Passive Foreign Investment Company
Table of Contents:
Introduction: What is PASSIVE FOREIGN INVESTMENT COMPANY (PFIC)?
Passive Foreign Investment Company is a foreign corporation based abroad that invests and makes income from passive investments. Now, the United States wants its citizens to put money into US corporations; tax them, rather than the taxpayer parking money abroad and avoiding taxes.
There are 2 tests that will certify the foreign corporation as a PFIC:-
- Income test. 75% or more of the corporation’s gross income for its tax year is passive income (as defined in section 1297(b)).
- Asset test. At least 50% of the average percentage of assets (determined under section 1297(e)) held by the foreign corporation during the tax year are assets that produce passive income or that are held for the production of passive income.
Based on the guidance from the IRS, a U.S. person that is a direct or indirect shareholder of a PFIC must file Form 8621 for each tax year under the following five circumstances if the U.S. person:
- Receives certain direct or indirect distributions from a PFIC,
- Recognizes gain on a direct or indirect disposition of PFIC stock,
- Is reporting information with respect to a Qualified Electing Fund (QEF) or section 1296 mark-to-market election,
- Is making an election reportable in Part II of the form, or
- Is required to file an annual report pursuant to section 1298(f). See the Part I instructions, later, for more information regarding the person that must file pursuant to section 1298(f).
How are PASSIVE FOREIGN INVESTMENT COMPANY (PFIC) TAXED ON YOUR FORM 1040?
There are 3 kinds of Tax regimes where a US person holding an interest in a foreign corporation is taxed.
- IRC SEC 1291 (Excess Distribution) – (The default Method) taxpayers are subject to special rules when they receive an excess distribution or recognize gain on the sale or disposition of the stock of, a section 1291 fund. A distribution may be partly or wholly an excess distribution. The entire amount of gain from the disposition of a section 1291 fund is treated as an excess distribution. Tax plus interest on deferral occurs when an excess distribution is received. The interest is accumulated over the entire deferral period.
- Mark-to-market method – PFIC shareholders who elect gains and losses from a “marketable stock”, a stock under section under 1296, on their income tax return for that year. Usually, the value of the stock at the beginning and the ending of the year are reported along with any sale of stock.
- Qualifying electing fund – (Rarely used) A PFIC shareholder having an investment in a QEF. The taxpayer must elect to treat the investment as QEF. A shareholder of a QEF must annually include in gross income as ordinary income its pro-rata share of the ordinary earnings of the QEF and as long-term capital gain its pro-rata share of the net capital gain of the QEF. Usually taxed on undistributed QEF income as and when it is earned.
Whats new for PASSIVE FOREIGN INVESTMENT COMPANY (PFIC) after TCJA Updates?
A checkbox was added on page 1 of Form 8621 for shareholders of stock of a foreign corporation that elects to treat such stock as the stock of a qualifying insurance corporation under section 1297(f)(2).
According to the IRS “ A U.S. person that owns stock of a foreign corporation and elects to treat such stock as the stock of a qualifying insurance corporation under the alternative facts and circumstances test within the meaning of section 1297(f)(2) must file a limited-information Form 8621’’.
If you do have foreign mutual funds, income from tax-deferred savings accounts, Non-qualified foreign pension, and retirement account, it may be considered a PFIC.
Also, if the value of your PFIC stock is less than $25,000($50,000 if married filing jointly), may be exempt from reporting.
Form 8621 is filed with the taxpayers’ return by the due date. Unlike other forms there are no penalties to not filing form 8621 along with your tax return, however, you need to be in compliance with the US tax laws at all times. Further instructions can be found on https://www.irs.gov/instructions/i8621
PFIC is a very complex topic and it’s best left to the Tax professionals to deal with it.
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