PFIC Pitfalls – Punitive Tax Treatment Of Investing In Foreign Mutual Fund Companies

Proceed With Caution Before Investing In A Foreign Mutual Funds

Before making a foreign investment, taxpayers should proceed with caution and be aware of the punitive tax consequences of investing in foreign mutual funds.

The U.S. tax code treats U.S.-based investment firms that offer foreign mutual funds much differently than foreign-based investment firms that offer foreign mutual funds. It’s important to realize this distinction which gives rise to the PFIC pitfalls.

The tax laws involving PFICs are extremely complex, and not very well known by the majority of investors and tax professionals.

However the key aspect to be aware of is that such investments are at a significant tax disadvantage to U.S.-based funds.

For example, current distributions from a PFIC are generally as ordinary income, which is taxed at a higher rate than capital gains (U.S. based foreign mutual fund investments are treated as capital gains).

Of course, there’s a simple reason for this – the U.S. modified the tax code to prevent U.S. taxpayers from deferring tax on passive income by making investments overseas.

PFIC Pitfalls For U.S. Taxpayers

In a most cases, U.S. taxpayers, including those living abroad, are better off sticking with investment firms based on U.S. soil.

The PFIC pitfalls for the U.S. taxpayer are that taxes and interest will be deemed to be owed in preceding tax years prior to the disposition (sale) of the foreign mutual fund investment – to make matters worse the tax rate that will be applied will be the highest ordinary income tax rate that applies during each of the preceding tax years when the investment was held. Thus, when coupled with the interest due during the holding period of the investment, U.S. taxpayers often will find themselves paying significantly more tax that they would have paid had they made an investment from a U.S.-based investment firm.

Click here to learn more about PFIC taxation.

At Tax Samaritan, we caution U.S. taxpayers that are investing in foreign mutual funds from a foreign securities account to be aware of the tax consequences of owing PFICs. The tax effects of any investment is a key factor to consider and will have a net result on your return.

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Tax Samaritan is a team of Enrolled Agents with over 25 years of experience focusing on US tax preparation and representation. We maintain this tax blog where all articles are written by Enrolled Agents. Our main objective is to educate US taxpayers on their tax responsibilities and the selection of a tax professional. Our articles are also designed to help taxpayers looking to self prepare, providing specific tips and pitfalls to avoid.

When looking for a tax professional, choose carefully. We recommend that you hire a credentialed tax professional such as Tax Samaritan that is an Enrolled Agent (America’s Tax Experts). If you are a US taxpayer overseas, we further recommend that you seek a professional who is experienced in expat tax preparation, like Tax Samaritan (most tax professionals have limited to no experience with the unique tax issues of expat taxpayers).

Randall Brody is an enrolled agent, licensed by the US Department of the Treasury to represent taxpayers before the IRS for audits, collections and appeals. To attain the enrolled agent designation, candidates must demonstrate expertise in taxation, fulfill continuing education credits and adhere to a stringent code of ethics.

Every effort has been taken to provide the most accurate and honest analysis of the tax information provided in this blog. Please use your discretion before making any decisions based on the information provided. This blog is not intended to be a substitute for seeking professional tax advice based on your individual needs.