Ep 26: What Is English For "PFIC"?
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In this episode, we discuss PFICs (Passive Foreign Investment Companies) and the dangers of investing in them.
We start by defining them with some examples and then discuss the tax compliance requirements and the potential penalties for non-compliance. We include financial planning considerations like foreign exchange and repatriation.
We explain why we want to get a detailed idea of any PFICs clients may have when we start working with them on financial planning or tax preparation.
Most of our clients /prospects are not aware that they have PFICs in their overseas portfolio.
We discuss ways of dealing with them, how to stay compliant or get rid of them, and also mention the particular case of those with work visas - who may want to keep the PFICs in their portfolio.
It's a fun discussion.
The speakers' views and opinions discussed in this episode should not be considered financial, tax, or legal advice. Consult your advisor for any legal, cross-border tax, and financial advice.
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Speaker 1 (00:06):
Welcome to the International Money Cafe Podcast, the show where we filter out the noise on cross-border taxes, finances, and life in the us. I'm your host, Jen Hams, certified financial planner, founder and owner of elgon Financial Advisors,
Speaker 2 (00:21):
And I'm your host, man, Nadi, enrolled agent, owner and founder of Amman Tax and Business Services. Join us on this journey as we explore the unique challenges faced by inbound outbound families and businesses on taxes, compliance, and financial planning. Let's get to the show
Fake Passive Foreign Investment Company
Speaker 1 (00:43):
And we are back with another shorty episode. This is where in 10 minutes or less man and I would take a term used in the cross border space and just give you a high level overview of what it is, where you need to think about and really how it comes into your financial and or tax planning. In today's episode, we're going to talk about something called a fake passive foreign investment companies. And the reason we want to talk about this, because every now and again we'll have folks reach out and say, oh, I shouldn't have pfi, or What's a pfi? So let's talk about what a PFI is in terms of your overseas assets. So Mana said, do you want to just define it?
What is a Passive Foreign Investment Company? (PFI)
Speaker 2 (01:30):
Yeah, absolutely. And there are definitions all over the place, but we really like this one from Investopedia. So Investopedia says, A passive foreign investment company is a corporation located abroad, which exhibits either one of two conditions based on income or assets. The first condition is at least 75% of the corporations gross income is passive, and what that means is that it's derived from other investments or other sources not related to regular business operations. The second condition is at least 50% of the company's assets are investments, which produce income in the form of earned interest, dividends or capital gains. So these are the two conditions if you want a little bit of history about PFIs, the Internal Revenue Service implemented regulations in 1986 to mostly prevent US taxpayers from differing tax on passive income earned by entities in low tax jurisdictions, which really means that they didn't want a US tax resident to be sending money overseas and investing in corporations overseas, and maybe some of these corporations had lower taxes and therefore the US was not able to get their fair share of taxes. So that's mostly what A PFI really is, Jane, and I think that maybe what we can talk about some common examples. How about that?
Common Examples of PFI
Speaker 1 (03:37):
Yeah, I like that. So one of the most common path that we see, and this tends to surprise people a lot, is where you have a foreign based or foreign registered mutual fund. And then another example would be a startup company which somehow ends up falling within the scope of the PFIC trap based on the definition that you just gave. The ramifications or implications of this is one, this PFIC or these overseas assets may be outside of the purview of US financial planners because remember, when we do taxes, when we do financial planning because of the citizenship based taxation system in the us, we need to include everything that you own in the world. So that's one. There's also other issues to do with let's say exchange rate and how that plays into it. Also, when it comes into, let's say repatriation kind of bringing the money into the us, there could also be some implications of that as well as let's say considerations of portfolio inclusion or foreign markets dependence. Some of them also tend to be expensive, so there could be additional fees, but I think the key thing, which is what we tend to think as being negative, is the punitive tax ramifications of having a pfi. So
Speaker 1 (05:09):
I think manasa would be interesting if you could just talk about what are some of these punitive tax ramifications.
Speaker 2 (05:16):
We'll be back after this important message.
Speaker 1 (05:19):
When we started the show, our goal was just to answer the questions that our community have. But Manasa, have you looked at the stats lately?
Speaker 2 (05:28):
Oh, absolutely, Jane. We have people listening to us from over 20 countries and that is super cool. So exciting. Thank you, dear listener. And if you want to be notified of our episodes as soon as they drop, please subscribe on the I am cafe.com. Thank you so much again. And now back to our regular episode.
Punitive Tax Ramifications of Having a PFI
Yeah, the punitive tax ramifications are what the pfic, all the media attention really. So this is a very complex topic and there are lots of details that go into this In a shorty episode. We will give you a high level overview of these tax implications.
Excess Distribution Regime
The first thing to remember is foreign mutual funds are subject to excess distribution regime under section 1291. Now, this excess distribution regime can be mitigated by making elections. Basically, the excess distribution regime means that the growth in these mutual funds are taxed annually and they could be taxed at the highest tax rate.
Making Elections
Speaker 2 (06:54):
So how are you going to make these elections are you can make a mark to market election if the stock is marketable stock, or you can make a QEF election, which is a qualifying electing fund election. You pay taxes again annually on the growth in the funds by making these elections. So the growth in these funds is measured by the excess of the fair market value at the end of the year over the adjusted basis of these funds at the end of the year. And what happens is this income is considered ordinary income. Again, this might be subject to taxes at the top tax rate. The calculation is very complicated. Another thing to remember is if you are going to make these elections, then the timing of making these elections is very important that they have to be made before the due date or the extended due date of the tax return, and it's available only in the first year.
Speaker 2 (08:06):
Your declaring these PFIs on your return. So you may be able to make retroactive elections, but that needs to be a whole another episode. So we won't go into that Today they are declared on 86 21, the mutual funds, the mark to market election, the QEF election, all of that goes on the form 8 6 2 1. Now, if the thresholds are met, which is the FATCA form 8, 9, 3 8, and the F bar, and we have talked about what these thresholds are, but briefly throwing it in here, the FAR threshold is $10,000.
FATCA Threshold
And the FATCA threshold depends on where you live, whether in the US or abroad. It's much higher than the FAR threshold, $50,000 in the US for filing single and a hundred thousand dollars filing jointly. So if your mutual funds cross these thresholds, then that information should also definitely be included on an F bar. And you check a box on the 89 38 that it is included on the 86 21. One more thing that we have to remember is if you are investing in a foreign partnership, et cetera, as a passive partner or a startup as a passive investor, then you may have other international forms that may be required to be filed based on the extent of your holding in these passive startups or businesses or corporations. And these forms that come to my mind of form 88 58, form 54 71, et cetera, there may not be a need to file a form 86 21 if you meet certain exceptions.
Speaker 1 (10:04):
Oh wait,
Speaker 2 (10:05):
Yeah,
Form 8621
Speaker 1 (10:06):
But I know not being compliant with foreign income and foreign tax forms really means a huge penalty. Are you saying we don't have to worry about the form 86 21, the PFIC form?
Speaker 2 (10:19):
Well, the 86 21 form is actually not, rather than noncompliance of the 86 21 is not subject to penalties. However, the statute of limitations on your tax return never closes or it never begins to run. Basically really quickly for our listeners, the statute of limitations is that it, if you have filed a return, then the statute of limitations runs out in three years from the time that you filed the return. However, it doesn't even start the clock if the 86 21 was never filed, which means basically that your return now remains open indefinitely for the IRS to come back and question that. And when you're talking about penalties, you have to remember, because there is this connection now to the FATCA form 89, 38 and the FA, and if you've missed filing or declaring the foreign mutual funds, then there are penalties for not filing that or not substantially completing your 89, 38 or FA. So there are some aspects of penalties to this in connection to the mutual funds, but not in themselves. So yeah,
Speaker 1 (11:41):
So I think what you just said, if I got it right, is if you have a pfic filing requirement and you don't do it, you are basically noncompliant and you remain noncompliant indefinitely. Oh boy. Okay.
Speaker 2 (11:57):
That's tough. Yeah, until you file the return with the 86 21 and yeah, it does get pretty complex.
Speaker 1 (12:07):
Okay,
Speaker 2 (12:07):
But then let's talk about how that applies to people who are here on a work visa or a non-immigrant status or a visa that way. Yeah,
Speaker 1 (12:18):
Yeah, that's a good one because one of the things you hear a lot of advisors talk about is if you have a perfect, let's just try and get out of it. Let's try and sell whatever is in there and just move on. And this could make sense if you are a permanent US resident or you are a US citizen and you plan to stay in the US permanently. Now, if you are a professional, a foreign national on a work visa, your case could be a little different because the couple years that you are in the US, you obviously want to make sure you are compliant, you're filing, but you're going to be leaving the US at some point to spend your time overseas. So in those cases, we may not suggest to get out of the perfect, especially if this pfic is like your retirement plan, your life savings. So we need to approach it in such a way that not only are we looking at your current situation, but also your future situation. So having to be compliant is not the worst thing. I think you really want to look at your whole situation, and that's a good point. If you're here on a work visa, you may want to keep it. Let's just make sure we are compliant. And with that, I think we'll come to the end. Anything else you want to add to this man, or do you want to close it?
Speaker 2 (13:39):
Well, I think that we are kind of close to the time that we have for a shorty, so yeah, thanks for listening everybody. And you can go to our website, the im cafe.com and subscribe. Thanks for listening. Bye.
Speaker 3 (13:55):
Thank you for listening to the International Money Cafe podcast. The content is for informational and educational purposes only, and should not be used as a substitute for professional advice. Seek the advice of your qualified service provider with any questions you may have regarding your cross order finances and tax needs.