American expats living and working abroad expand their investment choices outside of US stocks and US mutual funds. Most of the time US expats have a foreign pension account or they own directly foreign stocks. It is absolutely legal to own overseas investments. The issue that many US expats face is that some of these holdings might be PFICs. What is PFIC? PFICs stands for Passive Foreign Investment Company. The complexity of preparing US expatriate tax returns increases remarkably if a taxpayer owns PFICs.
This is the latest email from one of our clients, US expats living abroad and green card holders. “I have lived in London for 7 years now. Only recently I learned about PFICs and FATCA. I am shocked because I didn’t realize that as an American living abroad I might be subject to these exorbitant reporting requirements. Please clarify what is PFIC and under which circumstances I am required to report my PFICs holdings.”
What is PFIC?
Passive Foreign Investment Company or PFICs is a foreign corporation that meets the “income test” or the “asset test”.
- Income test. 75% of foreign corporation gross income is a passive income.
- Asset test. 50% or more of assets held by a foreign corporation generate a passive income.
Passive income includes dividends, interest, gains from the disposition of stocks and securities, and gains from commodities trading. As a result of it, most foreign mutual funds are PFICs.
What is PFICs reporting?
US expats are required to file form 8621 for each PFICs they hold in the following cases:
- Receive direct or indirect distributions from a PFICs.
- Recognize gains on a direct or indirect sale of PFICs.
- Make an election on Part II in regards to their PFICs holdings.
What is PFIC taxation?
Effective with a tax year 1998 US expats with PFICs reporting requirements are subject to one of the three methods of taxation:
- QEF (Qualified Electing Fund)
- MTM (Market to Market)
- Excess Distributions
What is PFIC history?
Passive Foreign Investment Companies rules go back to 1986 when they were originally passed as a part of the Tax Reform Act of 1986. The PFICs rules were introduced to eliminate a tax advantage for investors in passive assets overseas.
What is PFIC future?
FATCA (Foreign Account Compliance Act) was enacted as a part of HIRE in 2010. The provision about PFICs was introduced under FATCA that requires US expats to report PFICs holdings whether they received any distribution or not. However, the IRS put this requirement on hold. The instructions for form 8621 specifically indicate that
“Summary of Annual Information was added to reflect the new annual filing requirement of section 1298(f) which was added by section 521 of the Hiring Incentives to Restore Employment Act of 2010. However, this new Part I is not required until the underlying regulations are published. For now, they have been Reserved For Future Use. Form 8621 will be revised when Part I becomes effective.”
If the IRS decides to implement the PFICs ruling in a tax year 2013 or later, US expats will be required to file form 8621 for prior years per IRS Notice 2011-55.
Conclusion
FATCA is changing the tax systems across the globe. The IRS will have an access to the foreign financial accounts of US persons when FATCA will officially come into effect on January 1, 2014. Since PFIC holdings will be reported as a part of FATCA, US expats are advised to determine whether they have to report PFICs. US citizens and green card holders should contact a CPA that provides US expat tax services for U.S. citizens and green card holders.