I've read that the statutory PFIC option is generally not recommended and can have bad tax implications.
However, in some cases, there might be more concern as to which years tax is owing in than how much tax is owing. For example, it might be better to concentrate PFIC income and any resulting tax owing in the years after becoming aware of FBAR filing requirements. My question is in which year(s) does the bad tax hit from a statutory PFIC occur?
For example, suppose a PFIC was bought and held for five years. Then suppose that it was entirely sold off on the fifth year. If the statutory PFIC method was employed, would most of the statutory PFIC tax-hit tend to be concentrated on the last year -- the year in which it was sold?
Statutory PFICs - which year(s) are likely to be bad?
Moderator: Mark T Serbinski CA CPA
Hi Alex,
When you say "statutory PFIC". Do you mean the default tax regime of a PFIC, when no election was made in the past (ie. assuming it was never reported)?
The default tax regime is the "excess distribution method". Or "section 1291 fund".
If you've held the PFIC for five years, it would get this treatment for the previous years. You may make another election for 2013 (usually Mark-to-market), but still, the fund will get the default "excess distribution tax" for the years before 2013.
When you say "statutory PFIC". Do you mean the default tax regime of a PFIC, when no election was made in the past (ie. assuming it was never reported)?
The default tax regime is the "excess distribution method". Or "section 1291 fund".
If you've held the PFIC for five years, it would get this treatment for the previous years. You may make another election for 2013 (usually Mark-to-market), but still, the fund will get the default "excess distribution tax" for the years before 2013.
Hi Alex,
More info - I just noticed that you had a question in the last 2 lines.
Assuming you haven't made any elections on form 8621 regarding the PFIC - this would mean that the default tax regime applies "the excess distribution method".
If you sold the PFIC units in 2013, you would go about determining the total capital gain from the sale in US dollars. Let's say that 5 years ago, you contributed $1000 to a Cdn mutual fund. When you sold it, the proceeds were $1500, for a gain of $500. Note I've ignored USD-CAD conversion rates, and I've ignored dividends or distributions from the fund.
The gain of $500 would be considered to have been distributed evenly over the last 5 years, so, as if you had a gain of $100 per year. You then have to calculate the tax plus interest as if you underpaid the tax in previous years. This isn't great, it basically works out to a tax rate of 39% including the effect of interest (I've assumed 5% per year, but you'll have to use the exact rates from the IRS website). If you work this out, you should find that the tax is roughly $195. The highest marginal tax rates are used (39.6% for this year, and 35% for the previous 4 years).
You have an option to make a mark-to-market election for the tax year 2013. This might (likely will) reduce the tax owing by a small amount. Then the gain up to Dec 31, 2012 is spread evenly over the previous 4 years, when the tax rate was 35%. You then pay tax on the gain from Jan 1-2013 until the date you sold the shares. This tax is your average tax rate which should be lower than 39.6% unless you have a super high income.
Best Regards.
More info - I just noticed that you had a question in the last 2 lines.
Assuming you haven't made any elections on form 8621 regarding the PFIC - this would mean that the default tax regime applies "the excess distribution method".
If you sold the PFIC units in 2013, you would go about determining the total capital gain from the sale in US dollars. Let's say that 5 years ago, you contributed $1000 to a Cdn mutual fund. When you sold it, the proceeds were $1500, for a gain of $500. Note I've ignored USD-CAD conversion rates, and I've ignored dividends or distributions from the fund.
The gain of $500 would be considered to have been distributed evenly over the last 5 years, so, as if you had a gain of $100 per year. You then have to calculate the tax plus interest as if you underpaid the tax in previous years. This isn't great, it basically works out to a tax rate of 39% including the effect of interest (I've assumed 5% per year, but you'll have to use the exact rates from the IRS website). If you work this out, you should find that the tax is roughly $195. The highest marginal tax rates are used (39.6% for this year, and 35% for the previous 4 years).
You have an option to make a mark-to-market election for the tax year 2013. This might (likely will) reduce the tax owing by a small amount. Then the gain up to Dec 31, 2012 is spread evenly over the previous 4 years, when the tax rate was 35%. You then pay tax on the gain from Jan 1-2013 until the date you sold the shares. This tax is your average tax rate which should be lower than 39.6% unless you have a super high income.
Best Regards.
Thanks a lot for your help.
Yes, by statutory, I think I mean the default PFIC tax regime.
A slightly different, but related, question -- suppose another PFIC was not sold this year and went up a lot in value this year. Am I right in thinking that the mark-to-market election would create more taxable income and possibly more tax than the statutory regime this year?
I guess I understand that that the mark-to-market election would create as much extra taxable income as if the PFIC was bought at the start of the year, but sold at the end of the year.
What I don't understand is where the extra taxable income or tax comes from the default tax regime -- what makes it so punitive? Is it just taxing the dividends at a higher rate or charging back interest if this year's dividends are higher than previous year's dividends?
Yes, by statutory, I think I mean the default PFIC tax regime.
A slightly different, but related, question -- suppose another PFIC was not sold this year and went up a lot in value this year. Am I right in thinking that the mark-to-market election would create more taxable income and possibly more tax than the statutory regime this year?
I guess I understand that that the mark-to-market election would create as much extra taxable income as if the PFIC was bought at the start of the year, but sold at the end of the year.
What I don't understand is where the extra taxable income or tax comes from the default tax regime -- what makes it so punitive? Is it just taxing the dividends at a higher rate or charging back interest if this year's dividends are higher than previous year's dividends?
Hi Alex,
For your first question - if the PFIC went up a lot this year, and you haven't sold it, you won't get stuck paying for the gain this year. The problem is, if it never comes back down, you'll eventually have to pay the tax on the gain under the default regime once you do sell it. It usually works out best to make the mark-to-market election as soon as you can. In very serious cases, you could even ask the IRS for a "private letter ruling" asking for a retroactive "mark-to-market" election. Folks sometimes get this if there is a good reason you didn't know about the PFIC rules (ie. if your accountant never told you).
On your second question. The reason it is so punitive is to make sure someone, say, living in the US, doesn't deliberately buy a foreign mutual fund for the purpose of avoiding tax on un-distributed income. There is a variety of foreign mutual funds that are not required under law to distribute the income (capital gain distributions, and dividends). The UK has a type of mutual fund designed to not distribute income - that is perfectly legal in the UK, not in the US. Canadian mutual funds must distribute income, but the gain is not calculated using US dollars, and long and short term gains are not tracked. Therfore, the IRS wants to elimate the chance of any benefit by applying tax rates as ordinary income. The maximum marginal rate thing is used so that some wealthy person doesn't just wait until a low income year, and sell all the units. It sounds very harsh, and it is, but it is a way they remove any benefit of non-US mutual funds.
Cheers.
For your first question - if the PFIC went up a lot this year, and you haven't sold it, you won't get stuck paying for the gain this year. The problem is, if it never comes back down, you'll eventually have to pay the tax on the gain under the default regime once you do sell it. It usually works out best to make the mark-to-market election as soon as you can. In very serious cases, you could even ask the IRS for a "private letter ruling" asking for a retroactive "mark-to-market" election. Folks sometimes get this if there is a good reason you didn't know about the PFIC rules (ie. if your accountant never told you).
On your second question. The reason it is so punitive is to make sure someone, say, living in the US, doesn't deliberately buy a foreign mutual fund for the purpose of avoiding tax on un-distributed income. There is a variety of foreign mutual funds that are not required under law to distribute the income (capital gain distributions, and dividends). The UK has a type of mutual fund designed to not distribute income - that is perfectly legal in the UK, not in the US. Canadian mutual funds must distribute income, but the gain is not calculated using US dollars, and long and short term gains are not tracked. Therfore, the IRS wants to elimate the chance of any benefit by applying tax rates as ordinary income. The maximum marginal rate thing is used so that some wealthy person doesn't just wait until a low income year, and sell all the units. It sounds very harsh, and it is, but it is a way they remove any benefit of non-US mutual funds.
Cheers.
MG -- thank you very much -- this is really helpful!
Just to make sure I understand one important piece. In your previous post, you explain that.
"The gain of $500 would be considered to have been distributed evenly over the last 5 years, so, as if you had a gain of $100 per year. You then have to calculate the tax plus interest as if you underpaid the tax in previous years."
So do I understand correctly that you do not actually have to amend the past five years returns in order to distribute the gain evenly? What you do instead is pay lots of interest on THIS YEAR's RETURN on the distributed gains that are deemed to have been underpaid in previous years. Am I getting that right?
Just to make sure I understand one important piece. In your previous post, you explain that.
"The gain of $500 would be considered to have been distributed evenly over the last 5 years, so, as if you had a gain of $100 per year. You then have to calculate the tax plus interest as if you underpaid the tax in previous years."
So do I understand correctly that you do not actually have to amend the past five years returns in order to distribute the gain evenly? What you do instead is pay lots of interest on THIS YEAR's RETURN on the distributed gains that are deemed to have been underpaid in previous years. Am I getting that right?
I also have a more practical question on statutory PFIC. Looking at this section of the PFIC forms, the calculations look pretty complicated. How feasible are they to actually calculate in practice? Do they require information beyond that which is reported in the bank or PFIC account statements? For example, would the following information be enough an experienced PFIC accountant to complete the calculations:
* all purchase prices, quantities and dates made by the taxpayer
* all sale prices, quantities, and dates made by the taxpayer
* all dividends and/or interest payments paid out to the taxpayer with quantities and dates
Is there a big difference in accounting costs between statutory and market-to-market PFICs, for multiple PFICs?
* all purchase prices, quantities and dates made by the taxpayer
* all sale prices, quantities, and dates made by the taxpayer
* all dividends and/or interest payments paid out to the taxpayer with quantities and dates
Is there a big difference in accounting costs between statutory and market-to-market PFICs, for multiple PFICs?
Hi Alex,
This is correct. You do not need to ammend previous year's returns, just add the "additional tax and interest" to this year's filing. It's messy, and you won't be able to file online if you report using the default. I'd make a mark-to-market election as this makes things simpler going forward, and will most likely result in much lower tax.
One caution - since you're stuck with the default (statutory) treatment for the previous years - it is also implied that you have been reporting any dividends or distributions from the fund as "ordinary" dividends in those previous years. If you haven't been, then you should ammend past returns to report these.
Best Regards.
This is correct. You do not need to ammend previous year's returns, just add the "additional tax and interest" to this year's filing. It's messy, and you won't be able to file online if you report using the default. I'd make a mark-to-market election as this makes things simpler going forward, and will most likely result in much lower tax.
One caution - since you're stuck with the default (statutory) treatment for the previous years - it is also implied that you have been reporting any dividends or distributions from the fund as "ordinary" dividends in those previous years. If you haven't been, then you should ammend past returns to report these.
Best Regards.
On your second question: if you're hiring an account to take care of this, your financial statements should be sufficient to calculate the statutory dividends and gains of your PFIC funds. The costs of accounting should be lower for mark-to-market going forward.
I can't imagine any account would advise you to continue having the PFICs treated with the default regime. A mark-to-market or QEF election (if possible) would result in lower tax in almost every situation I can imagine.
I can't imagine any account would advise you to continue having the PFICs treated with the default regime. A mark-to-market or QEF election (if possible) would result in lower tax in almost every situation I can imagine.