If you are a citizen or permanent resident of the US, you are obligated to file taxes with the IRS each year, regardless of the country in which you reside. Not only are you required to submit the standard income taxes for expats, but you may also need to file an informational return on your assets held in foreign bank accounts with FinCEN Form 114 – also known as the Foreign Bank Account Report (FBAR).
Everyday income items that taxpayers generally come across that are considered active income are wages and self-employment income. Passive income comes from dividends, interest, and capital gains. However, what happens when you have foreign investments in Passive Foreign Investment Companies, also known as PFICs? Find out what expats need to know.
What Are PFICs?
An investment in a foreign mutual fund is classified as a Passive Foreign Investment Company, or PFIC. PFICs are taxed through a much more complex system with much stricter rules than US mutual funds or exchange-traded funds.
How Do I Know If I Have a PFIC?
According to US tax law, a foreign corporation that meets either the income test or the asset test is considered a PFIC. The income test is met if the PFIC generates 75% or more of its gross income from investments in passive sources such as interest, dividends, rent, or capital gains. The asset test looks at whether or not more than 50% of the company’s total assets are produced by passive income, which would not generate business income.
The IRS implemented regulations on PFICs to prevent US taxpayers from deferring tax on passive income earned by entities organized in low-tax jurisdictions. In other words, the law was supposed to remove advantages for shareholders investing in foreign mutual funds over US-based funds.
How Do PFICs Affect Expat Taxes?
Form 8621 is where you will report all of your income. Unfortunately, Form 8621 is a very long and complicated form. The PFIC itself, as well as its shareholders, are required to maintain accurate records of all transactions related to the PFIC, such as cost basis, dividends received, and undistributed income that the PFIC may earn. PFICs are subject to strict and extremely complicated tax guidelines under Sections 1291 through 1297 of the Internal Revenue Code.
Under Section 1291 of the Internal Revenue Code, excess distributions received from PFICs are allocated pro rata to each day in the investor’s holding period and are subject to interest charges on taxes deemed to be owed in preceding years. If you are a US person and you have PFICs, you will have additional filing requirements in order to report the ownership on those accounts.
Want Greenback to Handle Your PFIC-Related Taxes for US Expats?
Consult with an accountant that specializes in taxes for expats – like any of the accountants on the Greenback team! They can answer your questions about your ownership and interest in PFICs and how it affects your US expat taxes. Or, better yet, they can take care of your tax filing in its entirety.