Passive Foreign Investment Company

As if the Controlled Foreign Corporation designation isn't bad enough, there is one that is even worse. It is the "Passive Foreign Investment Company" (PFIC) label. Passive income seems to be a particular target for the tax man. This designation was created by Congress to appease the mutual fund industry which had to compete with passive investments made in non-Controlled Foreigh Corporations. To be ruled a PFIC, anything organized as a corporation that (1) receives 75% or more of its income from passive investment sources or (2) has invested 50% or more of its assets in passive investments as distinguished from investments in a trade or business.

Any US shareholder who owns ANY interest in a PFIC is required to file form 8621, however no filing for tax year 2010 was required which means the first required year is 2011.
The CFC tax rules and the PFIC rules overlap so the law was modified in 1997 to relieve U.S. shareholders of compliance with the PFIC rules if the same income was subject to tax under the subpart f rules for CFCs. BUT the "fine print" indicates that this relief is only available for taxpayers who elect to treat their portion of the PFIC as a "Qualified Electing Fund" (QEF) in which the taxpayer pays taxes on his or her share of the fund's current earnings. This election would only apply to U.S. persons who own 10% or more of the PFIC shares and where more than 50% of the stock is owned by five or fewer U.S. shareholders.

See how nutty this all is? A foreign partnership that is organized to make passive investments will not get the PFIC designation because it's not a corporation and that may be an option. Please note that the IRS may impute CFC designation to partnerships (even though they are not corporations) and those rules should be considered carefully.

Controlled Foreign Corporations

¨Controlled Foreign Corporation¨ (CFC) is a really nasty designation to have put on a foreign corporation in which you own shares. For a corporation to be labeled ¨CFC¨ U.S. shareholders have to own or control more than 50% of the stock. Please note that this is NOT ¨50% or more¨ but ¨more than 50%¨. That means that a corporation in which a foreign national owns 50% or more, cannot be labeled ¨CFC¨ no matter how many U.S. shareholders there are. OK, so what is the definition of a U.S. shareholder? I thought you´d never ask. A U.S. shareholder is a ¨person¨ who owns 10% or more of the corporation´s voting stock. Notice that´s ¨10% or more¨ NOT ¨more than 10%¨. Gotta´ watch these things folks. It can be tricky. It means that, if your ownership of voting stock in a foreign corporation ever exceeds 9.99999999...%, YOU are a U.S. shareholder of a foreign corporation. You can read an official quick summary here. The definition of a ¨person¨ probably is the following from an IRS bulletin:

United States Person The term “United States person” means (1) a citizen or resident of the United States, (2) a domestic partnership, (3) a domestic corporation, or (4) a domestic estate or trust.

This is the only definition I could find in recent publications and refers to FBAR which is closely related to CFC in intent. If I find another, different definition, I´ll publish it ASAP.

So, why is ¨CFC¨a bad label. It means several things but for one; filing the form 5471 is required and it´s not fun. If you want to have a look click here. Failure to file can generate penalties up to US$ 70,000. Look at the instructions and see.

Please realize that the IRS imputes ¨foreign corporation¨ status to foreign limitadas, LLCs and partnerships; so using one of those vehicles DOES NOT remove liability in the eyes of the IRS. Be warned.

Filing requirements

I've been getting a lot of question about filing requirements so here is the answer.

You must file a tax return if you earn the following amounts of income:

Self-employed, any age: $400
Children and Teens classified as a dependent: $5,700
Single, under 65: $9,350
Single, over 65: $10,750
Married, filing jointly, both spouses under 65: $18,700
Married, filing jointly, one spouse over 65: $19,850
Married, filing jointly, both spouses over 65: $20,900
Married, filing separately, any age: $3,650

The first question most delinquent expat taxpayers have is almost always “How many years of US expat taxes do I need to file?” Unfortunately, there is no single answer to this question as it really depends on the specific situation. Technically, the IRS asks that you file for all years that your income was over the thresholds, but usually six to eight years will suffice.

For the FBAR form 8938 this exception exists (straight from the IRS form instructions):

Exception if no income tax return required.

If you do not have to file an income tax return for the tax year, you do not have to file Form 8938, even if the value of your specified foreign financial assets is more than the appropriate reporting threshold.

There you have it.