PFIC classification for US investors

[muscleman]

I learned this from the Pershing square holdings discussion recently and I think it is worth in depth discussion because not many US investors seem to know it.

What foreign entity is classified as PFIC? IRS says:

The income test is met if 75% or more of the foreign corporation's gross income is passive income, defined as foreign personal holding company income with modifications.

 

The asset test is met if 50% or more of the foreign corporation's average assets (as defined in the IR Code) produce, or could produce passive income, or are assets (such as cash and bare land) that produce no income. The test is applied based on the foreign corporation's adjusted basis, for U.S. tax purposes, of the assets, or at the election of the particular shareholder, fair market values of the assets.

 

 

I am confused about this. If a foreign company is losing money on its operations, it should be able to still receive some interest on its cash balance. In that case, can we say more than 75% of the gross income is passive income?

What about holding companies like EXOR?

 

 

[Jurgis]

Disclaimer: I am not a CPA/etc.

 

If a foreign company is losing money on its operations, it should be able to still receive some interest on its cash balance. In that case, can we say more than 75% of the gross income is passive income?

 

Is the gross profit of the company negative? I think you are confusing operating profit and gross profit.

 

What about holding companies like EXOR?

 

Not sure. I believe it depends on whether holding company holds something that produces passive income. But you'd need someone more knowledgeable to say for sure.

 

(You may know the following, so skip if so)

The idea behind PFIC is to make it more difficult for US investors to get into non-US listed investment companies (funds) and escape taxation through investments that are not taxed in the foreign country. Otherwise, you could buy into a mutual fund in SomeCountry where cap gains are not taxed at corporate level, the fund invests in stocks, buys/sells, but you never pay short term taxes - you only pay when you sell out of the mutual fund after twenty years.

 

It's not that you are prohibited from owning PFIC. It only hurts you in tax reporting time. If you are small investor, I suggest not owning potential PFICs or owning them in tax sheltered accounts where you and IRS don't care. If you are not small investor, hire someone to do your taxes - just make sure they know about these things.

 

If you are small investor and you screw up with reporting, the likelihood of IRS auditing you is very low. I doubt many holders of GRVY, for example, reported according to PFIC. I doubt any were ever audited. :)

 

GRVY was the only PFIC that I owned I believe. Although I am sure there were other edge cases with cash-rich net-nets... I wonder how many Japanese net-net investors file taxes with PFIC accounting. :)

[muscleman]

Disclaimer: I am not a CPA/etc.

 

If a foreign company is losing money on its operations, it should be able to still receive some interest on its cash balance. In that case, can we say more than 75% of the gross income is passive income?

 

Is the gross profit of the company negative? I think you are confusing operating profit and gross profit.

 

What about holding companies like EXOR?

 

Not sure. I believe it depends on whether holding company holds something that produces passive income. But you'd need someone more knowledgeable to say for sure.

 

(You may know the following, so skip if so)

The idea behind PFIC is to make it more difficult for US investors to get into non-US listed investment companies (funds) and escape taxation through investments that are not taxed in the foreign country. Otherwise, you could buy into a mutual fund in SomeCountry where cap gains are not taxed at corporate level, the fund invests in stocks, buys/sells, but you never pay short term taxes - you only pay when you sell out of the mutual fund after twenty years.

 

It's not that you are prohibited from owning PFIC. It only hurts you in tax reporting time. If you are small investor, I suggest not owning potential PFICs or owning them in tax sheltered accounts where you and IRS don't care. If you are not small investor, hire someone to do your taxes - just make sure they know about these things.

 

If you are small investor and you screw up with reporting, the likelihood of IRS auditing you is very low. I doubt many holders of GRVY, for example, reported according to PFIC. I doubt any were ever audited. :)

 

GRVY was the only PFIC that I owned I believe. Although I am sure there were other edge cases with cash-rich net-nets... I wonder how many Japanese net-net investors file taxes with PFIC accounting. :)

 

I did some research and there were people complaining that he bought 5 PFICs in his IRA account and later he had to pay tax on these PFICs even though they are in his tax sheltered account! The rules could be very complex and I can't understand it.

GRVY is a Korean gaming company. I looked at it in 2010 and I felt lucky that I didn't buy. It seems to be doing horribly right now. Its gross margin is negative, so that means interest makes up more than 75% of its gross income, which puts it in PFIC. This really sucks.

 

Holding PFIC means every year you can elect to either mark to market or pay your share of its operating income tax. If you MtM, you have to pay short term cap gain tax every year, if the price goes up. If you elect QFE, it may not work well if you buy a closed end investment fund at a deep discount to NAV, because you are paying tax on the gain of NAV.

 

Anyway, I bought Pershing square holdings and quickly sold it this month as I learned PFIC. It seems too much headache for small guys like me to handle.

[Jurgis]

I believe you are wrong about IRAs/401(k)s, because the gains/losses are not taxable. PFICs are not MLPs or K-1 corporations that actually require tax gymnastics while in IRA.

 

I believe this guy is correct: http://www.costbasis.com/stocks/pficstock.html

I've seen some other tax professionals suggesting the same.

 

However, I am not a CPA, caveat emptor and all that.

 

I believe that IRS has/had a way to ask such questions to the IRS personnel directly. You might want to look into it if this important to you.

[muscleman]

I believe you are wrong about IRAs/401(k)s, because the gains/losses are not taxable. PFICs are not MLPs or K-1 corporations that actually require tax gymnastics while in IRA.

 

I believe this guy is correct: http://www.costbasis.com/stocks/pficstock.html

I've seen some other tax professionals suggesting the same.

 

However, I am not a CPA, caveat emptor and all that.

 

I believe that IRS has/had a way to ask such questions to the IRS personnel directly. You might want to look into it if this important to you.

 

Thank you. This seems a big headache that even some companies listed in the US may actually be PFIC. Why is the physical gold fund treated as PFIC?

[Jurgis]

 

Thank you. This seems a big headache that even some companies listed in the US may actually be PFIC. Why is the physical gold fund treated as PFIC?

 

Company may be listed in US, but not be an US company. I believe PHYS is Canadian. They claim that they are a PFIC partially intentionally for tax efficiency reasons: they seem to claim that if you file QEF, you can get 20% long term capital gains tax rate, while otherwise holding physical commodity makes you pay 28% collectible rate. I might be simplifying here. I did not try to fully understand the implications, since I don't plan to buy and hold this.

 

You can read more at http://sprottphysicalbullion.com/sprott-physical-gold-trust/tax-information/

[Ham Hockers]

One of the problems with PFIC investments (and why I brought it up on the PSH thread) is they are often paired with ownership restrictions for ERISA accounts in the U.S. In PSH for example, the company may force a sale of certain ERISA holders, which if memory serves is at the lower of market or cost. Unclear what happens with dividends but I've seen others where all distributions are also clawed back. So if you think you can be sneaky and hold the stock in a retirement account, you better be sure it is not an ERISA account (I'm still unsure if IRAs fall into this). It gets even more confusing if you're talking about a U.S. equivalent ticker that's created by someone other than the company to allow trading in the stock.

 

Now if you're a small holder, the IRS and the company may never find out, so in reality maybe you can do whatever you want.

[fareastwarriors]

As a result, US persons that are beneficiaries of or have interests in an organization or account exempt from tax (e.g., an individual retirement account (IRA) or a Section 529 plan) that own stock of a PFIC will not be subject to tax and reporting obligations under the PFIC rules.

 

 

http://www.pwc.com/en_US/us/tax-services/publications/insights/assets/pwc-irs-treasury-clarify-ownership-pfic-stock.pdf

[muscleman]

So if the company does not send documents to each US person to help him with the QFE elections, then there will be no way for the US person to do QFE election, right?

Mark to market election is subject to ordinary income tax rate, which is much higher.

 

Another question: Whether this year is elected as QFE has nothing to do with whether I elect QFE next year. So if I open a foreign investment closed end fund, and if this year's fund gains but the fund's shares actually decline in price, then I can avoid tax by electing Mark to Market?

 

One more question: If the foreign closed end fund has $200 NAV but I buy the fund shares at $100, and then if the fund gains 20% and the NAV grows to $240 that year and the share price goes up to $120, it seems like Mark to Market election actually saves tax?

[ERICOPOLY]

One of the problems with PFIC investments (and why I brought it up on the PSH thread) is they are often paired with ownership restrictions for ERISA accounts in the U.S. In PSH for example, the company may force a sale of certain ERISA holders, which if memory serves is at the lower of market or cost. Unclear what happens with dividends but I've seen others where all distributions are also clawed back. So if you think you can be sneaky and hold the stock in a retirement account, you better be sure it is not an ERISA account (I'm still unsure if IRAs fall into this). It gets even more confusing if you're talking about a U.S. equivalent ticker that's created by someone other than the company to allow trading in the stock.

 

Now if you're a small holder, the IRS and the company may never find out, so in reality maybe you can do whatever you want.

 

I understand it to be the case that "Rollover IRAs" are ERISA accounts (because they originated from an employer-sponsored plan), but a "Traditional IRA" or "ROTH IRA" are not ERISA.

 

http://finance.zacks.com/ira-accounts-erisa-qualified-6814.html

 

[muscleman]

I have a new thought and would like to get an opinion from smart folks like Ericopoly and other US super investors on the matter of PFIC taxes.

 

Let's say I start a foreign tax exempt closed end fund with my friend. NAV is $100 and fund share price is initially $100.

 

After year 1, fund share price still $100 but NAV $130. I choose mark to market election on the PFIC form. I pay no tax.

After year 2, fund share price still $100 but NAV $180. I choose mark to market election on the PFIC form. I pay no tax.

.........

 

After 40 years, fund share price still $100 but NAV $5 million. I choose mark to market election on the PFIC form. I pay no tax.

Then in year 41, my fund buys back my shares at $5 million. I pay the 20% long term cap gain tax on the difference between $100 and $5 million.

 

Am I missing something? This seems pretty tax efficient to me. Of course this is pure theoretical as the fund share price will likely go up over the 40 years instead of staying at $100, but suppose it does, it will be really nice?

[leeway]

 

I understand it to be the case that "Rollover IRAs" are ERISA accounts (because they originated from an employer-sponsored plan), but a "Traditional IRA" or "ROTH IRA" are not ERISA.

 

http://finance.zacks.com/ira-accounts-erisa-qualified-6814.html

 

 

Many thanks Eric for pointing out this. I was reluctant to move past 401K money to rollover IRA partially for ERISA status.

[muscleman]

 

I understand it to be the case that "Rollover IRAs" are ERISA accounts (because they originated from an employer-sponsored plan), but a "Traditional IRA" or "ROTH IRA" are not ERISA.

 

http://finance.zacks.com/ira-accounts-erisa-qualified-6814.html

 

 

Many thanks Eric for pointing out this. I was reluctant to move past 401K money to rollover IRA partially for ERISA status.

 

So if you have the rollover IRA and transfer the money further into a traditional IRA, does that get rid of this ERISA status? How about rollover IRA to roth?

[leeway]

I think so (losing ERISA qualification in both cases). Here is another link on this:

http://www.ehow.com/about_7605326_ira-accounts-erisa-qualified.html

 

I actually have some Roth 401K money too. Since there is no Roth Rollover IRA, I can only roll it over to a standard Roth and thus lose ERISA qualification. 

[Ham Hockers]

Let's say I start a foreign tax exempt closed end fund with my friend. NAV is $100 and fund share price is initially $100.

 

I believe that would make your entity a CFC (Controlled Foreign Corp), which is another can of worms.

[Ham Hockers]

Let's say I start a foreign tax exempt closed end fund with my friend. NAV is $100 and fund share price is initially $100.

 

I believe that would make your entity a CFC (Controlled Foreign Corp), which is another can of worms.

 

Also the whole scheme just sounds too good to be true, so it probably is. I mean, you probably wouldn't qualify for mark-to-market treatment at all, since your holding isn't really a marketable security.

[netnet]

I think so (losing ERISA qualification in both cases). Here is another link on this:

http://www.ehow.com/about_7605326_ira-accounts-erisa-qualified.html

 

I actually have some Roth 401K money too. Since there is no Roth Rollover IRA, I can only roll it over to a standard Roth and thus lose ERISA qualification.

 

Uh, not true, once you have changed employers or retired, you can rollover your 401K Roth funds into a Roth IRA.  (There may be some loophole that allows you to roll it over while still with your original employer, but I have not looked into that, so, as they say check with you tax professional first.

[muscleman]

Let's say I start a foreign tax exempt closed end fund with my friend. NAV is $100 and fund share price is initially $100.

 

I believe that would make your entity a CFC (Controlled Foreign Corp), which is another can of worms.

 

Also the whole scheme just sounds too good to be true, so it probably is. I mean, you probably wouldn't qualify for mark-to-market treatment at all, since your holding isn't really a marketable security.

 

But if I make it listed in a exchange, with only two shareholders---my friend and I, and we trade back and forth for a few shares per month to generate trading volume, doesn't that make it qualify for Mark to Market? ;)

[leeway]

I think so (losing ERISA qualification in both cases). Here is another link on this:

http://www.ehow.com/about_7605326_ira-accounts-erisa-qualified.html

 

I actually have some Roth 401K money too. Since there is no Roth Rollover IRA, I can only roll it over to a standard Roth and thus lose ERISA qualification.

 

Uh, not true, once you have changed employers or retired, you can rollover your 401K Roth funds into a Roth IRA.  (There may be some loophole that allows you to roll it over while still with your original employer, but I have not looked into that, so, as they say check with you tax professional first.

 

Netnet, not sure which part you meant "not true". Yes I can rollover the Roth portion of my old 401K (with a previous employer) to a Roth IRA account .  But since there is no so called "Rollover Roth IRA", the rolled-over money will be in a standard Roth IRA account and would not qualify for ERISA status. Thus by rolling the Roth portion of my old 401K account, I would lose some ERISA protection. 

 

You or anyone thinks otherwise?

[leeway]

some PFIC discussion here:

http://www.zerohedge.com/news/2015-04-02/more-unofficial-capital-controls-us-pfic-rules

 

[muscleman]

Just to confirm, buying PFIC stocks in a 401k plan should be fine, right? I got confused about the discussion of PFIC and ERISA accounts vs traditional IRA.

[muscleman]

I am interested in buying some PFICs in my 401k, but I felt bewildered that the following IRS announcement doesn't include 401k.

http://www.irs.gov/pub/irs-drop/n-14-28.pdf

 

an

organization or an account that

is exempt from tax under

section 501(a) because it is

described in section 501©, 501(d), or 401(a);

a state college or uni

versity described in

section 511(a)(2)(B); a plan described in se

ction 403(b) or 457(b); an individual

retirement plan or annuity as defined in

section 7701(a)(37); or

a qualified tuition

program described in section 529 or 530.

 

 

Why would IRA and 401a be exempt from the PFIC issues but not 401k?

[Jurgis]

Since there was renewed interest, I'm gonna post the list of CoBF favorite possibly PFICs:

 

Exor EXOSF - possibly

Premier Diversified Holdings PRDGF - pretty definitely

Clarke CLKFF - pretty definitely depending on year

PSHZF - Pershing Square - definitely

TPRE - possibly

GLRE - possibly

 

I'd like to hear any definite stories about clawbacks based on ERISA that Ham Hockers mentioned on page 1 of this thread. Any data? I did not find anything useful online regarding ERISA/PFICs.

[muscleman]

Since there was renewed interest, I'm gonna post the list of CoBF favorite possibly PFICs:

 

Exor EXOSF - possibly

Premier Diversified Holdings PRDGF - pretty definitely

Clarke CLKFF - pretty definitely depending on year

PSHZF - Pershing Square - definitely

TPRE - possibly

GLRE - possibly

 

I'd like to hear any definite stories about clawbacks based on ERISA that Ham Hockers mentioned on page 1 of this thread. Any data? I did not find anything useful online regarding ERISA/PFICs.

 

EXOR is definitely not a PFIC. The rule says if it holds more than 20% of a company's stock, then it should use look through approach. EXOR's major holdings are all over 20%, so the look through method shows it is not a PFIC.

 

TPRE and GLRE. No. PFIC has exceptions for banks and insurance companies.

 

 

[Jurgis]

 

TPRE and GLRE. No. PFIC has exceptions for banks and insurance companies.

 

That's actually not quite true. There was IRS proposal in 2015 to deal exactly with hedge-funds-masquarading-as-insurance-companies. I did not find info if it went through or not.