What is a Unit Trust for US investors?
A Unit Trust is an investment fund where your money gets pooled with other people’s money to buy a mix of investments, usually stuff like stocks, bonds, or other securities. You don’t directly own those investments. Instead, you own “units” in the trust, and the value of those units goes up or down based on how the underlying investments perform.
The whole thing is run by a fund manager, someone whose job is to pick and manage the investments. Normally, you don’t have to do anything other than invest and watch how things play out.
Sparsh Ganeriwala, an IRS Enrolled Agent with 12 years of expat tax experience, specializes in US tax preparation, tax planning, and tax advice for US citizens and Green Card holders living and working in India. Sparsh also specializes in subjects such as GILTI Tax and Transition Tax for US citizens and Green Card holders who own non-US companies *Schedule a consultation with Sparsh today.
*30-minutes US$377.
Table of Contents
Are Unit Trusts a good investment for US beginners?
They can be. If you’re just getting started and you want a professionally managed option that offers decent diversification, a unit trust might work for you. But like any investment, there are pros and cons.
What are the pros?
- Diversification: You’re not putting all your eggs in one basket. Unit trusts usually invest across a mix of sectors and asset types.
- Hands-off: A fund manager takes care of the decision-making, which is great if you don’t want to track the markets every day.
- Lower entry point: Some unit trusts let you get started with relatively small amounts, so you don’t need a big chunk of cash upfront.
And the cons?
- Fees: Unit trusts can come with higher fees compared to ETFs or index funds. Management fees and other costs can eat into your returns over time.
- Liquidity: You can’t just sell your units anytime during the day like you can with an ETF. You have to wait for the end-of-day NAV, and it might take a bit of time to process the sale.
- Performance depends on the manager: If your fund manager makes good calls, great. If not, you’re stuck with the results. You’re trusting their judgment, and they’re not always right.
What are the tax benefits of unit trusts for US investors?
There aren’t exactly “bonus” tax breaks just for investing in unit trusts, but the way your income from them gets taxed is still important to understand.
How are capital gains and dividends taxed?
- Dividends: If the trust pays out dividends, those usually get taxed as ordinary income unless they qualify as “qualified dividends,” which might be taxed at a lower rate.
- Capital gains: If the trust sells something for a profit, that gain might get passed on to you. You’ll pay either short-term or long-term capital gains tax, depending on how long the trust held the investment.
If you sell your own units in the trust and make a profit, that’s a capital gain too, and the same rules apply.
What about IRS reporting?
You’ll likely get a Form 1099-DIV or something similar at tax time that breaks down what you earned and what needs to go on your return. If you’re living abroad and investing through a foreign unit trust, it might get even more complicated and could involve PFIC rules (Passive Foreign Investment Company). That’s a whole other thing and often a reason to talk to a tax advisor.
US Unit Trusts vs Foreign Unit Trusts
US unit trusts – are generally treated as regulated investment companies or grantor trusts, meaning expats usually just deal with simple forms like 1099 or sometimes 1041 during tax season.
Foreign unit trusts – on the other hand, are often considered PFICs (Passive Foreign Investment Companies) by the IRS, which brings extra reporting requirements like Form 8621, plus possibly Forms 8938, 3520, or 3520-A depending on the trust structure. Even if you don’t take any income out of the foreign trust, just owning it can trigger filing obligations. For US expats, that means foreign unit trusts usually involve more paperwork and higher risk of penalties if not handled properly.
Are unit trusts tax-efficient?
They’re not usually as tax-friendly as ETFs. That’s because ETFs can use a special structure to minimize capital gains distributions. Unit Trusts don’t have that same setup, so they might generate more taxable events.
Thinking about investing in Unit Trusts? Consult with a tax specialist for professional advice.
How do PFIC rules affect Unit Trusts for US expats?
PFIC rules make investing in foreign unit trusts more complicated for US expats. A Unit Trust that’s based outside the US and earns mostly passive income (like dividends or capital gains) is often considered a PFIC, or Passive Foreign Investment Company, by the IRS.
If that’s the case, you’ll need to file Form 8621 every year whether or not you made money from the investment.
Additionally, PFIC tax treatment is notoriously unfriendly. If you don’t make special elections, gains can be taxed at the highest rate with extra interest added. Plus, if you forget to file the form, the IRS can keep your entire tax return open for audit indefinitely.
Can US citizens invest in foreign unit trusts?
Yes, US citizens can invest in foreign unit trusts, but access is limited and tax rules can be a hassle. Many overseas funds won’t accept US investors because of IRS reporting requirements like FATCA. Even when you find one that does, it’s often up to you, not the fund, to deal with the IRS side of things.
If you’re using a foreign brokerage, they may not warn you about the US tax consequences, so you’ll need to do your own research. Getting a tax professional experienced in these affairs can be extremely helpful.
FAQ'S
Can I hold a foreign unit trust in my US retirement account (like an IRA)?
No. Foreign unit trusts usually aren’t allowed in IRAs or 401(k)s due to IRS restrictions and custodial rules. Only IRS-approved investments are permitted.
What happens if I don’t report my foreign unit trust to the IRS?
Is a unit trust the same as a mutual fund?
Can I switch from a foreign unit trust to a US ETF to avoid PFIC rules?
Are all foreign investment funds PFICs for US investors?
