fund is an investment in a diverse portfolio of securities such as bonds, stocks, and other investments. From an individual investor’s perspective, instead of investing in hundreds of different companies, the investor can purchase a fund, and that fund owns shares in hundreds of different companies. Oftentimes, a mutual fund is formed as an entity such as a corporation or a trust with an asset management company overseeing the investment. Since it is technically a corporation/trust and it generates primarily passive income, this is why it can be deemed a PFIC.
What is an ETF?
The ETF is similar to the mutual fund, except that with an ETF, the taxpayer can trade the fund in real time to capture gains and losses throughout the day. With the mutual fund, the NAV is not determined until the close of trading hours, so taxpayers do not have the opportunity to capture price fluctuations throughout the day. But from a technical standpoint, an ETF is also typically formed as a corporation or trust with an asset management company and generates primarily passive income; thus, it can also be deemed a PFIC.
What is a Unit Trust?
Many foreign countries utilize the unit trust as something that is equivalent to a mutual fund or ETF. It is similar in concept and structure to a mutual fund or ETF, aside from the fact that typically they are held until a certain date and then the trust terminates. In addition, a unit trust typically is not actively managed the same way that a fund in the United States is. Ultimately though, if a unit trust is formed as a corporation or trust and generates primarily passive income, then it would be deemed a PFIC for U.S. tax purposes.
You Own a PFIC: What Now?
Owning a PFIC comes with many different tasks and reporting requirements. The taxpayer may have to pay excess distributions and may qualify for certain elections, although if they are not made in the initial year, they may have to make what is referred to as a purging election, which results in a significant tax implication. We are one of the only international tax law firms worldwide that specialize exclusively in offshore disclosure and have represented hundreds of taxpayers worldwide with complex PFIC issues. We have several resources on our website to assist you with understanding how PFICs work and what you can do to try to minimize the burden.
Late Filing Penalties May Be Reduced or Avoided
For Taxpayers who did not timely file their FBAR and/or other international information-related reporting forms, the IRS has developed many different offshore amnesty programs to assist Taxpayers with safely getting into compliance. These programs may reduce or even eliminate international reporting penalties.
Current Year vs. Prior Year Non-Compliance
Once a Taxpayer missed the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, Taxpayers should consider speaking with a Board-Certified Tax Law Specialist who specializes exclusively in these types of offshore disclosure matters.
Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)
In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful Taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties.
Need Help Finding an Experienced Offshore Tax Attorney?
When it comes to hiring an experienced international tax attorney to represent you for unreported foreign and offshore account reporting, it can become overwhelming for Taxpayers trying to trek through all the false information and nonsense they will find in their online research. There are only a handful of attorneys worldwide who are Board-Certified Tax Specialists and who specialize exclusively in offshore disclosure and international tax amnesty reporting.
*This resource may help Taxpayers seeking to hire offshore tax counsel: How to Hire an Offshore Disclosure Lawyer.
Golding & Golding: About Our International Tax Law Firm
Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure.
Contact our firm today for assistance.