US expats have been under some extreme hardships as a result of FATCA and the requirements to provide clear documentation of the “beneficial ownership interest” in all of their offshore bank and investment accounts. This allows the IRS to track specific accounts, transactions and balances to the unique social security number or taxpayer ID of any US taxpayer including expats. However, one of the greatest surprises to US expats has been the issues associated with what appears to be a simple transaction on the surface: purchasing mutual funds outside of the United States. This leads to a question: should US expats own foreign mutual funds and what are the US tax implications of offshore mutual fund ownership?
The problem is foreign mutual funds (those outside of the United States) are characterized as Passive Foreign Investment Companies or PFICs. The investment income from a PFIC is taxed at the highest personal federal income tax rate (39.6%) and it can actually work out to be much higher. The US expat may not use losses in the PFIC to offset gains in other non-PFIC investments. PFIC gains are taxed on an annual basis, whether the expat receives a distribution or realizes the gain or not.
In addition, IRS tax rules require the US expatriate to report each separate foreign mutual fund PFIC on the IRS Form 8621. The IRS Form 8621 is quite complex and requires extensive and detailed documented record keeping. The IRS itself estimates that a typical Form 8621 will take 30 hours or more of annual accounting time to prepare and file.
So what is the net impact when US expats own foreign mutual funds that are actually PFICs? Any income is taxed at the highest potential rate under US tax law. Each PFIC must be meticulously tracked and reported to the IRS. The vast majority of US expats in this situation will be forced to hire an external accounting firm that will charge them thousands of dollars.
Allen Barron is uniquely positioned to serve US expats in all international tax issues including FBAR preparation and filing, PFIC and Form 8621 compliance, as well as FBAR compliance and the preparation of US tax returns. We invite you to contact us for a free consultation at 866-631-3470.