The Foreign Account Tax Compliance Act of 2010 has changed the nature of Tax Reporting for American Expatriates. Formerly benign Passive Foreign Investment Companies (PFICs) have become a tax nightmare incurring significant costs in tax preparation and taxes affecting investment performance.
By David Kuenzi, 2017.
If you are a U.S. citizen or a U.S. permanent resident who has been living and working outside the U.S. and investing your savings through a non-US financial institution, you need to learn what a Passive Foreign Investment Company is very quickly. Why? Because the passage of the Foreign Account Tax Compliance Act (FATCA) has ushered in a new era of dramatically heightened enforcement by the U.S. laws regarding taxation of and reporting on investments held outside the U.S. by U.S. Citizens or U.S. permanent residents.
There has already been much discussion about IRS Form 8938, which, since 2011, has been required filing for Americans abroad with more than $300,000 of financial assets held outside the U.S (for American residents in the US, the threshold is only $50,000). Form 8938 requires not only the listing of assets held outside the US, but also specifically requires a box to be checked if the assets are “Passive Foreign Investment Companies.”
What are PFICs?
The moniker “Passive Foreign Investment Companies” (PFICs) sounds like some exotic and highly-specialized investment, and, as a result, many Americans automatically assume that they do not own any. For many unsuspecting Americans, abroad this conclusion is a mistake, because PFICs are simply “pooled investments” registered outside of the United States encompassing mutual funds, hedge funds, insurance products and non-U.S. pension plans. A bank account might also be a PFIC if that account is a money-market fund rather than simply a deposit account, because money market accounts are essentially short-maturity fixed-income mutual funds. Furthermore, PFIC rules can and generally do apply to investments held inside foreign pension funds unless those pension plans are recognized by the U.S. as “qualified” under the terms of a double-taxation treaty between the U.S. and the host country. Due to FATCA, the consequences of this mistake have become very significant.
The tax treatment of PFICs is extremely punitive compared to the tax treatment of similar investments that are incorporated in the U.S. For example, an American holder of a U.S. incorporated mutual fund invested in European stocks pays the low long-term capital gains rate of 15% if the fund is held for more than one year. The same American investor who buys a nearly identical fund listed in the UK or in Switzerland (or any place outside the US) will find their investment subject to the PFIC taxation regime, which counts all income (including capital gains) as ordinary income and automatically taxes it at the top individual tax rate (39.6%). In some cases, the total tax on a PFIC investment may rise to well above 50%. Furthermore, capital losses cannot be carried forward or used to offset other capital gains.
PFIC Compliance for Non-US Mutual Funds
High taxation rates are not the only big disadvantage of PFICs for American investors. The other major complicating factor of PFICs is the onerous task of simply complying with IRS reporting rules for PFICs. Ownership is most common among expatriate Americans, many of whom employ accountants specializing in tax preparation for Americans abroad. However, hiring an expatriate tax specialist does not guarantee that the proper PFIC related filings are being made and the taxes paid.
Often, the client inadvertently fails to divulge (and the tax accountant fails to request) the necessary information on the client’s mutual funds, hedge funds, or other financial holdings. In other cases, if the client and the tax preparer have negotiated a fixed fee for tax preparation, the preparer may be reluctant to ask about possible PFICs because record keeping and preparation time for the complicated form 8621 (required to be filed for each PFIC investment owned) is estimated by the IRS to be 22 hours per year!
As a result of the 2010 FATCA law, form 8621 must be filed every year for separate PFIC (previously 8621 only had to be filed in years of when the fund paid distributions to the fund holders). It does not take long to realize that filing form 8621 for three to four PFIC investments (or more) might quickly run up a tax preparation bill to many thousands of dollars, no matter how much (or little) the underlying investments are worth or how well they have performed.
However, this scary picture raises an obvious question. If this is such a big trap, why has there not been more discussion of the issue and why have I never read about it before? The reason is that until now the IRS faced many obstacles to enforcing the PFIC rules and lacked the resources to go after filers on the issue. Failure to file Form 8621 and properly report PFICs has hardly ever resulted in an audit or a prosecution for tax fraud. The PFIC issue has been safely ignored until now, even by professional tax preparers. But times have changed.
FATCA makes PFIC Reporting Mandatory
The FATCA legislation not only requires new self-reporting on PFICs, non-US Mutual Funds and other foreign held financial assets, but also requires all “foreign financial institutions” to report on the assets held by U.S. citizens and U.S. permanent residents directly to the IRS. While it may seem hard to believe that foreign financial institutions would willingly comply with such reporting requirements, the fact is that industry observers have observed nearly universal compliance rules by banks, brokerages, insurance companies, mutual funds (anything “financial”) around the world, because of the severe sanctions the FATCA law imposes on non-compliant financial institutions. The point is that all U.S. citizens must assume that the IRS will have a direct and easily accessible window onto their holdings in foreign financial institutions. It will be easy to cross-reference direct reports by these institutions to the IRS with self-filed form 8938 and 8621 and determine whether or not your PFIC investments have been properly reported and the tax properly calculated and paid.
David Kuenzi founded Thun Financial Advisors in 2008 with a mission to bring world-class investment management and financial planning services to cross-border families and Americans abroad.
David is a recognized expert on cross-border wealth management, especially with respect to Americans living abroad. He has been frequently quoted on topics ranging from FATCA to currency management in The Wall Street Journal, CNN, NPR, the Economist, Bloomberg, CNBC and many other forums. His own writings have appeared in publications such as the Wall Street Journal, International Investment Adviser and Emerging Money.
Before founding Thun Financial, David worked as a securities analyst and institutional broker specializing in European and emerging markets. His employers included Chase Manhattan Bank, Deutsche Bank, Bank Austria and the Harvard Institute for International Development. His career included postings in New York, London and Moscow.
David grew up in Wisconsin, but spent most of his professional career in New York City and in Europe before returning to Madison in 2005. He received his undergraduate degree from the University of Wisconsin and completed graduate work in politics and economics at Columbia University and Harvard University before launching a career in finance. David is a Certified Financial Planner™ and speaks English, Russian and Spanish.
We are hosting a seminar to learn more as part of our "Need to Know" series.
Please join us:
Thursday, June 22
Calle Tutor, 24
You must pre-register on Eventbrite:
May 17, 2017
Salesforce‘s performance was strong in 2016, and we expect this trend to continue when the company reports its first quarter earnings on May 18th. Its top line grew by more than 25% last year, and consensus estimates suggest marginally lower growth for the first quarter due to to seasonality. Salesforce generates revenues primarily from subscription fees and support for its services. With customer preferences shifting towards cloud-based products, the company’s enterprise cloud computing solutions – which include apps and platform services, as well as professional services to facilitate the adoption of its solutions – will play a key role in boosting its growth. Competitors such as Microsoft and Amazon also saw 10% and 43% growth, respectively, in their cloud-based revenues, which indicates that the entire cloud segment is likely growing at an impressive pace.
Our President's breakfast this month spotlights Salesforce's general manager, Enrique Polo de Lara. His topic: "The digital transformation in the main industries in Spain. The new role of the companies in the digital society."
Join us Monday, June 12,
IE Campus - [Area 31]
Calle Maria de Molina, 31
Salesforce is betting big on its AI CRM platform, Einstein, and we expect it to boost adoption of the company’s cloud solutions. Sales Cloud – the company’s flagship product – grew 13% over the prior year, and continued to be the largest contributor to the Subscription and Support segment. Service Cloud and Marketing Cloud saw revenue increases of around 27% and 42%, respectively. We expect growth across the CRM and software businesses.
Geographically, Salesforce continued to perform well in the Americas, which contributed 74% of total revenues and grew by 27% year-on-year to $6.23 billion for fiscal 2017. Asia-Pacific – where the public cloud market is expected to grow at 12% and reach $11.5 billion by 2018, per Gartner – witnessed the most growth for the company, with revenues from the region increasing 34% y-o-y to $793 million. The increased focus on the Asian market is likely to benefit the company’s quarterly performance.
Profitability remains a key area of focus for Salesforce, as its GAAP EPS remained negative at $(0.07) in the previous quarter, though non-GAAP EPS of $0.28 was up 47% from the prior year. Operating expenses grew at over 25% as the company continued to spend extensively on sales and R&D in order to effectively compete with rivals such as SAP and Microsoft. This trend is not expected to change in Q1. (Forbes, May 17, 2017.
Independence Day of the United States, also referred to as the Fourth of July or July Fourth in the U.S., is a federal holiday commemorating the adoption of the Declaration of Independence 241 years ago in 1776 on July 4 by the Continental Congress. It declared that the thirteen American colonies regarded themselves as a new nation, the United States of America, and were no longer part of the British Empire.
Independence Day is commonly associated with fireworks, parades, barbecues, carnivals, fairs, picnics, concerts, baseball games, family reunions, and political speeches and ceremonies, in addition to various other public and private events celebrating the history, government, and traditions of the United States. Independence Day is the National Day of the United States.
During the American Revolution, the legal separation of the Thirteen Colonies from Great Britain in 1776 actually occurred on July 2, when the Second Continental Congress voted to approve a resolution of independence that had been proposed in June by Richard Henry Lee of Virginia declaring the United States independent from Great Britain rule. After voting for independence, Congress turned its attention to the Declaration of Independence, a statement explaining this decision, which had been prepared by a Committee of Five, with Thomas Jefferson as its principal author. Congress debated and revised the wording of the Declaration, finally approving it two days later on July 4. A day earlier, John Adams had written to his wife Abigail:
The second day of July, 1776, will be the most memorable epoch in the history of America. I am apt to believe that it will be celebrated by succeeding generations as the great anniversary festival. It ought to be commemorated as the day of deliverance, by solemn acts of devotion to God Almighty. It ought to be solemnized with pomp and parade, with shows, games, sports, guns, bells, bonfires, and illuminations, from one end of this continent to the other, from this time forward forever more.
Adams's prediction was off by two days. From the outset, Americans celebrated independence on July 4, the date shown on the much-publicized Declaration of Independence, rather than on July 2, the date the resolution of independence was approved in a closed session of Congress.
Historians have long disputed whether members of Congress signed the Declaration of Independence on July 4, even though Thomas Jefferson, John Adams, and Benjamin Franklin all later wrote that they had signed it on that day. Most historians have concluded that the Declaration was signed nearly a month after its adoption, on August 2, 1776, and not on July 4 as is commonly believed.
Coincidentally, both John Adams and Thomas Jefferson, the only signers of the Declaration of Independence later to serve as Presidents of the United States, died on the same day: July 4, 1826, which was the 50th anniversary of the Declaration. Although not a signer of the Declaration of Independence, James Monroe, another Founding Father who was elected as President, also died on July 4, 1831. He was the third President in a row who died on the anniversary of independence. Calvin Coolidge, the 30th President, was born on July 4, 1872; so far he is the only U.S. President to have been born on Independence Day.
(Wikipedia, June 8, 2017)
So join us to celebrate one of America’s iconic holidays!
Investments as an American Abroad: What would you need to know to build a secure financial future while staying in compliance with the IRS.
June 22nd – Thursday 19:00-20:30
Calle Tutor, 24 – Madrid
Do´s and don´ts when investing as an American abroad. What not to do (ostrich strategy), how to open a US account from as an American Abroad. US and non-US spouse, special considerations when investing. PFIC and Form 8621. Spanish fiscal perspective and the investments that give right to the authorization of residence.
Speakers: James Levy (Clearwater Private Investments) Alejandra Pastor & Ricardo Delicado (Sagardoy Abogados) and Antonio Rodriguez(US Tax Consultants)
Registration required: :at https://acmneedtoknowinvestmentsforamericanslivinginspain.eventbrite.com
We hope to create a one-stop shop for news and events celebrating our club and the American culture. Let us know if YOU have an idea for post you think would be a valuable (or fun) tidbit.