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May 14, 2015 - Debra Rudd

Is my investment account a PFIC?

Hello from Debra Rudd.

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This week’s topic: Is my investment account a PFIC?

This question came from reader M. Lightly edited, here is the question:

I have a foreign investment account that holds 10 foreign investments. Do I have one PFIC (the account) or 10 (the foreign investments)? And can I aggregate the reporting for all of it on a single 8621?

This is a common question, so I wanted to devote this week’s email to providing a comprehensive answer.

A foreign investment account is not a PFIC

Recall that the acronym “PFIC” stands for “Passive Foreign Investment Company”. A passive foreign investment company is defined in Section 1297(a) of the Code as:

any foreign corporation if –

(1) 75 percent or more of the gross income of such corporation for the taxable year is passive income, or

(2) the average percentage of assets (as determined in accordance with subsection (e)) held by such corporation during the taxable year which produce passive income or which are held for the production of passive income is at least 50 percent.

Luckily, that is as far as you need to delve into the Code. An investment account is not a corporation – it is an account that a financial institution maintains on your behalf. Therefore an investment account cannot be a passive foreign investment company. Your account is not a PFIC.

But the assets inside the foreign investment account may be PFICs

Your account at the foreign financial institution holds the foreign investments you own. Those investments could be bonds, stocks, funds, or other types of investments. To determine if you have PFICs, you must look at each of the investments you own and apply the definition of a PFIC.

So how do I know if I have a PFIC?

The two criteria given in the PFIC definition in Section 1297(a) are known as the “income test” and the “asset test”.

  • The income test tells you to determine if 75 percent or more of the gross income of the corporation is passive. If it is, the corporation is a PFIC.
  • The asset test tells you to determine if 50 percent or more of the corporation’s assets are passive or are held for the production of passive income. If they are, the corporation is a PFIC. (Hint: Cash is considered a passive asset for the asset test.)

Note that your investment only needs to qualify under one of the two tests to be a PFIC.

What is “passive income” exactly?

Passive income for the purposes of Section 1297 is defined in Section 954(c). It includes things like interest, dividends, capital gains and losses, commodities transactions, foreign currency gains, and so on.

Bonds are not PFICs

Bonds are debts, not equities. In other words, if you own a bond, you do not have ownership in a company – you have ownership in a debt instrument. Therefore bonds cannot be PFICs, even though they produce passive income (interest).

Stocks can be PFICs

Stocks are equity ownership in a corporation. If the foreign corporation meets either the income test or the asset test, it is a PFIC.

Most publicly traded stocks are not PFICs, because they are businesses producing primarily non-passive income and holding primarily non-passive assets.

Take Nestle stock, for example. Nestle is a corporation organized under the laws of Switzerland, so it is a foreign company.

Nestle has inventory, receivables, factories, warehouses, offices, etc on its balance sheet far in excess of cash. Those are all assets held for the production of non-passive income. The vast majority of Nestle’s assets are held for the production of non-passive income, so it does not meet the 50% or more passive asset test.

Nestle’s income comes primarily from sales of products. That is non-passive income. The majority of Nestle’s income is not interest, dividends, capital gains, and so on. Nestle does not meet the 75% or more passive income test.

We can be reasonably certain that Nestle is not a PFIC. Most companies you own stock in will behave this way, but it is important to remember that your stock in a regular company like Nestle can be PFIC stock if the company meets either the income test or the asset test.

Funds are usually PFICs

Mutual funds, exchange traded funds (ETFs), bond funds, currency tracking funds, and similar assets are all vehicles that make various investments and pay out a portion of the returns to you.

A fund makes investments in corporations and various instruments on your behalf so that it can generate income such as interest, dividends, capital gains, foreign currency gains. These are all types of passive income, and indeed, typically a fund receives 100% passive income and 100% of its assets are held for the production of passive income.

Foreign funds are usually PFICs.

How can you tell if your stock or fund is foreign?

Many times I have seen foreign investment accounts that hold US investments. If it is a US investment, it is not a PFIC, even if it meets the income test or the asset test or both.

An easy way to determine whether your investment is US or foreign is to look at the International Securities Identification Number (ISIN), if one is provided. If one is not provided on your statements, you may be able to obtain it from the financial institution where your account is held, or you may be able to find that information on the Internet.

The ISIN numbering system begins with a two-letter country code. “US” means it is a United States investment. If the first two letters of the ISIN are “US”, it is not a PFIC.

Can I use one Form 8621 for many PFICs?

You must file a separate Form 8621 for each PFIC. This comes directly out of the Form 8621 instructions: “A separate Form 8621 must be filed for each PFIC in which stock is held directly or indirectly”. (I did not add the emphasis; the bold print comes directly from the instructions).

I am not your CPA; this is not advice to you

I just find this stuff fun. And I love to make broad generalizations based on a simple fact pattern. The information herein may not apply to the specific facts of your situation. Please hire a professional if you need advice.

Thank you

Thanks for reading, and I’ll see you next week.

PFIC and CFCs