Passive Foreign Investment Companies
PFIC is an intricate and niche outside US investment option which is not exactly preferred by many US citizens. But, it’s worth mentioning that today, the realm of PFIC tax provisions have developed to such depths that some of the US investors may inadvertently become PFIC investment holders.
For instance, being unknown to that PFIC nature of foreign entity or ownership transferred to a different entity). This in turn makes such investors subject to unexpected taxes and reporting compliances. Not to mention that the IRS heavily scrutinizes international investments by its citizens to tackle tax escaping and money laundering issues. Thus, it’s better to partner with experienced and competent professionals to handle your PFIC tax issues.
It is a company which has the following characteristics:
- It is located in a foreign country and
- either 75% of the company’s gross income is passive, that is, from sources not directly related to the company’s core operations or👇🏼
- at least 50% of the company’s assets are investments, generating revenue in the form of dividends, interest, capital gains, etc.
Example of PFIC: Abroad based private equity funds, hedge funds, mutual funds, startups as per the definition of PFIC, etc. The aforementioned conditions for PFIC are applicable to almost all foreign investments.
Tax Consequences of Having a PFIC
Internal Revenue Services (IRS) has stringent and highly complicated tax provisions pertaining to PFICs. A US citizen or Green Card owning a PFIC might be subject to tax rates as high as half of the foreign income. Even if one changes the structure of his/her PFIC, the best he can achieve is the marginal tax rate like on the regular income.
Below are the default rules governing the taxation of PFIC in the US:
- All the distributions are considered as regular income and are taxed at the highest federal tax rate of 40%;
- Capital gains (increase in the value of assets) are not long-term capital gain rate, they are considered as normal income and are taxed at the highest current federal tax rate irrespective of the marginal tax rate for which your income is eligible to;
- If you have opted for deferred gains in your PFICs, you will be subject to pay non-deductible penalty interest which is compounded daily till the time gains are released.
Please note that you can salvage some tax by opting for the Mark-to-Market accounting method on your foreign investments or by filing the investment Qualified Electing Fund (QEF), which has its own set of complications.
Methods to Report and Pay Tax on PFIC
- Default Election: Section 1291 of IRS as already defined above.
- QEF Election: If the fund where you made investments complies with IRS guidelines, then your PFIC income is considered and taxed as the regular income. But there are separate provisions on capital gains and reporting.
- Mark-to-Market Election: Taxpayers reports yearly gains and unrealised losses at market value as ordinary income for tax returns purposes
Citizens and Green Card holders owning shares in a PFIC have to mandatorily file IRS Form 8621. It is used for the purpose of reporting distributions, gains, income and appreciation in QEF elections. 8621 is a lengthy and complex form per se that even by IRS’s own estimates might take 40+ hours to fill out. Thus, it is crucial to consult experienced and competent professionals while handling PFIC compliances and taxation issues.
We are a confluence of Certified Public Accountants (CPAs) and attorneys with more than 8+ years of experience in the field of international and cross-border taxation. We have an international clientele comprising 3500+ corporate houses, firms, small and macro scale business, High Net Worth Individuals (HNWI), etc. We have helped many Indian entrepreneurs, US citizens and even Bollywood celebrities to sort all and any of their taxes issues.
To know more about how we will deliver value to you with our optimum and innovative taxation and financial solutions give us a call on 7727887799 (also available on WhatsApp) or drop us an email containing your business requirements at firstname.lastname@example.org and our team will reach out to you within 2 hours.
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