For something with such a mundane name, passive foreign investment companies (PFICs) can massively affect your tax planning and personal finances.

And not in a good way.

To be honest, there’s nothing at all “passive” about their impact, and they can be a major tax trap for US citizens and expats.

Furthermore, if you get caught in that trap, IRS rules make it both complicated and costly to extricate yourself.

So, find out more about PFICs, how they could affect you, and why you need to take urgent action if you believe you have assets in one.

Many of your non-US-based investments could be deemed to be passive foreign investment companies

In  overly simple terms, a PFIC is a foreign investment owned by a US person that generates most of its income passively – so derived from investments or other sources that aren’t regular business operations – or at least 50% of its assets must be investments that produce passive income or capital gains.

This captures the vast majority of non-US collective investments, such as ETFs, mutual funds, unit trusts, and OEICs.

The PFIC designation was introduced by Congress to disincentivize US taxpayers from investing in foreign entities not subject to the same tax rules as US-based corporations.

However, in true “sledgehammer to crack a nut” style, it has meant that even if you have moved to the US and still have investment assets offshore, you may be liable for a tax charge.

For example, if you are invested in ETFs – even simply index trackers – in a Stocks and Shares ISA in the UK, these holdings are likely PFICs. What was a tax-efficient wrapper on one side of the Atlantic will become quite the opposite on the other, as you will be liable for tax on the gains and income from those assets.

The PFIC rules can also affect you many years down the line, even if you have divested yourself of all your overseas-based investments. For example, you may inherit a UK investment portfolio, which could contain PFICs.

There will be punitive tax charges on PFIC gains

Unless you have taken proactive mitigation measures, the earnings from any PFIC you hold will be treated as “excess distributions” and will be taxed in the US.

Unlike most other investments, which may be subject to Capital Gains Tax (CGT), you will be charged Income Tax on your PFIC earnings. Furthermore, this will be the top rate of tax during the period in which you hold the investment, rather than your applicable marginal rate.

This means that, rather than the potentially lower rate of CGT that you may be used to, you could face a tax charge of up to 37%, plus interest depending on how long you have held the PFIC (plus potentially state tax, depending on where you live).

As you will no doubt now appreciate, PFICs can be a significant tax burden for expats in the US, to the extent that the tax charges could well exceed the value of investment benefits.

Holding passive foreign investment company assets will leave you facing onerous and costly reporting requirements

As well as the potentially severe tax implications, if you’re an expat in the US with PFIC assets, you’ll also face onerous reporting requirements.

This is primarily down to the fact that you’ll have to file complex annual reports, which will include completing Form 8621 for each asset.

This means that if your aforementioned ISA has 10 investment funds in it, you will need to complete a form for each as part of your annual tax return.

As you can imagine, this will be time-consuming and is likely to involve significant administrative costs.

There are steps you can take to mitigate the costs of passive foreign investment companies

The best way to avoid PFIC problems is to take preventative steps before you leave your home country and become an expat in the US.

You should ensure that your emigration “to-do” list includes detailed planning about your accrued investments before you get on the plane.

However, if you have already made the move and realise you are facing the issues that you have read about here, there are two things you need to do:

  1. Be active and tackle the problem now, as any delay will just exacerbate an already potentially serious issue; and
  2. Take expert advice from a cross-border tax expert.

On one of our recent We’re the Brits in America podcasts, we took a closer look at PFICs with Brian Dunhill, an experienced cross-border financial planner based in the UK.

He takes a deep dive into the methods of addressing the problem head-on and coming into compliance.

More positively, he also flagged up some effective investment strategies that can help you avoid the issues you’ve read about here, while allowing you to construct an internationally diversified portfolio.

It’s well worth a listen.

Find out more: PFICs: The number one expat landmine that can easily be avoided  

Get in touch

If you are a British expat living in the US and would like to talk about your investments and find out how to invest non-US currencies without triggering PFIC rules, please get in touch to arrange an Exploratory Zoom call to talk through your options.

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