A PFIC Overview: US Taxation of Foreign Passive Investments

Making Sense of PFIC – A Passive Foreign Investment (PFIC) Guide

What is a PFIC

While there are many complicated aspects to international tax and reporting, the IRS requirements for having to report Passive Foreign Investment Companies (PFIC) are some of the most daunting and complex. Technically, the PFIC is an acronym for Passive Foreign Investment Company, and U.S. taxpayers worldwide (including U.S. Expats) who meet the reporting requirements, may have to report their PFICs on various international information reporting forms each year such as the FBAR and Form 8621. There are only a handful of international tax law firms across the globe that represent taxpayers consistently in PFIC matters. At Golding & Golding, we specialize in international tax, with a focus on international reporting and PFIC compliance for taxpayers who are already out of compliance. Over the past several years, we have written many articles on issues involving PFIC tax and reporting but wanted to take a step back and provide an introductory understanding of the PFIC and whether or not you may be required to report your PFIC to the IRS and FinCEN.

What is a PFIC?

From a baseline perspective, a PFIC is essentially a foreign passive investment that is owned by a US person. For example, a taxpayer may have a holding company overseas that does little more than own foreign investments such as stocks and funds. Alternatively, a taxpayer may not have a foreign holding company but may directly own foreign mutual funds and other pooled Funds such as ETFs. These are examples of a US person owning a foreign passive investment that would most likely qualify as a PFIC.

PFIC/CFC Crossovers, GILTI, Subpart F and Excess Distributions

While identifying whether or not a taxpayer has a PFIC issue can be complicated, there are various rules, exceptions, and nuances that make it very complex to determine what the taxpayer must do next. Without delving too deep into the specifics, taxpayers should be aware that if their PFIC is also a Controlled Foreign Corporation (CFC), then there are certain crossover rules. This will impact whether or not certain transactions result in excess distributions, Subpart F income, and/or GILTI — and what will qualify as an exception.

At the outset, it is just important to know that if a Taxpayer owns a controlled foreign corporation that owns passive investments or was created solely to act as a passive investment tool, the Taxpayer will probably have a PFIC situation.

Which Forms to File to Report PFIC?

When it comes to reporting PFICs, the two main international information reporting forms are the FBAR and Form 8621. The FBAR is used to report foreign bank and financial accounts. Pooled funds qualify as foreign accounts, so they are reported to the IRS. Thus, if a taxpayer owns several mutual funds overseas for example, they must report these mutual funds on their FBAR — and the complexity of the reporting involved will be in part determined by whether or not the funds are in an account or held individually. For purposes of Gorm 8621, each PFIC is parsed out separately to determine basis and income, even if the funds are held in an account.

PFIC Taxation

If a taxpayer does not make any election for their PFICs, then they will be taxed under the excess distribution regime, which means, for example, an otherwise qualified dividend that would be taxed at 0%, 15%, or 20%, will instead be taxed at the highest tax rate available (excluding the allocable amount for the current year unless the Taxpayer is in the highest tax bracket) along with interest on the tax liability. This may result in a tax liability of more than 50% depending on the year of the excess distribution and how long the investment has been held. To try to lessen the blow, the taxpayer may be able to make an election.

Making PFIC Elections

When it comes to PFICs, taxpayers may have the opportunity to elect to treat the income and growth/losses from their PFICs more gently than under the excess distribution regime. The two main elections are the Qualified Electing Fund (QEF) and the Mark-to-Market. Each type of election has its own pros and cons, noting that the QEF election is typically better from a tax standpoint, but unfortunately requires some cooperation from the Foreign Financial Institution to ensure it is providing the taxpayer with the necessary statements that the IRS requires. Without the information/statements, the election cannot be made. Likewise, to make a mark-to-market election the PFIC must be marketable, which can sometimes pose a problem depending on the nature of the investment.

No PFIC Election – Excess Distributions

As mentioned above, if a taxpayer does not make any election, then they will be taxed under the excess distribution regime. In a nutshell, this means that in most years, if there are no distributions then there is no tax. But, once there are distributions or redemptions, the taxpayer will be taxed at a much higher tax rate than they would have ordinarily been taxed if the investment was domestic, such as a domestic mutual fund.

Late Election/Purging PFIC Election

For taxpayers who make elections after the first year of the investment, they generally also must make a late purging election which means they have to prepare an excess calculation distribution in the year they make the election, along with making the election, and then moving forward they can operate under one of the different election types. Depending on how long the investment has been held, making a late/purging election can be very costly. Likewise, taxpayers may try to qualify for a reasonable cause exception for making a late election, but unlike other types of reasonable cause submissions, there are very strict requirements to qualify for reasonable cause for missed PFIC elections.

Exceptions to Filing the Form 8621

There are not many exceptions to having to file Gorm 8621. But, for some taxpayers who may qualify as having less than $25,000 in total PFICs ($50,000 Married Filing Jointly) and no excess distributions in the current year of reporting, they may be able to limit their reporting. There is a bit of conflict between what is provided in the instructions and what is provided in the regulations as to whether part one of Form 8621 must be filed or whether the Form is not required at all.

Penalties for Missed PFIC Reporting

Unlike other types of international information reporting forms such as the FBAR or form 8938, there is no monetary penalty for not reporting form 8621. But it is important to note that if the form is not filed then the taxpayer’s tax return remains open for that year and to what extent their return remains open is up for debate depending on whether you are representing the taxpayer or whether the IRS is taking a position contrary to the Taxpayer.

Late Filing Penalties May be Reduced or Avoided

For Taxpayers who did not timely file their FBAR and other international information-related reporting forms, the IRS has developed many different offshore amnesty programs to assist taxpayers with safely getting into compliance. These programs may reduce or even eliminate international reporting penalties.

Current Year vs Prior Year Non-Compliance

Once a taxpayer missed the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, taxpayers should consider speaking with a Board-Certified Tax Law Specialist who specializes exclusively in these types of offshore disclosure matters.

Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)

In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful Taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties. 

Need Help Finding an Experienced Offshore Tax Attorney?

When it comes to hiring an experienced international tax attorney to represent you for unreported foreign and offshore account reporting, it can become overwhelming for taxpayers trying to trek through all the false information and nonsense they will find in their online research. There are only a handful of attorneys worldwide who are Board-Certified Tax Specialists and who specialize exclusively in offshore disclosure and international tax amnesty reporting. 

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure. 

Contact our firm today for assistance.