“PFICs” – What is a PFIC – and their Complications for USCs and LPRs Living Outside the U.S.

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Passive Foreign Investment Companies (“PFICs”) have one of the most complex set of tax rules in the Internal Revenue Code.

What is a PFIC?

Many USCs and LPRs have no idea that they may have one – or several of them?  Maybe they have owned hundreds of PFICs in their “plain vanilla” investment accounts?  Maybe they have a private and closely held company with a few assets that cause it to be a PFIC?

A PFIC can be as simple as an investment in a mutual fund that is formed outside the U.S.

Banks and financial institutions around the world promote investments in a range of mutual funds, such as Barclays in Spain, Barclays UK, Deutsche Bank, etc.PFIC Form 8621

Of course, if you live in your country of residence outside the U.S., you will most certainly be investing through the financial institutions that dominate that marketplace.

PFICs can also arise from owning shares in a small private company that owns shares in another foreign corporation.

The basic rule of when a foreign corporation is a PFIC, is if it meets either the (i) “income test” or (ii) “asset test”.

There is no minimum ownership requirement.  Owning 1 unit or share out of 200 million issued can still cause the investment to be a PFIC to the USC or LPR investor.

The income test is met when at least 75% of the income is passive income as defined under the law.  The asset test is satisfied when at least 50% of the foreign corporation’s average assets produce such passive income.

The USC or LPR residing outside the U.S. has to report the PFIC on IRS Form 8621, Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund.

As is almost always the case with the federal tax law, there are complex definitions and in this case complex regulations. New temporary (T.D. 9650) and proposed (REG-140974-11) regulations were recently issued by the Treasury Department for PFICs.

The effects of a PFIC will be discussed in another post.  They are not fun for the USC or LPR residing overseas – and can cause excess U.S. taxes depending upon (i) how long the the PFIC investment is held and (ii) whether any U.S. tax elections have been made by the United States Citizen or LPR.

Unfortunately, the tax law does not provide any relief for USCs who, in good faith, failed to file or report their PFICs and the income and gains generated from such investments.

More to come . ..



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