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More Unofficial Capital Controls In The US: PFIC Rules
Submitted by Nick Giamburino of International Man
More Unofficial Capital Controls In The US: PFIC Rules
It ranks at the very top of potential tax nightmares, especially if you invest internationally.
This nightmare could become a reality if you happen to invest in what the IRS deems a Passive Foreign Investment Company (PFIC), which are taxed at exorbitant rates and have highly complex reporting rules. Most foreign mutual funds are PFICs, as are certain foreign stocks.
It’s not illegal to invest in a PFIC, but practically speaking, the costs of doing it are so incredibly onerous that it’s prohibitively expensive in the vast majority of cases.
PFIC rules amount to unofficial restrictions on investing in certain foreign assets and are yet another indicator of the disturbing trend of creeping capital controls in the US.
Capital controls are used by many countries and come in all sorts of shapes, sizes, and labels. The purpose, however, is always the same: to restrict and control the free flow of money into and out of a country so that the politicians have more wealth at their disposal to plunder.
What Is a PFIC Investment?
As always, it’s important to first define our terms.
As far as the IRS is concerned, passive income includes income from interest, dividends, annuities, and certain rents and royalties.
If a foreign corporation or investment vehicle meets either of the two conditions below, it will be deemed to be a PFIC.
1) If passive income accounts for 75% or more of gross income, or
2) 50% or more of its assets are assets that produce passive income.
If you own a foreign mutual fund—even a cash management fund—it probably qualifies as a PFIC. But it’s not just foreign mutual funds; it can be any foreign stock that meets either of the above conditions as well.
Bottom line: even the simplest international investments can create significant tax problems.
(Clarification: an offshore LLC that makes an election to be classified as a disregarded entity or a partnership is not a PFIC.)
What Are the PFIC Rules?
To say the consequences of owning a share in a PFIC are severe would be an understatement.
First, the complexity of the PFIC rules are way out of league for TurboTax or your average tax preparer. You’ll need the assistance of a specialist, and lots of it. The IRS estimates it takes up to a stunning 30 hours of tax preparation time to complete Form 8621, which needs to be filed for each PFIC every year. It’s an incomprehensible waste of human and financial capital that could otherwise go to productive use.
Regardless of whether or not it proves to be a good investment, it’s hard to imagine a situation where the benefit of holding a PFIC outweighs even the cost of reporting it.
But let’s say an investor is willing to pay the ridiculous cost of reporting and the PFIC does prove to be a good investment. In this case, unless the investor makes one of the elections explained below, he suffers the following punitive tax rates and special rules:
- For any year in which you receive a dividend or sell any PFIC shares, you face a complex calculation that involves prorating the PFIC’s return over your entire holding period and applying an interest charge. In contrast to the bizarrely complicated PFIC rules, capital gains tax for other investments are relatively simple to calculate and are only due when the gain is realized through a sale.
- Most capital gains are taxed at a top federal rate of 20%, plus the Obamacare surcharge of 3.8%, for a total of 23.8%, which is favorable compared to the top ordinary federal income tax rate of 39.6%. Capital gains in PFICs, however, are effectively taxed at the highest ordinary income rate plus the interest charge mentioned above. The tax and interest due can eat up 70% or more of your gain.
- A capital loss on a PFIC can’t be used to offset capital gains on other investments.
Until recently, PFIC rules were weakly enforced.
But that’s all changed now, thanks to the Foreign Account Tax Compliance Act (FATCA), which forces every single financial institution on the planet to submit information on their American clients to the IRS. This puts more information at the US government’s fingertips than ever before, including information about PFICs.
Fortunately, there are a couple of ways out, though they aren't ideal.
First, if the PFIC meets certain accounting and reporting requirements, the US investor can elect to treat the PFIC as a Qualified Electing Fund (QEF), which eliminates the punitive tax rates. In practice, you can’t count on a PFIC to provide the information you would need. And even if it does, you would be taxed on your share of its income and gains year by year, even if you didn’t receive any dividends.
Second, generally speaking, there is an exemption from PFIC reporting if PFIC holdings do not exceed $25,000 ($50,000 for married couples filing jointly).
Third, if you hold a PFIC through an IRA or other certain retirement accounts, you may be exempt from Form 8621 filing requirements.
With the complexity and unfavorable tax rates that come with them, it is clearly better to avoid owning PFICs over the exempt amount in non-retirement accounts when looking to invest offshore. (This is not to be construed as tax, investment, or legal advice. As always, discuss your situation with a qualified advisor.)
Conclusion
Taking a step back and looking at the big picture, it’s clear the PFIC rules are part of the long-term trend of the US government using burdensome regulations to effectively shrink the number of options available for those seeking to diversify internationally. These roadblocks are a clue as to how desperate and bankrupt it really is.
You shouldn’t be deterred, as that is exactly what the politicians want to happen. They prefer your savings remain within their immediate reach so that it’s easier to fleece. Instead of being deterred, you should be emboldened to act to protect yourself before the window of opportunity fully shuts. You do not want to be like a sheep that has been penned in for a shearing. If you consult with a tax professional and comply with all of your obligations, you should have nothing to worry about.
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Rules???? they are whatever we say they are....this week.....
Rules, consequences, punishment and recompense are for You and me, not for the elected/chosen/connected class.
We don't want serfs to own these but it would be difficult to justify banning it. We'll just tax it to death instead!
It's bad to be an American nowadays... Not so long ago it was bad to be a Russian, or an East European (that one is still debatable...), or a Chinese. Today, everybody seems to have it easier, at least when it comes to dealing with your own gov (paid from your own tax money...)
We PFIC'ed some folks
Keep stacking
Aww c'mon, dontcha care about your country?....`erryone needs 4-5 60" LCD TV's and designer clothes....Invest in Style....
I get the feeling we will have some FABULOUS looking Homeless in the upcoming years.....
Get your gold and get out of the system before it is too late.
Does anyone know if mining ETFs (in this case NYSE: SIL- Global X Silver Miners ) with ~70% of AUM in foreign companies, will be affected by these new rules? Thanks much in advance.
Good question. Another thing to watch for: actively trading dozens of 'ETFs' that are actually partnerships can be a lesson in K-1 hell...
I'm not sure these are "new" rules. I've been doing PFIC filings for years for my Central Fund of Canada holdings. They take me about 15 minutes each year. Fill in about 4 numbers and add it to the stack of forms.
Yes, the forms are obscure and confusing, yes most "tax" service professionals are completely dumb about them and charge a buttload to officially come up to speed, yes the IRS stinks, yes you can get eaten alive if your PFIC doesn't conform to various guidelines (CEF does) and you have big gains.
But..., the PFIC rules aren't new; just FACTA, which hopes that lots of data will soon be spoon fed to the US. There is a risk that PFIC regulated securities were being overlooked on all sides, because the IRS themselves don't remember their own regulations and many people who buy things don't look into related paperwork needs at the outset.
Edited to add: Oh. The "P" in PFIC is "passive"; so most thing effected by it are *not* active companies like miners or etfs of miner. They are often things you buy just to hold (bullion), and in some cases fronts for shady money laundering fronts where money is made without any actual business being there (thus the reason for the PFIC regs in the first place).
Generally, no. ETFs in the US are typically run as open-end investment companies (a US-based Trust or Corporation), much the way Mutual Funds are. In other words, they are US-based financial entities, even though foreign investments may be a majority of what they hold. Miners would also generally be considered an ACTIVE investment.
[edit] Obviously, SWCroaker is more familiar with PFIC rules than I am, although in my defense I will say two things:
1. Sounds like we arrived at substantially the same answer by two similar paths.
2. I did stay at a Holiday Inn Express last night. So I've got that going for me.
Just for kicks, I decided to take a look at US tax system. Just a quick glance, just to figure out what all the fuss is about.
I was a mental wreck by the end. I've never seen so many rules, regulations and forms in my life! And I'm talking CIVILIAN taxes. I didn't even want to look at CORPORATE taxes, I'd have gone totally ga-ga, I suspect! No wonder accountants, tax lawyers and bureaucrats are such big business. You effectively NEED them just to comply with tax regulation! Forget about finding loopholes!
But this led me to a thought. Every day, on Zero Hedge, we talk about "oil bubbles", "credit bubbles", "Stock bubbles" and "Bond bubbles". But what about a labour bubble? What if President was elected who cut all this regulation which rendered a lot of these professions redundant? What would happen then?
In short, there are so many "bubbles" forming when it all pops, quite a lot of the other will go, too.
Although I'm still prepping (gold, silver, food, etc) for the implosion, suddenly, I'm not looking forward to it. This could end REALLY badly...
N.B: This thought was a revelation to me, but no doubt you lot figured it out ages ago. Please don't spit venom at me!
What's your tax system? Since they've collectively stolen nearly everything I have here, I'm in the market for a new one...
UK. It's not perfect, but at least I'm not hitting the Scotch after doing my returns and you have a better chance at keeping your money...
I think he meant to point out Obama's Tax Bubble(Revenue).
"No wonder accountants, tax lawyers and bureaucrats are such big business."
BINGO
but, past performance is no guarantee of future performance
sustainability?'
'
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They are closing the gates behind us, very slowly. At first…
•?•
V-V
After being made aware of US "inquiries" into a small tourism-related business I have (or that should be had) in Central America, my partner and I sold out and shut it down last week. Hey, we're both retired, so the cash on the sale will see us out of this world. I can see our actions being copied around the world. The European Union is looking to do the same thing - wonder when they will start over-taxing US-owned businesses. Should be fun to watch!
Panama Attracts lots of Retirees looking for B & B, Eco Farming, Coffee Growing, maybe Trees, Maybe Seeds, Maybe Flowers, ... not a bad place for beaches, resorts, diving, boating, fishing, even so old plantations.
I've looked a little at this for years.
I would assume to keep money in foreign bank offshore, but they do go bankrupt in at least a couple of countries I have looked at.
FACTA has made it hard to keep money offshore I would guess. If the total dollars are small to run a business might be okay. But guess once you sell you have a big amount of dollars in an account which might make it worse.
I hate not having options. And repatriating money can result in 3% loss as the Foreign Government takes a direct fee.
So I guess buying a house with money already offshore would be the solution. Maybe renting a house or apartment to locals could be good, but a slow recovery of funds.
Probably a business owner's nightmare.