What is a Passive Foreign Investment Company (PFIC)?
A PFIC is a Passive Foreign Investment Company, which is where a company decides to make a foreign (non-US) investment. A relevant and common example of a PFIC is when a company invests in a non-American mutual fund, however, the term encompasses a far wider range of investments than simply this. Examples include pension funds, hedge funds, and insurance companies based outside the US. The gross income of the company has to be passive; the revenue would be obtained from sources and investments that are not related to the company’s regular business operations. Many people are unaware they have a PFIC often because of investments made from those in control of a mutual fund in which they have invested.
How will I know if I have a Passive Foreign Investment Company (PFIC)?
PFICs can be challenging to identify, and it may require some detailed research in order to assess if you have one. Two clear tests in order to identify a PFIC are the Income Test and the Asset Test. Firstly, if 75% or more of a company’s gross income is passive, the company is classed as a PFIC (the income test). Secondly, if 50% or more of the assets that are held by the company are for the purpose of generating passive income, the company can also be classed as a PFIC (the asset test). These tests apply to a large proportion of foreign investment accounts and is part of the reason why many people are unaware that they have a PFIC.
What should someone do if they discover that they have a PFIC and how is it reported to the IRS?
If someone discovers that they have a PFIC, or have shares in a PFIC, they should report it to the IRS as part of their tax return by filling in IRS Form 8621, as it is becoming increasingly likely that the IRS will eventually identify it if the individual does not declare it. The form asks for general information about the fund to be provided, such as its account number, its value, its distribution, and its gain or loss, amongst other things. It is required that this form be filed in on an annual basis.
Why do people not like PFICs?
Most people tend to dislike PFICs, as the regulations and rates around their taxation are relatively harsh and can be up to the highest US marginal tax rate. As mentioned above, many people are unaware that they have a PFIC in the first place, and thus they dislike how harshly they are taxed on an investment they were unaware was liable to taxation. People also dislike the taxation of something that is not tangible to them; they may have an unrealised gain that they do not know about that they are being taxed on, as it is only on paper. This can begin to cause cash flow problems for people in certain cases, as they have to pay tax on their investment without receiving the gain from it.
The profit is on paper, but not real money in the bank… so paying the tax with real money is a concern.
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Are there any exemptions to the taxation of PFICs?
PFICs are taxed depending on income, and thus there is no fixed answer as it would vary from investment to investment, although as mentioned above, the taxation rate can be up to the highest US marginal tax rate. However, there are ways in which the PFIC can be taxed at a lower level, which can be discussed with our specialist IRS-licensed tax advisors.
How do you get out of a Passive Foreign Investment Company (PFIC)?
Once an individual has established that they have invested in a PFIC, many wish to get out of that investment as soon as they can. It is something that is never too late to sort, and indeed the sooner this is done the better. In some cases, it is possible to make changes even before the end of the calendar year, and thus potentially not have to report the PFIC beyond that tax year. It is again advisable to contact a tax advisor or company in order to assist with this process.
You can book a free consultation with a member of our tax team to discuss your investments to see if you’re likely to unknowingly invest in a PFIC. You can also discuss how to look for the best opportunity to divest if you’re already invested.
How do you avoid a Passive Foreign Investment Company (PFICs)?
PFICs are best avoided by advanced tax planning ahead of time. It would be advisable for any US individual looking to invest in a company/fund to do this. Contacting an international US tax advisor is helpful in this scenario; they would be able to answer questions and help with a tax plan, which would often help the individual avoid having to pay a higher rate of tax… and sometimes avoid US tax altogether.
Contact us at Expat US Tax to have an initial free 20-minute consultation regarding PFIC’s and ways to save you money. We are also able to file tax returns on your behalf should you need it under a pre-agreed fee that won’t be adjusted through the process.