What is a PFIC?
Yesterday I was talking to an accountant about the intricacies of PFICs, ISAs, and the entirely plausible strategy of giving up a green card to get away from the Borg that is the IRS.
She asked the entirely reasonable question, “Where can I find out more about this stuff?” Sadly, unless you are willing to delve into the Code, Regulations, and a few hard-core tax treatises, the answer is “Nowhere.”
This website is my attempt to get some answers out there into the real world about the arcane international tax stuff I live with every day. And this blog post is one of many I will be doing over the next few weeks on various topics related to PFICs. We know these things all too well, and Elena and Debra in our firm have been bugging me to start blogging about PFICs. David navigates through PFIC-land with awe-inspiring ease. So here goes.
What is a PFIC?
What is a Passive Foreign Investment Company? People who participated for the 2009 Voluntary Disclosure Program know this from first-hand painful experience. Those of you who intend to throw yourself under the 2011 OVDI bus will find out soon, in the form of massive accounting fees and startling tax bills. Tax lawyers pronounce this as “PEE-fick.” (Yes, I know. You studied at the University of South Park, too.) (But I digress….)The technical definition
The technical definition, according to U.S. tax law, is a foreign corporation that meets either the “income test” or the “asset test.” The “income test” looks at the income of that foreign corporation and if 75% or more is passive income (interest, dividends, rent, capital gain), you pass the test. The “asset test” looks at the assets of that foreign corporation and if more than 50% of the assets are the kind of assets that could produce passive income.Foreign mutual funds are PFICs
It is a near certainty that mutual funds outside the United States are organized as corporations. Foreign corporations. This means that if you are the proud owner of a foreign mutual fund, you have a PFIC. You have to look, however, to be sure. If the fund is a partnership or trust, then it won’t be a PFIC.Exchange-traded funds are PFICs
Exchange-traded funds are almost certainly PFICs. They’re usually corporate entities whose shares trade on the stock market just like a regular company’s shares. The assets of an ETF? Stock. Passive assets. Meets the “asset test.” Again, your only salvation is to find out if possibly that ETF is formed as an entity other than a foreign corporation.So what?
Look through your portfolio of investments outside the United States. If you have any PFICs, you face a punishing tax return preparation exercise. Form 8621 is where everything is reported. I’ll talk more about the consequences of owning PFICs, but in a nutshell:- Your tax return preparer faces a hard job. (Translation: expensive for you if they know what they’re doing. Disaster-time if they’re learning on your tax return).
- Your tax return is likely to be bounced by the IRS if you don’t do it right. There seems to be little tolerance for “close enough is good enough.”
This article is saying that finally the IRS is requiring Form 8621 for all PFICs (mutual funds) but there is an exemption for RRSPs, RRIFs, RPPs. There is no exemption for RESPs or TSFAs – for these accounts you have to report the mutual funds inside them and file Form 8621.
Phil,
regarding a PFIC inside an RRSP, I came across this PWC article:
http://www.pwc.com/ca/en/tax-insights/new-regulations-for-passive-foreign-investment-companies.jhtml
Can you comment on what the article is actually saying…
Thanks
PFIC inside an RRSP. That is sort of like Churchill’s riddle wrapped inside an enigma.
Good question. I will put it on my blog topic list to write about.
So I’m wondering about a PFIC held within a RRSP where income has been deferred under the US/Canadian Tax Treaty.
Too bad about UCLA also …
Asher
Thanks for your comments.
The excess distribution (default) method should be timely as long as there have been no reportable events (distributions, dispositions). If there were any distributions, then presumably the account may be rendered non compliant under OVDI/OVDP. Of course, if the distribution was not an ‘excess’ distribution, then there should not be any income. But without past records or some identification of lots, it would be hard to show what was excess and what was not. Just some random thoughts ..
Mark, I was offering what I believe to be the reason for the IRS applying the PFIC rules to voluntary disclosures. Some taxpayers entered the OVDP, and then, when the foreign account statements arrived, the taxpayers saw that the securities had not been sold. If the securities had not been sold, there was no taxable income realized. The taxpayer would then withdraw from the OVDP without paying the 20% penalty. By applying the PFIC rules, taxable income is created even though the security is not sold. As a result, the taxpayer would have to pay tax on the PFIC income, remain in the program, and pay the 20% penalty.
I understand your point that a taxpayer can elect the method of PFIC taxation (MTM, excess distribution . . .) but one issue is whether the taxpayer made a timely election. Presumably, if the foreign securities were undisclosed in past years, then the election was not timely made.
Asher, I don’t know about OVDP 2009, but in OVDI 2011, the IRS says that you can use the default method if you don’t want to use the IRS method. So if one funded a PFIC account with untainted funds AND there were no dispositions (distributions or sales), then it could be excluded from FBAR penalty calculation as there was no taxable event. The taxpayer would still have to pay a large amount of tax at some point since the deferred tax would now be paid at the maximum rate, plus the interest charge.
That would be a rare condition, but are you saying that the IRS wants to penalize PFIC accounts even if they meet the conditions above ?
Mark, in the 2009 OVDP, the IRS didn’t apply the PFIC rules until about a year into the OVDP. Until that point, taxpayers who had not realized foreign income because they held investments without selling them, even though the investments appreciated in value, were able to exit the OVDP (see OVDP FAQ 9) without penalty. By applying the PFIC Mark-to-Market rules, the IRS was able to arrive at taxable income, even though the investment was not sold. Thus, the IRS was able to cut down the number of people leaving the OVDP, and apply OVDP penalties. I’m not as certain that the PFIC rules are quite a gift.
ACtually, for people in OVDI, the PFIC issue is much simpler than normal because of a method the IRS offers. And its actually quite good in some ways since PFIC gains are taxed at only 20%, rather than your 35%.
So effectively this penalizes anyone for holding stocks in foreign stock exchanges? Hold a Canadian mutual fund share or ETF, jail time for you! Americans are going to hold blame canada marches through the streets.