Mutual funds, and ETFs in general, are companies, which may not be clear at first appearance. This is true for both domestic and international versions.
You are purchasing shares and becoming a part-owner of these organizations when you invest in them. The fund, or ETF, then invests the money it receives from investors in assets listed in its prospectus (stocks, bonds, gold, commodities, real estate, and so on) in order to create passive income for its investors.
If you look closely, you’ll see that most foreign funds and ETFs pass both PFIC tests: the majority of their income is passive, and the majority of their assets create passive income. As a result, they qualify as PFICs for tax reasons.
A foreign fund is one that is registered outside of the United States rather than one that invests in foreign assets. A fund that invests in Brazilian stocks and is listed on a US stock market is not a PFIC. A PFIC, on the other hand, is a fund that invests in US companies and is listed on a Brazilian stock exchange.
What exactly is a PFIC?
A PFIC is a non-U.S. corporation with at least 75 percent of its gross income designated as passive income and at least 50 percent of its assets designated as passive income producing investments. Dividends, interest, rent, royalties, and capital gains from the sale of assets are all examples of passive income.
Is Vanguard a private equity firm?
“How can I detect a PFIC?” is a regular question we get. The fact that mutual funds from U.S. businesses with overseas operations, such as Vanguard, are normally not deemed PFICs, is important to grasp. If you open a foreign fund with UBS, a Swiss investing firm, the fund will be classified as a PFIC.
If a foreign firm or foreign investment fund fits one of the following two characteristics, it is classified as a passive foreign investment company (PFIC).
Income that is generated passively (via investment vehicles) rather than actively is referred to as passive income (income earned in exchanged for goods and services). The following are examples of passive income:
- Gains from the sale or exchange of certain assets, certain commodities transactions (including futures), and foreign currency transactions.
Is iShares considered a PFIC?
Shares in foreign firms that qualify as Passive Foreign Investment Companies (PFICs) under the Internal Revenue Code may be held by iShares Funds.
Is it necessary to pay taxes on ETFs?
Equity ETFs, which can include anywhere from 25 to over 7,000 different equities, are responsible for ETFs’ reputation for tax efficiency. In this way, equities ETFs are comparable to mutual funds, but they are generally more tax-efficient because they do not distribute a lot of capital gains.
This is due in part to the fact that most ETFs are managed passively by fund managers in relation to the performance of an index, whereas mutual funds are generally handled actively. When establishing or redeeming ETF shares, ETF managers have the option of decreasing capital gains.
Remember that ETFs that invest in dividend-paying companies will eventually release those dividends to shareholders—typically once a year, though dividend-focused ETFs may do so more regularly. ETFs that hold interest-paying bonds will release that interest to owners on a monthly basis in many situations. Dividends and interest payments from ETFs are taxed by the IRS in the same way as income from the underlying stocks or bonds, and the income is reflected on your 1099 statement.
Profits on ETFs sold at a profit are taxed in the same way as the underlying equities or bonds. You’ll owe an additional 3.8 percent Net Investment Income Tax if your overall modified adjusted gross income exceeds a certain threshold ($200,000 for single filers, $125,000 for married filing separately, $200,000 for head of household, and $250,000 for married filing jointly or a qualifying widow(er) with a dependent child) (NIIT). The NIIT is included in our discussion of maximum rates.
Equity and bond ETFs held for more than a year are taxed at long-term capital gains rates, which can be as high as 23.8 percent. Ordinary income rates, which peak out at 40.8 percent, apply to equity and bond ETFs held for less than a year.
What defines a PFIC fund?
In practice, a PFIC is a non-US mutual fund, OEIC, ETF, unit trust, or other investment vehicle incorporated as a non-US corporation (or trust, which the IRS deems to be an investment company).
Is this a PFIC investment?
Simply click the “unsubscribe” link at the bottom of the email to stop receiving it. I promise I won’t be sad. The space in your inbox is valuable real estate. I am a merciless unsubscriber from email lists.
This week’s topic: Is my investment account a PFIC?
I have ten international investments in my foreign investment account. Is it one PFIC (account) or ten PFICs (foreign investments)? Is it possible to combine all of the reporting on a single 8621?
Because this is a frequently asked subject, I decided to devote this week’s email to providing a thorough response.
A foreign investment account is not a PFIC
The acronym “PFIC” refers for “Passive Foreign Investment Company,” as you may recall. Section 1297(a) of the Code defines a passive foreign investment corporation as:
(1) Passive income accounts for 75 percent or more of such corporation’s gross income for the taxable year, or
(2) During the taxable year, the average percentage of assets owned by such corporation that create passive income or are held for the production of passive income is at least 50% (as determined in accordance with paragraph (e)).
Fortunately, it is all you need to know about the Code. An investment account isn’t a company; it’s a bank account that a financial institution manages for you. As a result, a passive foreign investment business cannot be an investment account. Your account does not qualify as a PFIC.
But the assets inside the foreign investment account may be PFICs
The overseas investments you own are held in your account at the foreign financial institution. Bonds, equities, mutual funds, and other sorts of investments could be included. You must examine each of your investments and use the definition of a PFIC to see if you have PFICs.
So how do I know if I have a PFIC?
The “income test” and the “asset test” are the two conditions listed in Section 1297(a) of the PFIC definition.
- The income test instructs you to assess if the corporation’s gross income is passive to the tune of 75% or more. If this is the case, the company is a PFIC.
- The asset test asks if 50 percent or more of the company’s assets are passive or held for the purpose of producing passive income. If they are, the company is classified as a PFIC. (Hint: For the asset test, cash is considered a passive asset.)
To be considered a PFIC, your investment must meet one of the two criteria.
What is “passive income” exactly?
Section 954 defines passive income for the purposes of Section 1297. (c). Interest, dividends, capital gains and losses, commodities trades, foreign currency profits, and so on are all included.
Bonds are not PFICs
Bonds are not equities, but rather debts. To put it another way, if you hold a bond, you don’t own a corporation; instead, you own a debt instrument. Bonds, despite producing passive income, cannot be classified as PFICs (interest).
Stocks can be PFICs
Stocks are a type of equity ownership in a company. A PFIC is a foreign corporation that meets either the income or asset requirement.
Because they are enterprises producing mostly non-passive revenue and keeping primarily non-passive assets, most publicly traded equities are not PFICs.
Take, for example, the Nestle stock. Nestle is a foreign company because it is organized under the rules of Switzerland.
On its balance sheet, Nestle has significantly more inventory, receivables, factories, warehouses, offices, and other assets than cash. All of these assets are held for the purpose of generating non-passive income. Nestle does not meet the 50% or more passive asset test since the great majority of its assets are held for the generating of non-passive income.
Nestle’s revenue is mostly derived from product sales. This is referred to as non-passive income. Interest, dividends, capital gains, and other forms of income do not make up the majority of Nestle’s revenue. Nestle does not fulfill the passive income requirement of 75% or greater.
Nestle is not a PFIC, we can be relatively assured. Most corporations in which you own stock will act in this manner, but keep in mind that your stock in an ordinary company like Nestle can be PFIC stock if it meets either the income or asset condition.
Funds are usually PFICs
Mutual funds, exchange traded funds (ETFs), bond funds, currency tracking funds, and other similar assets are all vehicles that invest and give you a percentage of the profits.
A fund invests on your behalf in corporations and various assets in order to earn income in the form of interest, dividends, capital gains, and foreign currency profits. These are all forms of passive income, and in most cases, a fund receives 100% passive income and holds 100% of its assets for the purpose of passive income generation.
How can you tell if your stock or fund is foreign?
I’ve seen a lot of international investment accounts with US investments in them. Even if it fulfills the income requirement, asset test, or both, it is not a PFIC if it is a US investment.
Examining the International Securities Identification Number (ISIN), if one is supplied, is a simple approach to establish whether your investment is US or international. If your statements don’t include one, you might be able to get one from the financial institution where your account is maintained, or you might be able to discover it on the Internet.
A two-letter country code is used to start the ISIN numbering system. “US” denotes that the investment is made in the United States. If the ISIN’s initial two letters are the same, “It is not a PFIC if you say “US.”
Can I use one Form 8621 for many PFICs?
For each PFIC, you must file a separate Form 8621. “A separate Form 8621 must be submitted for each PFIC in which stock is held directly or indirectly,” says the Form 8621 guidelines. (The bold print comes straight from the directions; I didn’t add it.)
I am not your CPA; this is not advice to you
This is just something I enjoy doing. And I enjoy making big generalizations based on a few facts. The information presented here may or may not apply to your individual circumstances. If you require assistance, you should consult a specialist.
What are the signs that a corporation is a PFIC?
A tax regime in the United States that applies to U.S. citizens who own stock in a foreign firm that largely holds or earns passive investments and income. U.S. persons are required to declare their allocable portion of the PFIC’s taxable income and to comply with specific reporting requirements under the “passive foreign investment company” (“PFIC”) tax regime. The PFIC regime is designed to deter Americans from founding a foreign corporation and utilizing that firm to invest in mostly passive investments in order to avoid paying federal income taxes in the United States. Harsh tax consequences may be imposed on such US citizens, potentially increasing their total federal income tax liability.
If either the 50 percent asset test or the 75 percent income test is met, a foreign corporation is considered as a PFIC. The income test determines whether a foreign corporation is a PFIC if the average proportion of the value of the assets owned by the corporation (measured quarterly) during the taxable year that create passive income, or are held for the purpose of producing passive income, is at least 50%. Or if 75 percent or more of its gross income is defined as ‘passive income,’ which includes dividends, interest, royalties, rents, and annuities, among other things.
Exception during the first year of business. For the first taxable year in which it makes gross income, a corporation that would normally fit the criteria for a PFIC would not be regarded as one. Only if the following conditions are met does the exception apply: (1) No predecessor of such corporation was a PFIC; (2) the United States stockholders establish to the satisfaction of the IRS that such corporation will not be a PFIC for either of the first two taxable years following the start-up year; and (3) such corporation is not a PFIC for either of the first two taxable years following the start-up year.
Regardless of whether the PFIC distributed any money to the U.S. stockholder, the PFIC tax regime imposes a major filing obligation and forces U.S. people to pay tax on an annual basis. To that purpose, many U.S. investors demand that corporations assess their PFIC status on a yearly basis and give extensive information (along with tax returns filed in accordance with the Code) to enable them to properly submit the U.S. shareholder tax return. Companies must be aware of their PFIC duties under any investment agreement since the PFIC laws apply to each U.S. stockholder, regardless of the stockholder’s position in the firm.
The PFIC tax regime is designed to deter Americans from founding (or owning) foreign firms and utilizing those entities to invest in mostly passive investments, so attempting to avoid paying federal income taxes on their earnings. If a U.S. person is recognized as possessing an interest in a PFIC, he or she may be subject to extra tax and interest charges if a “excess distribution” is received. The term “excess distribution” refers to certain payouts from the PFIC, as well as gains from the sale of stock in the PFIC. This special tax and interest charge is similar to the amount of US federal income tax that would have been due if the foreign firm had distributed all of its earnings each year. Excess distributions are calculated once a year and might be complicated.
The Internal Revenue Service (“IRS”) has tight and exceedingly convoluted tax standards for investments recognized as PFICs. The PFIC, as well as its stockholders, are expected to keep accurate records of all transactions involving the PFIC, including share cost basis, dividends received, and any undistributed income.
Every non-US corporation that solicits investments from US citizens is and will be required to provide the investors with an annual determination of the company’s PFIC status, as well as, in a growing number of cases, information about the company’s income, in order for the investor to comply with US tax rules.
The PFIC restrictions, on the other hand, exclude investors who fall into one of the following categories:
a. Dual resident taxpayers — taxpayers who, due to treaty tie-breaker provisions, are classified as nonresident aliens for the taxable year. In conformity with requirements, the treaty-based return position should be declared.
b. 30 day holding period – if a taxpayer purchases a PFIC fund during the taxable year or the immediately prior taxable year and keeps it for less than 30 days;
c. Residents of some United States territory, such as Guam, the Northern Mariana Islands, or the US Virgin Islands;
d. De minimis – If the worth of the PFIC is less than $25,000 (or $50,000 for shareholders who file joint returns) and the taxpayer did not receive an excess dividend.
For relevant U.S. taxpayers, PFIC reporting regulations can be an administrative burden and result in tax payments. As a result, the regulations’ exceptions might be a huge comfort for these taxpayers. In addition, the following taxpayers must be more vigilant when it comes to PFIC:
Are ETFs required to report funds?
Because of the way the US’s citizenship-based taxes and punitive Passive foreign investment company (PFIC) tax policy collide, US citizens and permanent residents (green card holders) living in the UK are unable to access the same UCITS funds and ETFs as other UK and EU residents. Holding US domiciled funds or ETFs is one of the few viable alternatives for these investors to hold collective investment vehicles.
However, some “offshore” fund holdings are prohibited in the United Kingdom. Gains in a non-UCITS fund or ETF that does not have HMRC reporting status are taxed at higher income rates rather than the lower and more advantageous capital gains rates.
Many US-domiciled funds and ETFs will not be required to report to HMRC. Vanguard’s US domiciled ETFs, on the other hand, include a number of HMRC reporting vehicles. As a result, a US citizen or green card holder living in the UK can invest in these ETFs without being subject to either country’s unfavorable “offshore” tax regime.
What is the best way to monitor my PFIC status?
A PFIC is a foreign corporation (a “tested foreign corporation”) that generates at least 75 percent passive income during the tax year (the “Income Test”) or has an average percentage of assets that generate passive income of at least 50 percent (the “Asset Test”).
Are mutual funds in Canada PFIC?
A Passive Foreign Investment Company (PFIC) is a non-U.S. corporation (or a non-U.S. entity treated as a corporation under U.S. tax principles) with passive income accounting for 75 percent or more of its gross income, or where at least half of the corporation’s assets produce or are held to produce passive income. Canadian mutual funds are classified as PFICs under this criterion.
If you own non-registered Canadian mutual funds and are a US taxpayer, you are most likely subject to the Passive Foreign Investment Company (PFIC) laws, which require you to declare income from each PFIC on your US tax return.
The PFIC regulations are complicated. For information on how these laws may affect their circumstances, investors should consult their own U.S. tax expert.