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).
A practical scenario
We realise that is quite a lot to absorb, so here is a practical scenario.
Mr Expat purchased a UK mutual fund in 2013. While the fund has performed well over the years, he discovers only this year that the fund is considered a PFIC for US tax purposes.
The fund does not provide a PFIC annual information statement.
In order to avoid the onerous Section 1291 default regime, Mr Expat files a MTM election (on the IRS Form 8621) on his 2016 tax return, transitioning him to the preferable MTM regime moving forward.
In such case, Mr Expat would be deemed for tax purposes to have sold the fund on 31 December 2016. Any appreciation in the fund would be taxed at the highest marginal tax rate in addition to a penalty interest charge that has been compounding since 2013.
In the future, Mr Expat's basis in the fund would be increased by the taxed amount - but that is small consolation for the PFIC tax hit taken by Mr Expat for the 2016 tax year.
Relevance of the pound
In order to understand the relevance of the weakened British pound, we need to start with a fundamental rule of US expat taxation.
US citizens, even those residing abroad, are viewed for US tax purposes as using the US dollar as their "functional currency" for monetary transactions, including the purchase and sale of foreign investments.
As such, in the case of Mr Expat, even if his mutual fund appreciated over the years, due to the sharp decrease in the value of the British pound, the US dollar value of his investment may have actually decreased (or only increased insignificantly) by 31 December 2016.
If this is the case, then the deemed PFIC sale resulting from the MTM election should seemingly have no adverse tax consequences, because there should be no excess of fair market value of the PFIC over its adjusted basis, and therefore there should be no PFIC taxation of the investment under the onerous Section 1291 rules.
Thus, expats with a UK source investment would be wise to do two thing. First, consult with a tax adviser regarding the potential PFIC status of your investment and second, consider making a MTM election while the British pound remains weak.
This may put you in a much better position from a US tax perspective moving forward as compared to dealing with the default PFIC regime.
That being said, each taxpayer scenario involving a PFIC interest is unique and should be analyzed on a case-by-case basis.
