While abroad U.S. expats sometimes choose to invest in vehicles that inadvertently trigger additional U.S. reporting requirements. One of these reporting requirements are in regards to Passive Foreign Investment Corporations (PFICs), which can be triggered by a U.S. person simply putting their money into a non-U.S. mutual fund.
Passive Foreign Investment Company (PFIC) Reporting for Expats
A PFIC (passive foreign investment company) is a company that is primarily invested in passive investments, such as: foreign-based mutual funds, money market accounts, pension funds, etc., with at least one U.S. shareholder.
The Income Test and the Asset Test are used to identify if an investment is a PFIC.
- If 75% or more of the corporation’s gross income is passive income, like interest, or dividends, it fulfills the income test.
- If 50% or more of the corporation’s total assets are passive assets which produce passive income it fulfills the asset test.
Issues with PFIC Investments
Normally, income from domestic mutual fund investments are subject to standard capital gains tax in the U.S., even if these mutual funds are invested in foreign investments. If a foreign mutual fund is determined to be a PFIC, distributions from the fund are treated as ordinary income, and thereby subject to ordinary income tax rates, which are higher than capital gains tax rates. Furthermore, these taxes are deemed to be owed for each tax year until the PFIC mutual fund is disposed. These taxes when combined with the applicable interest could result in an unexpected tax bill.
PFIC Reporting for U.S. Taxes
To report distribution, capital gains, or other income from investment in foreign corporation through mutual funds, real estate investment, etc. the US citizen needs to file IRS Form 8621. There are several different ways the PFIC can be treated and taxed depending on the circumstance. Section 1291, Mark to Market, and QEF elections each come with their own benefits and drawbacks. Generally the QEF election is simplest and most beneficial to the taxpayer, but on most occasions the investment fund does not provide the proper paperwork to make it eligible for the QEF election.
Do you have questions about the U.S. reporting requirements for your foreign investments?
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