Ep 55: What is English for "Is It A PFIC Or Not"?
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In this conversation, we discuss the complexities of Passive Foreign Investment Companies (PFICs) and their implications for U.S. tax residents with overseas investments.
We explain what PFICs are, the tax burdens associated with them, and provide practical steps for identifying whether a foreign fund qualifies as a PFIC.
The discussion emphasizes the importance of consulting tax professionals and understanding the tax implications of foreign investments.
Takeaways
PFIC stands for Passive Foreign Investment Company.
PFICs are legally permissible for investment, but they come with tax burdens.
Growth in foreign mutual funds is taxed at income tax rates.
IRS Form 8621 can take up to 25 hours to complete.
Foreign mutual funds and retirement accounts can be PFICs.
Three ways of identifying if a foreign fund is a PFIC or not.
Chapters
00:00 Understanding PFICs: The Basics
02:59 The Tax Implications of PFICs
05:28 Identifying PFICs: Practical Steps
Episode Links and Resources
Ep 42: What is English For "Gift & Estate Taxes?"
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Jane Mepham, CFP (00:02.38)
How do you determine if an overseas security mutual fund is a PFIC or not? By the end of today's show, we're going to give you three ways of identifying if a security or a mutual fund overseas is a PFIC or not, which is critical for you as a U.S. tax resident with overseas assets in the U.S.
But first, let's do a quick refresher of what is a PFIC and why should we be concerned about.
What’s a PFIC?
Manasa Nadig, EA (00:33.879)
Yes, so a PFIC basically stands for Passive Foreign Investment Company.
And the acronym is PFIC. The key word here is passive. So remember that a PFIC is a non-US corporation that meets either a 75 % passive income test or a 50 % passive asset test, which means it earns most of its income from passive sources like dividends, interests, and so on, or holds most of its assets. Assets that produce passive income. So the US tax laws created these PFIC rules to prevent US taxpayers from deferring taxes and put in place a very punitive tax law around these PFICs. So basically that is what a PFIC is, Jane.
Jane Mepham, CFP (01:36.696)
So let me just ask the question one more time. Okay. We know they're not illegal, right? They're okay to invest in, but why should people be concerned about investing in PFIC fix or not? Before we can talk about how you identify them. If somebody asks you that question, how would you answer it?
What’s The Problem With PFICs
Manasa Nadig, EA (01:58.153)
Of course, we have to talk about that because they are legal. You can definitely invest in them or hold on to them if you've already invested in them. That's not the issue. What the issue here is the punitive tax regime around the so-called PFIC Now, let me explain it in short where if you look at the growth in the mutual funds,
In the US, a growth in the mutual fund is taxed at favorable long-term capital gains rates, which are unrealized capital gains. But...If these were foreign mutual funds, then the growth in these mutual funds do not get that favorability as far as taxes go. In fact, they are taxed at the highest ordinary income tax rates. So depending on how much you are holding and what the growth in these funds are, they could become quite a bit of a tax burden.
On a person holding these PFIC funds. there are specific elections that could be made to mitigate this, what is called an excess distribution regime or a PFIC tax regime. You could also look at tax treaties between the country where your mutual fund is and the US.
But you may or may not get a mitigation for taxes in this case, Now, really quickly, the tax part of this holding your mutual funds is reported on the IRS form 8621. In fact, the IRS themselves say that it could take up to 25 hours to complete a form 8621. So,
Manasa Nadig, EA (04:07.072)
You know, if you are holding on to, let's say, let me give you some examples. Let's say foreign mutual funds fall into this category, definitely. And these would be foreign registered mutual funds and or foreign registered money market funds. Sometimes a foreign retirement account could also be considered a PFIC and or life insurance policies in foreign countries that are invested in the market could also be categorized as PFIC But of course, you would have to look at each one specially and determine whether they are a PFIC or not.
So these are just some of the examples of PFIC that we know.
Jane Mepham, CFP (04:56.096)
Right. And so let's talk about, because you've already talked about what's bad about them. If somebody comes to me and they give me a foreign statement and they say, Hey Jane, are these things PIFICs or not? We've come up with three ways of identifying if something is a PFIC or not that you can actually do at home. And that's what we want to address.
So this addresses mutual funds or securities, as we've said, which are registered overseas. And that's a key thing. They'll call them foreign-domiciled securities. And there three ways you can tell whether this thing is a PFIC or not.
3 Ways To Tell If a Foreign-Domiciled Mutual Fund Is a PFIC or not
One, and I always recommend, go down this path, reach out to your tax professional, your CPA, your EA, your cross-border professional, and ask them, are these things PFIC or not?
Let's see what they tell you. Number two, reach out to the foreign fund company overseas and directly ask them if these funds are PFIC exempt or not. What we've discovered is if they're PFIC, the foreign company is not going to be able to give you that assurance. So if they're not able to assure you that these things are PFIC exempt or not, assume they're PFIC right?
Number three, look at your statements. Look at the ISIN. The ISIN number is an international securities identification number, which is a number given to all international securities. It will uniquely identified as a security. So you look at that, it's usually a 12 character alphanumeric code.
If the first couple of digits are not US then you know this thing is a PFIC. Does that make sense, Manasa?
Manasa Nadig, EA (06:59.306)
It does. Although these there may be other instances of where you might be holding a PFIC, which may not fall into this. So definitely what Jane said, the first thing you should do is check with your CPA or EA and get their input if that investment could be categorized as a P FIC. So, yeah, Jane, I think we kind of covered the three things that
Manasa Nadig, EA (07:29.26)
we need to look at. Yes.
Jane Mepham, CFP (07:31.926)
Sounds good, then let's conclude it. This is a shortie
Manasa Nadig, EA (07:35.057)
Absolutely. So thanks for listening folks and if you like our content please follow us on Spotify or on Apple wherever you listen to our podcasts give us a five-star rating because if you rate and you subscribe and listen to us our podcast will be pushed out to more listeners and that would be great and we hope you share our podcast with your friends and family. Thank you for listening. Bye.
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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.