If you’re a US taxpayer investing in foreign mutual funds or overseas companies, you might be walking into a tax minefield without realizing it. That minefield is called a PFIC – and the IRS takes it very seriously.
What is a PFIC?
A PFIC, more so known as Passive Foreign Investment Company, is a foreign (non-U.S.) corporation that meets either of the following tests:
- Income Test
- At least 75% of its gross income is passive income
- Asset Test
- At least 50% of the assets produce, or are held to produce, passive income
The IRS created PFIC rules to prevent U.S. taxpayers from avoiding U.S. taxes after investing in foreign companies that provide passive income.
Some of the most common sources are foreign mutual funds, EFTs, or holding companies. If your income is categorized as a PFIC, you’ll need to file Form 8621 every year.
What Counts as Passive Income?
There are a few types of income that can trigger PFIC status in a business. Some of the most common are:
- Interest
- Dividends
- Capital Gains
- Rents
- Royalties
While they sound like easy sources of income, the IRS taxes them tremendously.
Why PFICs are a Problem for U.S. Investors
Investing in companies abroad sounds like a great investment opportunity until you learn the tax complexities that come with your earnings. The IRS has created steep tax requirements on what your income brings such as:
- Complex IRS reporting — Form 8621 must be filed every year
- Gains taxed at high ordinary income rates, not lower capital gains rates
- No tax deferral — if you delay recognizing gains, the IRS imposes interest charges
- No foreign tax credit relief in many cases
Unfortunately all of this can lead to high tax bills, lower returns, and complex compliance situations.
To Invest or To Not Invest?
Foreign investments can diversify your portfolio, but PFIC rules can complicate your taxes. In some instances, investing in U.S. companies could potentially be better in the long run. If you’ve already invested in a foreign company, no need to panic. If you haven’t already, talk to a qualified tax advisor to ensure you’re meeting filing requirements.
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