A year on from the Brexit vote, Ephraim Moss and Joshua Ashman, co-founders of Expat Tax Professionals LLC, consider the opportunities for US expats who have investments treated as passive foreign investment companies (PFICs).
The PFIC elections
There are two elections generally available to mitigate the more onerous aspects of PFIC taxation under the default Section 1291 rules.
If a qualified electing fund (QEF) election is made, then in contrast to the default rules, PFIC shareholders include each year in gross income the pro rata share of earnings of the QEF and include as long-term capital gain the pro rata share of net capital gain of the QEF.
In order to make a QEF election, a shareholder must have received a PFIC Annual Information Statement from the PFIC. Often, investors are not provided with such a statement from the PFIC, so the QEF election is not available.
If a mark-to-market (MTM) election is made, then in contrast to the default and QEF rules, PFIC shareholders include each year as ordinary income the excess of the fair market value of their PFIC stock as of the close of the tax year over its adjusted basis in the shareholder's books (normally the purchase price).
The MTM election is generally available only with respect to marketable securities.
However, since many PFIC investments consist of marketable securities, the MTM election is the far more accessible election for the typical US expat investor.
Making the MTM election
In the ideal scenario, a PFIC shareholder would timely make a MTM election for the first year of PFIC ownership in order to completely avoid the onerous default Section 1291 regime.
Many of our clients, however, only realize they have a PFIC problem several years into their investments.
In such case, a taxpayer can transition from the default regime to the MTM regime by making a MTM election starting with the current year, but with one important catch.
The default Section 1291 rules apply in the first year of the MTM election (and only thereafter, do the friendlier MTM rules apply), and in such first year, you must treat the excess of the year-end fair market value over your basis in the PFIC as gain from a deemed (not actual) sale of the PFIC subject to the default rules.
As such, the excess is taxed at highly punitive rates in addition to the onerous penalty interest charge.
