PFIC 101: How to Tell if You Have PFIC Stock Interests
It may seem easy to know whether a U.S. taxpayer has stock interests overseas. You may think that you will cross that bridge if and when you decide to invest in a foreign investment company. But you may have PFIC stock interests you don't recognize. In other cases, you may know you own the stocks, but not realize that taxable events have occurred, or that your company as qualified as a PFIC.
This is the third post in a blog series helping U.S. taxpayers who own stock interest in foreign companies understand their reporting and tax obligations. Previous posts covered the definitions of Passive Foreign Investment Companies (PFIC) their reporting and PFIC tax obligations. Today's post will explain how to tell if you have PFIC stock interests. A future post will describe what you can do to avoid PFIC excess distribution interest penalties.
Indirect PFIC Stock Interests
The IRS considers a shareholder any U.S. person who owns stock in a passive foreign investment company. S corporations and partnerships are not considered shareholders, but they do still have reporting requirements. Tax exempt entities do not have to report their PFIC interests.
Not every PFIC stock holder intentionally founded or bought into a foreign investment company. There are a variety circumstances that could cause a U.S. taxpayer to have an indirect ownership interest in PFIC stocks. Indirect PFIC stock interests create taxable events whenever the direct owner of the shares receives a stock distribution from the PFIC or disposes of the shares. When that happens, a taxpayer may not realize they have reporting and tax obligations for their indirect ownership interests.
Layers of PFIC Ownership
Often, indirect PFIC stock interests come when a U.S. taxpayer owns interest in another company that in turn owns PFIC stock. For example, indirect PFIC ownership could come from:
- Owning over 50% of a foreign company that has PFIC shares
- Owning an interest in one PFIC that in turn owns shares in another PFIC
- Owning a domestic company that invests in a PFIC
- Owning an interest in a pass-through entity, like an LLC, that invests in a PFIC
Many shareholders, especially minority interest holders, don't follow the buying and selling done by their companies. When there are tiers of PFIC stock interests, they can carry hidden tax consequences for unwitting shareholders.
Trust Beneficiaries and PFIC Stock Interests
When a trust controls PFIC stock interests, the beneficiaries of that trust may not even know they have interests in foreign assets. When a trust receives a distribution from PFIC shares, the beneficiaries are required to report that as PFIC income - including the possibility of excess distribution penalty interest. There are also taxable events that don't create actual income for the trust or its beneficiaries, but must still be disclosed.
When these trusts include concrete distribution instructions between beneficiaries, determining each beneficiary's share is a matter of arithmetic. But when it comes to discretionary trusts, the rules become murky. Trustees should consult with a tax attorney whenever there are foreign stocks in the trust portfolio to satisfy their fiduciary duties to their trustees when it comes to their PFIC stock interests.
PFIC Stock Options
Ownership isn't always all or nothing. U.S. taxpayers may have options to purchase PFIC stock. This could result from:
- Employment agreements
- Lending collateral
- Public sale of warrants
Even owning PFIC stock options can have tax consequences. Selling that stock or exercising the option may also have reporting and tax consequences. If a taxpayer's financial circumstances include foreign stock options, they should meet with a tax attorney to review whether the company is a PFIC and what they need to do if it is.
Constructive and Deemed Distributions of PFIC Stock Interests
Even when a U.S. shareholder knowingly invests in PFIC stock interests, there may be times when actions taken by the company create taxable events. When a company invests in foreign property, or adjusts its stocks, it can result in a constructive distribution - a tax event the IRS treats as income to the shareholder.
A deemed distribution is even less obvious to the taxpayer. The IRS will deem a distribution to have occurred when a PFIC stock holder's interests are reduced or terminated, such as through public stock offerings, or the addition of new partners to a parent PFIC. These transactions are often invisible to the stockholders. Even when they knew the transaction was coming, they may not realize the tax consequences.
When a constructive or deemed distribution happens, a shareholder is treated as having a received an immediate gain, even if he or she doesn't receive any funds. Instead, the shareholder's basis in the PFIC shares increases. Later, when the distribution actually occurs, the shareholder takes the funds tax-free.
Knowing how to tell if you have PFIC stock interests, or current PFIC tax obligations starts with working with tax professionals knowledgeable of how the Tax Reform Act works. Even where the rules are unclear, a tax attorney can help you clarify your obligations and meet them in a timely way.
Attorney Joseph R. Viola is a tax attorney in Philadelphia, Pennsylvania with over 30 years experience. If you have questions about your potential PFIC tax obligations, contact Joe Viola to schedule a consultation.