What is a PFIC and how could your offshore investments actually lead to a higher taxation rate on earned income? A Passive Foreign Investment Company or PFIC is classified by the IRS in two ways:
- 75% or more of the income from the foreign corporation is classified as “passive income,” such as rents, royalties or fees and not earned through standard business transactions
- 50% or more of the foreign corporations assets are classified as investments that generate income such as corporate gains, interest or dividends
Why is it important for a US taxpayer to understand the definition of a PFIC? Because many US investors have been surprised to learn that their offshore mutual funds, partnerships or ownership interests are classified by the IRS as a PFIC. This results in a the highest tax rate possible, and excludes the application of more attractive capital gains rates. US taxpayers and investors are dismayed to learn that the company or partnership cannot and will not provide separate interest or share valuation required to calculate the actual starting value, appreciation or loss and ultimately income or losses for US tax purposes.
PFICs are also governed by some of the most complex IRS rules and US tax laws. The experienced international tax attorneys at Allen Barron work to protect your interests. We ensure that you are compliant with strict documentation and reporting requirements relating to your basis in the investment or company, dividends and any undistributed income retained by the company itself. The tax consequences of a PFIC are much more harsh than the same type of investment based here in the United States. As an example, if you invested in a US-based company (instead of the foreign entity) and the US company purchased the same European investments, your tax basis would be based on capital gains (approximately 15%). When your investments are classified by the IRS as a PFIC, the tax rate leaps to the top individual tax rate (approximately 39.5%). In other words, you will pay almost 25% more in taxes for a foreign based corporation or mutual fund, than you would for a US corporation or mutual fund making the same investments.
What is a PFIC and why are PFIC tax issues so complex? Why do you face a 39.5% tax rate on your PFIC investment income? If you have foreign or offshore investments or are concerned with PFIC issues and the IRS we invite you to contact us for a free consultation at 866-631-3470.
