Time to rethink your offshore PFIC investments? What is a PFIC and why should you be concerned about the impact it will have on taxation? Why should a PFIC investment worry you as a US taxpayer?
A passive foreign investment company, or PFIC, is a foreign corporation that either maintains 50% or more of its assets in the form of securities or cash, or a foreign corporation that derives more than 75% of its gross income from passive income, such as rental income , interest and/or dividends. There are many offshore investments that the IRS will classify as PFICs, such as mutual funds, insurance companies, hedge funds, foreign money markets, exchange-traded funds (EFTs), closed-end funds, and foreign pension funds. Another common description of a PFIC is any form of non-US company that manages “pooled investments.”
“Once a PFIC, Always a PFIC.”
There has been a rush to form in the past few years offshore corporations and invest in foreign trusts to “shield” the income from the US tax authorities. This strategy not only becomes riskier, but also opens the door to a whole new level of punishment. After a US taxpayer learns that his investment or company has been designated as a PFIC, his natural question is “how do we change the nature of the company or its ownership to get out of the costly IRS PFIC rules?
The answer is “never mind. Once a PFIC, always a PFIC.” Once a non-U.S. corporation is classified as a PFIC for the tax year in which the taxpayer acquires an interest in that corporation, the taxpayer must always treat it as a PFIC—even if that foreign corporation no longer meets the gross income or asset tests under the IRS PFIC rules .
“Investment, Inheritance or Immigration – Surprising PFIC Rules”
You can acquire a direct or indirect interest in a PFIC through your own investments, inheritance, or if you already own stock in a non-US company when you immigrate to the US. You can trigger consequences simply by using these assets as collateral for a loan. It’s also important to understand that the expensive IRS PFIC rules supersede other tax-free provisions regarding transactions. You may be surprised to learn that simply inheriting an asset, owning it before arriving in the US, or using that asset in a transaction can increase your US tax burden.
Many American investors choose to invest money abroad in an attempt to diversify their portfolio. In other cases, a US expat simply uses domestic investments or enrolls in a “foreign” (in their case, domestic) pension fund or pension system.
The high US taxation and costs associated with PFIC investments
US taxpayers are often surprised to learn that their offshore investment actually qualifies as a PFIC under IRS rules. They are even more horrified by the exorbitant tax rates associated with these investments, which often are 50% or more when you consider the amount of taxation (based on the highest personal tax rate, currently 37% for 2023), along with penalties and interest. To make matters worse, US taxpayers may not defer gains or deduct many of their losses (which are limited to PFIC investments).
US taxpayers with PFIC investments are beginning to understand the incredible costs and nightmare of reporting IRS compliance for these offshore investments. Those who have invested in a PFIC should generally identify and hire a tax professional who can manage international tax planning and reporting. However, adding an international tax professional to your team does not necessarily mean that your PFIC investments are properly accounted for and that you have paid the appropriate taxes.
The client in this scenario may fail to disclose the investment or provide supporting information related to its PFIC investment(s).
In other cases, a US taxpayer may provide all the supporting information provided by the PFIC investment, trusting that their tax professional has what they need to complete IRS and state tax returns. But they’re in for some additional bad (read: expensive) news.
The next challenge in the process of accounting for a PFIC investment and paying the appropriate taxes is actually quite serious: the accounting process itself and the methodology regarding the realization of income and losses are quite different in Europe and around the world than here in the United States. countries. Consequently, considerable time must be invested to “translate” the reported offshore PFIC accounting from the International Financial Reporting Standards or IFRS used in Europe and many other parts of the world to the Generally Accepted Accounting Principles or GAAP style of accounting , which we have standardized here in the US.
In addition, PFIC investments are required to be reported on IRS Form 8621, Information Return by Shareholder of Passive Foreign Investment Company or Qualified Electing Fund, and each particular PFIC requires its own separate 8621.
Simply put, it takes a lot of time, and the American taxpayer is quite often shocked to see the number of hours it takes to complete the analysis, let alone the bill for the services rendered.
FATCA changed the global economic reporting system, and the IRS now receives electronic information about US taxpayers from banks, financial institutions and sovereign tax authorities around the world. As a result, the IRS is able to more easily identify unreported PFIC investments, as well as misreporting and underpayment of related taxes.
It’s probably past time to rethink your offshore PFIC investments. US taxpayers with existing PFIC investments should consult an experienced and qualified international tax and transaction planning expert. Is there a strategy in place to move these investments into other vehicles? What alternatives can provide a higher actual net return after expenses and taxation of a PFIC