Is it time to rethink your offshore PFIC investment(s)? What is a PFIC and why should you be concerned about the impact it will have upon taxation? Why should investment in a PFIC concern 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 gross income passive earnings, such as rental income, interest and/or dividends. There are many offshore investments the IRS will classify as a PFIC 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 for a PFIC is any form of non-US company that manages “pooled investments.”
“Once a PFIC, Always a PFIC.”
There has been a rush over the past several years to form offshore corporations and invest in foreign trusts in order to “shield” income from US tax authorities. This strategy is not only becoming more risky, it is opening the door to a whole new level of penalization. Once a US taxpayer learns their investment or company has been designated as a PFIC their 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 “it doesn’t matter. Once a PFIC, always a PFIC.” Once a non-US corporation has been 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 satisfies the gross income or asset tests under IRS PFIC rules.
“Investment, Inheritance or Immigration – Surprising PFIC Rules”
You may acquire a direct or indirect interest in a PFIC through your own investment(s), inheritance, or if you already own shares in a non-US company when you immigrate to the US. You may trigger consequences simply by using those assets as collateral for a loan. It is also important to understand that costly IRS PFIC rules supersede other tax-free regulations regarding transactions. You may be surprised to learn that simply inheriting an asset, owning it prior to coming to the US or using that asset in a transaction may increase your US tax burden.
Many US investors choose to invest money abroad in an effort to diversify their portfolio. In other cases, a US expat is simply leveraging local investments or enrolled in a “foreign” (in their case, local) retirement fund or pension system.
The High US Taxation and Costs Associated with PFIC Investment
US taxpayers are often surprised to learn that their offshore investment actually qualifies as a PFIC under IRS rules. They are even more dismayed by the exorbitant tax rate associated with these investments which is often 50% or more when you consider the amount of taxation (based upon the highest personal tax rate, presently 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 on PFIC investments).
US taxpayers with PFIC investments are coming to understand the unbelievable cost and reporting nightmare of complying with IRS rules for these offshore investments. Those who have invested in PFICs must usually identify and employ a tax specialist who can manage international tax planning and reporting. However, adding an international tax specialist to your team doesn’t necessarily mean your PFIC investments are being properly reported and that you’ve paid the associated taxes.
The client in this scenario may fail to disclose the investment or provide supporting information associated with their PFIC investment(s).
In other cases, the US taxpayer may provide all of the supporting information provided by the PFIC investment, believing their tax professional has what they need to complete the IRS and state tax returns. But they are in for some additional bad (read: expensive) news.
The next challenge in the process of reporting a PFIC investment and paying appropriate taxes is actually quite profound: the process of accounting itself and methodology regarding the realization of income and losses is quite different in Europe and around the world than it is here in the United States. Therefore, a substantial amount of time must be invested to “translate” the reported offshore accounting associated with the PFIC 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 we’ve standardized on here in the US.
In addition, PFIC investments are required to be reported on IRS Form 8621, Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund and each specific PFIC requires its own separate 8621.
Simply put, this is heavily time consuming, and the US taxpayer is quite often shocked to see the number of hours required to complete the analysis, let alone the bill for services rendered.
FATCA has changed the global economic reporting system, and the IRS now receives electronic information on 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 miscalculated reporting and the underpayment of associated taxes.
It is in all likelihood past the time to rethink your offshore PFIC investment(s). US taxpayers with existing PFIC investments should consult an experienced and qualified international tax and transactional planning expert. Is there an available strategy to move these investments to other vehicles? What alternatives may provide a higher actual net return after expenses and PFIC taxation?
We invite you to learn more about the integrated tax, legal, accounting and business consulting services of Allen Barron and contact us or call today to schedule a free consultation at 866-631-3470.
