Foreign investments

The nightmare of U.S. foreign investment taxation

Flagship financial education aims to help people with their financial well-being and provide individuals with the information they need for financial control, stability and simplicity.

For several years, Beacon Financial Education has been very active in informing and educating Americans and people connected to the United States in the Netherlands on the FATCA puzzle (Foreign Account Tax Compliance Act of the United States) that provokes this group of expats through their local seminars, webinars, newsletters and articles. Especially those who have a connection with the United States are not always fully aware of what their connection with the United States involves.

In this article, BFE will explain PFICs, passive foreign investment firms (read: non-US), the complexity of investing as a US / US connected person, and the draconian taxation these PFICs are subject to.

What is a PFIC?

A PFIC is a passive foreign investment company, a company based outside the United States that meets the requirements of the income test or the asset test.

Income test

If 75% or more of the corporation’s gross income for its tax year is passive in nature (investment income such as interest earned, dividends, or capital gains), the corporation is considered a PFIC (within the meaning of of article 1297 (b) of the Internal Revenue Code).

Asset test

At least 50% of the average percentage of the assets of the foreign company (could) produce passive income (investments that produce income in the form of earned interest, dividends or capital gains) or are held for the production of passive income such as cash or bare land.

PFICs include almost all non-U.S. Mutual funds, hedge funds, mutual funds, exchange-traded funds (ETFs), and many foreign insurance or provident / pension products.

So if you are investing your money outside of the United States, chances are you will have to do it with PFICs. And while you may not be taxed in the country of PFICs, you should be aware that this is probably not the case in the United States. After all, U.S. taxation applies to all U.S. taxpayers, and with the entry into force of FATCA, it has become impossible to avoid it (due to new self-reporting requirements for PFICs, as well as the obligation of foreign financial institutions (FFI for short) to report assets held by U.S. citizens to the IRS).

The purpose of the PFIC status of an investment

The 1986 tax reforms and the implementation of FATCA in 2010 aimed to close tax loopholes. Foreign investments with foreign financial institutions that include foreign mutual funds have been subject to US taxation at very high rates and with extremely complicated IRS tax rulings (established in Sections 1291 to 1297 of the Code tax), discouraging US taxpayers from continuing to practice this practice. form of investment – and therefore this form of tax evasion.

Foreign reporting mutual funds compared to those based in the United States are more complex, confusing to say the least, time consuming and expensive, and earnings are taxed at much higher and very unfavorable rates.

PFIC: a taxpayer’s nightmare

If a US citizen has a distribution of passive foreign investment company income or a direct or indirect interest in a PFIC, they must complete and file Form 8621. How you will be taxed depends on the choice you have made. .

Mark-To-Market

The first is the “Mark-To-Market” (MTM) and the taxation is based on the quoted prices of foreign mutual funds, if the stock is said to be “tradable stock”. However, the IRS regulations are so strict that there are only a few foreign funds that would qualify.

Eligible election fund (FAQ)

The second is called a QEF or “Qualified Elective Fund”. This requires a detailed declaration from the PFIC: the annual information declaration of the PFIC must accurately reproduce the taxpayer’s share in proportion to the ordinary income and the net capital gain of the QEF for the tax year.

Complex

The Section 1291 fund is the default option and comes into effect when the shareholder chooses not to treat the PFIC as a QEF or mark-to-market fund. Consequences? A distribution may be treated – in whole or in part – as an excess distribution (the distribution in the current tax year is greater than 125% of the average of the distributions received in respect of those shares by shareholders during the years. three previous tax years) and will be taxed at the highest marginal personal income tax rate.

Okay, that probably gives you a headache already… isn’t it? But, in fact, PFIC tax rulings are much more complex than the simplified descriptions above. Twenty-seven long and complicated pages. Adjustments, exemptions, references to other rules of the tax code, consequences… not to mention the difficult drafting. You would definitely need an expert tax advisor to help you with this. In addition, you must complete a Form 8621 for each PFIC in which you have invested. Filing your taxes can take a full day up to a full work week.

Investing abroad impossible for US persons?

Beacon has educated American expats and those connected to the United States about the consequences and implications of FATCA for years. After all, no one wants to risk the hefty penalties of not reporting offshore financial assets or risking a possible bank account foreclosure.

FATCA has made expatriate financial planning for Americans harder and more complicated, and investing virtually impossible – or unprofitable. After all, FATCA makes reporting PFICs a prerequisite.

Avoiding investing in PFICs therefore seems the most logical thing to do, especially since tax filing is so incredibly complex. However, you might already be subject to a PFIC report and not know it. If you, as a cross-border professional, have worked in multiple countries and made social security and / or pension payments, you may need to report PFICs, as these payments may have been placed with relevant investment companies. as PFICs by the IRS.

So it can be difficult to avoid having a PFIC, but it is important to minimize the number you have and only invest in those that are elective qualified funds (FAQs). It is important that your offshore investments comply with US tax regulations (in order to have the potential to be taxed as a capital gain rather than being treated as regular income, and taxed as such), that you find a quality qualified investment manager. , and that the PFIC meets IRS tax reporting requirements.

New investment options

Recently, new investment options for US citizens and US connected people have become available. Options that make investing more accessible than before, options that are FATCA proof and comply with the stipulations of IRS 8621 (Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund).

Whether these options are suitable for an individual can only be determined during a consultation, during which a licensed investment advisor will review that person’s personal financial and tax situation. But these new investment opportunities are worth considering, especially if you want to control your own money and your own wealth.

Flagship financial education has access to a global network of financial, tax and investment advisers. You can register here for a free consultation with one of their privileged partners in the Netherlands.

Beacon Financial Education does not provide financial, tax or legal advice. None of the information on this site should be taken as financial, tax or legal advice. You should consult your financial, tax or legal advisers for information regarding your specific tax / legal situation.


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