American expats living abroad have an opportunity to invest in a wide range of investment vehicles. Specifically, the United Kingdom residents have an access to a variety of tax-free collective investments. US citizens and green card holders who have been advised to acquire foreign mutual funds as a part of their investment strategy should be prepared to deal with harsh US expat tax consequences. We have seen more and more clients with PFIC holdings who are astonished by the increasing complexity of US expatriate tax returns. 

What is a PFIC?

Per a general definition, a Passive Foreign Investment Company (PFIC) is a foreign corporation that meets either the “income test” or the “asset test”.

–     Income test. A foreign corporation that generates 75% of its gross income as a passive income (dividends, interest income, rent, capital gain) is considered a PFIC.

–     Asset test. If 50% or more of assets held by a foreign corporation produce a passive income, then this foreign corporation is a PFIC.

Since most of the foreign mutual funds are PFICs, American expats are advised to review their holdings and determine whether they might be subject to additional US expat tax requirements.

Who is currently subject to PFIC filing requirements?

Currently a PFIC form must be filed in one of the following scenarios:

–     American expatriates who received direct or indirect distributions.

–     US taxpayers who sold PFIC shares.

–     US persons who make an election on Part II in regards to their PFIC holdings.

However, US citizens and green card holders with PFIC holdings must keep records of their investments whether they are currently required to file a PFIC form or not. American expats should be prepared for an unpleasant surprise while navigating the murky waters of the US tax law. 

Future of PFIC reporting

American expatriates who are confused about PFIC filing requirements are in a good company. The IRS still cannot decide what to do with PFICs either. The Foreign Account Compliance Act (FATCA) that was enacted as a part of HIRE in 2010 has one of the provisions about PFICs. The 2010 PFIC provision mandates American expats to report annually the PFIC holdings whether they received distributions or not. Although, the FATCA is spreading across the continents and transforming the global tax system, the PFIC annual reporting requirement has been put on hold. Per the latest PFIC instructions for a 2012 tax year, the IRS indicates that

“Summary of Annual Information was added to reflect the new annual filing requirement of section 1298(f) which was added by section 521 of the Hiring Incentives to Restore Employment Act of 2010. However, this new Part I is not required until the underlying regulations are published. For now, they have been Reserved For Future Use. Form 8621 will be revised when Part I becomes effective.”

What will happen if the IRS finally decides to make everybody file a PFIC form in a tax year 2013? Per IRS Notice 2011-55 taxpayers will still be required to file Form 8621 for all years during which the PFIC reporting has been suspended. It means that American expats will have to file PFICs for a tax year 2010, 2011 and 2012. The future might not be shiny and bright for all PFIC owners.

PFIC and FATCA

US citizens and green card holders who keep on ignoring PFIC filing requirements are advised to read more What is FATCA. The UK signed a FATCA agreement with the USA on September 12, 2012. The financial institutions will be required to report the information about financial accounts of US holders. The IRS will match this information to US expatriate tax returns and penalize PFIC owners.

Conclusion

US citizens and green cared are advised to review their investment portfolio and identify any investments that might be considered PFICs. Per the IRS, American expatriates should be prepared to spend 31 hours to prepare a PFIC form. Unfortunately, lack of knowledge doesn’t exempt a taxpayer from liability. Proper guidance from an expat tax preparer is encouraged to avoid potential harsh penalties.