Reporting Requirements for Non-US Mutual Funds (PFIC)

The current efficiency and ease of swift globalization has resulted in interactions between people and businesses from different nations all around the world.  It used to be a huge feat to make financial trades and investments on a global scale; however, information technology and the Internet have rapidly changed the dynamics in that arena.  Anyone who is thinking of or has already acquired investments outside the borders of the United States needs to be particularly knowledgeable about IRS tax obligations in order to avoid getting into financial troubles.

Whether you are an investor looking for some global exposure for your portfolio, a person working overseas, a foreign born United States resident, or someone who happens to have inherited international accounts, if you own non-U.S. mutual funds, there are intricate IRS rules for these Passive Foreign Investment Companies (PFIC) that you need to be aware of.  These reporting requirements can be very difficult to understand, and so it may behoove you to have them deciphered by a tax attorney to ensure you are in compliance.

PFIC Important Detail

In order to avoid being unsuspecting, it is important to keep in mind some basic facts about PFICs.  First, these are any corporation organized under the laws of a non-U.S. jurisdiction, which satisfies either an income test or an asset test.

  • The income test is satisfied if 75% or more of the foreign corporation’s gross income is passive income.
  • The asset test is satisfied if 50% or more of the foreign corporation’s assets produce or are held to produce passive income.
  • Simply put, passive income can be characterized and earned from dividends, interest, royalties, rents, annuities, capital gains from sale or exchange of property which produces such income and foreign currency gains.

The last thing you want to be is naïve about your investment holdings because the consequences can be financially dire to you.  In particular, if you own investments that are registered outside of the United States, chances are that you probably have PFICs.  The rules governing how these should be reported are complex and in order to properly report and disclose all information on IRS Form 8621 requires a thorough understanding of the tax laws in this area.

With a PFIC, the criteria of how to determine the income amount from the investment that needs reporting must first be established.  Depending on your portfolio a legal tax expert may be the best person to use for this examination.  In a nutshell, here is the big picture of how reporting method is concluded:

  • Qualified Electing Fund Method (QEF):  Probably the most favorable election for a PFIC is treating it as a QEF because under this method there is a distinction between capital gain and ordinary gain.  However, in order to use a QEF, the PFIC must provide the taxpayer with an Annual Information Statement that clearly makes the above distinctions.  This report could in most cases be a tall order for these foreign funds because in almost all instances, foreign mutual funds just do not keep books and tax records that may be used for proper IRS reporting.
  • Mark-To-Market Election Method:  The next election is mark-to-market.  This treatment applies to marketable stocks in the investment which simply means that these stocks are regularly exchanged on a national security exchange platform that is regulated by a foreign government.  Thus, this election allows for identification of the stocks’ fair market value and any gains on the sale of positions will be treated as ordinary gains.
  • Section 1291 Method:  Also known as the excess distribution method, this treatment is the most common one.  The statute that controls this method says that application pertains to any distribution in excess of 125% of the average distributions received by the investor over the immediately preceding three year period or any sale of mutual fund shares.  The excess distribution is considered to have been earned ratably over the taxpayer’s investment period in the fund.  Furthermore, for a disposition, any gain is treated as having been earned ratably over the investment period as well.  Once again, arriving at the proper calculation is arduous and often involves significant amounts of tax as well as possible interest.  For the area of loss on disposition, this statute does not allow it to be claimed as a deduction.

We Are Here To Help

You have probably gathered by now that proper reporting requirements for PFICs are a complicated feat.  Dallo Law Group specializes in this area of tax law, and you can breathe easier when you have us evaluating your investments.  Because we specialize in PFICs, we have a good methodology in coming up with the proper accounting and record-keeping needed to arrive to the correct calculations for your investments.  This process is done with the highest integrity and efficiency.

Moreover, times have changed in the area of foreign investments.  Legislation has been passed that specifically targets and has streamlined proper international reporting requirements.  Long gone are the days of secretive foreign accounts, and unpaid tax and reporting consequences can be brutal.  It is better to do all you can to stay in compliance.  Our professionals at Dallo Law Group maintain the goal to provide you with the best advocacy and personal service in tax law.  We remain committed to our clients and look forward to a lasting relationship for all your IRS tax needs.