Traditionally, when a U.S. person would find themselves spending long times abroad and potentially living in a foreign country, they would start to make investments in the local economy. Most commonly, expatriates would find themselves investing in foreign mutual funds without the realization that they had ended up with investments in a Passive Foreign Investment Company (“PFIC”).
PFICs are generally pooled investments that satisfy either an income or asset test pursuant to IRC § 1297. The income test is where a foreign corporation produces 75% or more of its gross income as passive income. The asset test is where 50% or more of the average value of a foreign corporation’s assets consist of assets that would produce passive income. Passive income is any kind of income which would be foreign personal holding company income under IRC § 954(c), such as dividends, interest, royalties, rents and annuities. U.S. persons who are PFIC shareholders are then subject to special tax rules in regard to their ownership interest and can suffer extremely unfavorable tax treatment IRC § 1291 – 1296.
With the rise of the Foreign Account Tax Compliance Act (“FATCA”), many expatriates and their foreign financial advisors became aware of the U.S. tax implications for ownership of PFICs. FATCA is a global tax law which seeks to establish automatic exchange of taxpayer information, with agreements between 112 jurisdictions according to the U.S. Department of the Treasury.
Seeking to dis-invest themselves of the potential tax disadvantages of PFICs, many expatriate investors have started to move their money back into U.S. based investments and often setup partnerships stateside. While this may alleviate issues regarding foreign investments, it is crucial for expatriates living abroad to consult with local tax advisors to fully understand the tax implications of their investments in the United States and to see if they might benefit from any tax treaty that is currently in place between the United States and their country of residence.