Tom Zachystal is president of International Asset Management providing financial planning and investment advice for Americans living abroad.
Instead of paying capital gains rates when you sell, as a PFIC owner, you pay the highest marginal income tax rate, plus interest charges on annual gains.
In many cases, the tax owed can exceed the actual profit. Holding a PFIC for five years, for example, and then selling for a modest gain can trigger a large tax bill with compounded interest. These aren’t theoretical penalties; they are real PFIC penalties that can apply years after the investment. Furthermore, there may be penalties for not having reported them.
The PFIC Reporting Burden
You’ll need to file Form 8621 for each PFIC you own annually, even if the investment generated no income. It’s one of the toughest IRS forms to complete, and errors can disqualify you from making tax-saving elections. Essentially, if you skip filing, you default straight into punitive PFIC tax treatment. There is one exception: If your total PFIC holdings are $25,000 or less ($50,000 for those filing jointly) on the last day of the tax year and you received no distributions, you can skip Form 8621. However, foreign bank account (FBAR) and personal FATCA reporting of offshore foreign assets may still apply.
The simple advice if you discover you have a PFIC is to seek advice from a U.S. expat tax specialist as soon as possible.
What Are Other Ways To Invest As An Overseas American?
The simplest way to avoid PFIC problems is to avoid investing in overseas registered pooled investments and funds in the first place. You have several other choices as an American living abroad if you’re looking for international exposure or diversification:
A U.S.-Based IRA Or Roth IRA
If you have earned income and meet eligibility requirements, contributing to a traditional or Roth IRA remains one of the most tax-efficient options for U.S. expats saving for retirement. These accounts are not subject to PFIC rules and allow access to a wide range of U.S.-domiciled investment products with favorable tax treatment. If you earn in U.S. dollars, you’ll also save on currency conversion costs compared to investing abroad.
U.S.-Domiciled Funds With Global Exposure
By investing in U.S.-based mutual funds or ETFs that invest internationally, you can gain international exposure and diversification benefits while remaining within the U.S. regulatory framework. There are a couple of caveats though: First, if you live in the EU, EU rules may prevent you from investing in U.S. funds; second, most U.S. brokerage firms won’t work with non-U.S. residents.
Individual Foreign Stocks Or Bonds
If you definitely want to invest abroad, buying foreign equities or bonds directly, rather than overseas mutual funds, can help sidestep PFIC rules. This path requires more active management and an understanding of foreign markets, as well as a relationship with a brokerage firm that will allow trading on non-U.S. exchanges.
Real Estate (U.S. Or Abroad)
Real estate can be a tax-efficient and inflation-resistant asset class. U.S.-based property offers familiarity and potential tax advantages for American citizens, while overseas real estate may provide lifestyle and cost-of-living benefits, along with local rental income.
Regardless of your preferences, as an overseas American, you should ensure any investments you make are in the context of your overall financial plan and align with your long-term goals. Engaging an advisor familiar with working with expats can help you avoid making costly mistakes related to PFICs, among many other issues.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.
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