Passive foreign investment companies (PFIC)

Passive Foreign Investment Companies ("PFIC") and their tax treatment is one of the main legal issues surrounding foreign investments. A significant number of cases submitted during IRS Voluntary Disclosure Programs involve PFIC investments. As the U.S. government increases compliance enforcement, it is important for all U.S. taxpayers to be attentive in reporting their investments.

Foreign corporations designated as Passive Foreign Investment Companies or PFIC have intricate laws and rules surrounding their tax treatment. Many of these rules are tied to which elections (if any) are made; just knowing how and when to make which elections is a complicated matter itself, for most investors. Consequently, this compounds the difficulty for determining the appropriate tax treatment on income lost or gained through a PFIC.

Despite the tax complexities faced by individuals with a financial interest in a PFIC, it is important to have a basic understanding of PFIC treatment in order to have an adequate conversation with a tax attorney or tax professional. Classification of a PFIC results from a foreign corporation qualifying through one of two tests relating to passive income; the asset test, or the income test. A foreign corporation with 50 percent or more of its assets producing or intended to produce passive income qualifies as a PFIC pursuant to the asset test; additionally, a foreign corporation obtaining 75 percent or more of its gross income from passive sources is considered a PFIC according to the income test. Passive income differs from standard income produced through the operation of a business and includes (but is not limited to) dividends, interest, royalties, rents, annuities, and certain gains from property transactions, commodities trading, and foreign currency with some exceptions.

When handling difficult tax classifications like a Passive Foreign Investment Company, it’s important to have an experienced team like the professionals at Moskowitz LLP, a tax law firm, to advise you in reviewing your investments to determine any tax liability, as well as to ensure that compliant reporting procedures are maintained, as well as taking full advantage of the tax savings opportunities of taking beneficial elections or planning to qualify to take tax saving elections.

Also see: Net Investment Income Tax Regulations Update: 12/2013, IRS Form 8621

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