Did you notice that your tax return may have been thicker this year than in the past? Did your tax advisor tell you that he could not file your tax return electronically because you had too many Forms 8621, Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund? If so, you are not alone. 

You may be asking yourself, "What is a Passive Foreign Investment Company?," more commonly referred to as a PFIC. Many Americans may assume they do not own any interests in a PRIC because they are unaware of indirect investments through other activities or the implications of investments recommended by their investment advisors. The consequences of making this assumption can be costly because of the additional taxes imposed on PFIC income and the additional tax costs of compliance.

First, if a taxpayer's investment is subject to the PFIC taxation regime and a qualified electing fund (QEF) or mark-to-market (MTM) election is not in effect, "excess" distributions from the PFIC (including capital gains) are treated as ordinary income and  automatically taxed at the top individual tax rate of 39.6 percent. In addition, an interest charge is imposed. The higher taxation rates of investing in a PFIC are not the only disadvantage. The other major complicating factor of investing in a PFIC is the onerous and complicated task of complying with the IRS rules for PFICs. The IRS estimates that, on average, the preparation time for the Form 8621 is approximately 20 hours each year.

New regulations require all U.S. persons that directly or indirectly own shares in a PFIC at any time during the year to file Form 8621 for all PFICs, starting with their 2013 income tax returns. Prior to these new regulations, Form 8621 only had to be filed in certain circumstances. The new regulations expand the class of persons required to file a Form 8621.

Specifically, the regulations require the filing of Form 8621 in all cases by the lowest tier U.S. person in the chain of ownership that is a PFIC shareholder. While U.S. persons who own stock indirectly above that lowest tier (e.g., U.S. partners of a domestic partnership) are generally required to file the Form 8621 to report an excess distribution from a PFIC or an income inclusion as a result of a QEF or MTM election made by the direct PFIC shareholder, the regulations provide an exception to eliminate duplicative reporting in certain cases.    

Under this exception, where a U.S. person indirectly owns shares in a PFIC through another U.S. person, and that other person timely files a Form 8621 to make a QEF or MTM election with respect to the PFIC, the indirect U.S. owner generally will not be required to file a duplicative Form 8621 with respect to the same PFIC stock. For example, if a domestic partnership has made a QEF election with respect to a PFIC that it owns directly, the partnership must file a Form 8621. A U.S. partner in that partnership, however, generally will not be required to file another Form 8621 with respect to that same PFIC stock it indirectly owns through the partnership.

The regulations also contain two de minimis exceptions, where reporting is not required, if the following criteria are met:

• The aggregate value of all PFIC stock owned by a U.S. shareholder at the end of the tax year does not exceed $25,000 (increases to $50,000 for taxpayers who file a joint return with their spouses); or
• The PFIC stock is owned through another PFIC and the value of the shareholder's proportionate share of the upper-tier PFIC's interest in the lower-tier PFIC does not exceed $5,000. 

These exceptions are likely to apply to shareholders that own interests in publicly traded or widely held foreign corporations, thereby eliminating the requirement to file the Form 8621.Unless a taxpayer can establish reasonable cause for not filing the Form 8621, the statute of limitations for the entire tax return will not start until the Form 8621 is filed. In that case, the entire return is treated as incomplete, and as a result, the IRS can audit the return beyond the normal three year statute of limitations. 

Further, certain specified foreign financial assets are required to be reported annually on Form 8938, Statement of Specified Foreign Financial Assets, if certain reporting thresholds are met. Because specified foreign financial assets include shares in a PFIC, reporting of any PFIC stock owned is required to be reported on Form 8938 unless it is reported on a timely filed Form 8621. An individual U.S. shareholder of PFIC stock that files a Form 8621, however, is still required to disclose the number of Forms 8621 that were filed. Failure to report certain foreign financial assets on a Form 8938, if required, will result in a penalty of $10,000, unless reasonable cause can be shown for the failure. Additionally, any underpayment of tax attributable to undisclosed foreign assets can be subject to an additional penalty of 40 percent of the amount of the understatement, and criminal penalties may also apply.

The issues discussed above demonstrate an important point in that, when it comes to wise and efficient investing, all U.S. citizens and residents need to understand what types of investments they hold, especially if these include investments in offshore investment vehicles, as this can increase your tax liability and tax reporting responsibilities, as well as carry potential penalties for non-disclosure of these assets. For more information on these issues, contact your local CBIZ MHM tax professional.

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