A taxpayer with shares in a passive foreign investment company (a “PFIC”) may qualify to make either a qualified electing fund (“QEF”) election or an election to apply mark-to-market treatment with respect to marketable stock. All things equal, taxpayers will typically prefer QEF treatment. The code, however, requires that the taxpayer meet certain criteria before they can make a valid QEF election. If a taxpayer makes a mark-to-market election, the Code generally provides that the MTM election remains in place until the foreign company ceases to be a PFIC or the IRS consents to the revocation of the MTM election in light of a “substantial change in circumstances.”
Sometimes, the information necessary to make a QEF election is not available at the time that the taxpayer files their tax return. Indeed, investments in PFICs can present notorious challenges in terms of obtaining the necessary documentation to support a QEF election.
Previously, we have look at the tax treaty tiebreaker and how it relates to taxation of Subpart F and PFIC income as well as eligibility for streamlined offshore procedures. This is another in a series of posts on the tax treaty tiebreaker (which is a standard provision in most U.S. tax treaties).
The Internal Revenue Code of the United States requires two things:
1. The calculation of taxes; and
2. The reporting of information.
The Internal Revenue Code of the United States is based on three basic principles:
1. A dislike of all things “foreign”. (If you see the word “foreign” a penalty is sure to follow.)
2. A hatred of all forms of non-U.S. “tax deferral”
3. An attempt to stop the “leakage” of “U.S. taxable assets” from the U.S. tax base. (Examples include the U.S. tax treatment of the “alien spouse” and the U.S. S. 877A “Exit Tax” that may be payable when one makes the decision to renounce U.S. citizenship).
Often taxpayers, whether Canadian or U.S. tax filers, are self-preparing their own returns with tax preparation software packages purchased in the market place. Problems arise numerous times in that the taxpayer not being aware of tax law, has omitted to file various required annual foreign information returns. This is likely due to the fact the software is not a professional version and/or the taxpayer-preparer is not reading any of the software return’s diagnostics.
The following is a response to comments made about an article written by Rachel Heller on medium.com titled, “Why I renounced my US citizenship (Hint: it’s not because I’m avoiding taxes!).” The article was well written, interesting and attracted responses from Homeland Americans. (It was reproduced here and attracted even more comments.) The comments from U.S. residents demonstrated again that they do NOT understand the problems experienced by Americans abroad.
If you are a U.S. expat that has invested or is considering investing in foreign mutual funds, there are a number of serious U.S. tax considerations that you should take into account. These considerations stem mainly from the characterization of most foreign mutual funds as so-called “PFICs” for U.S. tax purposes. They also stem from the fact that, with the advent of FATCA, the IRS is paying closer attention to foreign investments by U.S. persons. In this blog, we introduce you briefly to the world of PFICs and point out some of the specific tax issues associated with PFIC status:
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Reporting Of Passive Foreign Investment Income
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I understand that if my income is all from Canada I will have no U.S. tax payable, then why is the cost of the U.S. tax preparation so expensive relative to my simple Canadian T1 return?
For most U.S. persons residing in Canada, there may be no tax payable if substantially all of your income is from Canadian sources because of the foreign tax credit mechanism. The annual inflation-adjusted foreign earned income exclusion ($97,600-2013) which is a deduction in arriving at adjusted gross income on the U.S. 1040 tax return, may exclude your T4 or self-employment income from taxation. However leakage may result if income determination for U.S. tax purposes under the IRS Code and Regulations is different from Read More
The PFIC regime was not introduced until 1986. Prior to 1986, U.S. taxation of foreign corporations was strictly tied to control of the corporation held by U.S. persons. This allowed not only the foreign mutual fund to avoid U.S. taxation, but also U.S. persons who invested in the fund. How so?
For starters, the fund itself avoided U.S. taxation because it was a foreign corporation that derived only foreign-source income. The fund was able to avoid the taint of being classified as a controlled foreign corporation, or “CFC” because it was owned by a large number of U.S. and foreign investors, each of whom owned a relatively small percentage.
U.S. investors avoided U.S. taxation in two primary ways. First, the fund paid no dividends. Read More
Creeping up to the New Year, the Internal Revenue Service (“IRS”) showed an uncharacteristic sign of holiday goodwill. On December 30, 2013 the IRS issued Temporary Treasury Regulations providing guidance with regard to so-called “passive foreign investment companies” (“PFIC”). The areas covered in the Regulations include guidance in determining ownership of a PFIC (specifically, attributing ownership of PFIC stock through partnerships, estates and trusts), the annual filing requirements for shareholders of PFICs and guidance on the exception to the requirement for certain shareholders of foreign corporations to file Form 5471, “Information Return of U.S. Persons with Respect to Certain Foreign Corporations.’
Broadly speaking, the US tax laws impose a special tax and interest charge on a US person that is a shareholder of a PFIC when the investor receives an “excess distribution” from the Read More
What Every American Investor Must Know
Many American investors are confused by sales pitches of expat investment advisors who are unfamiliar with United States tax laws. While it is true that no tax may be payable in the fund’s jurisdiction (Isle of Man, Guernsey or the UAE, for instance), significant US taxes are payable by the American owner. Confusion abounds when Americans invest in foreign mutual funds, life policies, savings plans, portfolio bonds and similar fund arrangements as compared to when they invest in US-based funds.
Generally, with a US fund virtually all of the income and the gains are distributed annually to investors and reported directly on their US tax returns. The fund sends both the investor and the IRS a form 1099 detailing the shareholder’s income earned in the fund. Foreign investment vehicles are not subject to this kind of disclosure. The American investor must flounder along and determine the proper US tax treatment of his investment.
The US tax laws are clearly designed to deter US persons from investing in offshore funds, whether the investment is made directly or indirectly (e.g., through a BVI company, non-US trust etc.). They prevent the income or gains from escaping US taxation and, impose harsh sanctions on the US investor eliminating any possible tax deferral. Read More