What Is A Passive Foreign Investment Company (PFIC)?
Any foreign company that meets either the asset test or income test is a passive foreign investment company.
The asset test is met if 50% or more of the foreign corporation’s assets produce or could produce passive income.
The income test is met if 75% or more of the foreign corporation’s gross income is passive income which includes income such as:
- Rents and royalties derived in the active conduct of a trade or business
- Interest and dividends
In other words, the company’s income is based primarily on investments versus a standard operating business that provides a service or produces a product.
The most common passive foreign investment company that U.S. taxpayers will encounter are foreign-based mutual funds, partnerships or other pooled investment vehicles such as ETFs (exchange traded funds).
The Pain Of A Passive Foreign Investment Company
A passive foreign investment company (PFIC) is subject to severe and extremely complex tax and tax reporting treatment on these investments.
A passive foreign investment company shareholder must keep extensive records in order to comply with all required tax reporting and perform the necessary tax calculations that includes a record of all transactions, including purchase transaction, basis, dividends and sales transactions.
It is very clear that the pain incurred by investing in a passive foreign investment company from U.S. tax treatment is meant to discourage any such investment by U.S. taxpayers. While there are elections available to lessen the severity of tax due, there is no options to lessen the cost of compliance. Thus, often the best course is to avoid such investments altogether.
To learn more about passive foreign investment companies (PFICs), please see our article on “What Is A PFIC?”.
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