What Is A PFIC & How Does It Affect Australian Expats?
Have you recently made the move to the US for your career? Been based over there for a few years? If you fit this category than you need to be aware of what is a PFIC. We commonly see Australian expats ‘accidentally’ holding PFIC’s in their superannuation accounts and/or their investment portfolios. Unfortunately, this creates an opportunity for the IRS to penalise you on holding these types of investments.
What is a PFIC?
A PFIC or more commonly known as a ‘Passive Foreign Investment Company’ is a foreign(non-US) company or trust that meets one of the following tests:
- 75% or more of its gross income is passive. OR
- 50% or more of the assets produce passive income.
These PFIC’s can include but not limited to Australian managed funds, Australian listed investment companies(LIC’s) and Australian domiciled exchange traded funds(ETF’s).
If you are now based in the US and have held these investments prior to you expatriating over there, and still hold them, then the IRS will seek to charge you at the highest federal tax rate(39.6%) on the capital gain and income you have received from the investment. What is also a major concern being that the IRS will seek to tax the years that you have held that investment prior to you expatriating and leverage interest charges on the year to year capital gains and income as well.
The IRS tax regime is ever far-reaching and this is one of the pitfalls we are seeing. Since the introduction of the Foreign Account Tax Compliance Act(FATCA) and the Common Reporting Standard, we are seeing a growing number of Aussie expats getting caught out with ‘Big Tax Bills’ due to the data sharing requirement under this legislation.
Tax Structures to beware of prior to expatriating to the US
We often find that expats-to-be can sometimes have complex tax minimisation structures in place to allow them to spread their income to other family members to reduce their overall tax liability. This may include but is not limited to holding investments such as shares, investment property or managed funds in a family trust or sometimes a company. Whilst these sorts of structures are a great way to spread your income whilst you’re a permanent tax resident, once you depart over to the US this creates a bit of a tax headache for yourself. Remember the classification of what a PFIC is? We have seen cases where the IRS has classified an Australian family trust as a PFIC, the reason being that it held an investment property and some blue-chip shares. These investments all pay passive income and 100% of the assets held in the trust produce passive income. It created a situation where suddenly the family were liable to pay a large amount of tax due to its classification as a PFIC.
Further on trusts when you are expatriating, the central management and control must remain in Australia. This means that at least 50% of the beneficial interests in income, property or assets must be from Australia residents. This can also correlate to the structure of a Self-Managed Super fund, there are several ways to get around this but it does involve some complex advice and for that reason we won’t go into it
How does my Australian Superannuation get impacted?
There are several ways the IRS taxes your Australian superannuation accounts and although the legislation is outdated, the private rulings are still in the IRS’s favour. Currently, Australian super is not recognised as a foreign pension but is classified as either a ‘Foreign Grantor Trust’ or ‘Employee Trust’ by the IRS. The USA-AUS double taxation agreement was completed in 1984 and at this time superannuation in Australian wasn’t compulsory and there were very limited privatised retirement schemes around either.
Presently, if you are a member of an Australian superannuation fund, such as an industry super fund you will be in an investment option (Balanced, Growth, MySuper etc) which is known as a pooled fund. You are in this pooled fund with other members and the super fund invests these pooled monies to achieve a return for its members. Now you have no control over where your money is invested but if you have only been in that pooled fund for two years and the pooled fund bought a ‘PFIC’ 8 years ago and sells it whilst you’re a member, the IRS will tax you on the entire 8-year period that the pooled fund has held the investment. Let’s also remember you are taxed at the highest federal tax rate as well and there is the potential for some US states to also levy a PFIC tax.
Further on Australian superannuation accounts, because they are classified as either a ‘Employee Trust’ or ‘Foreign Grantor Trusts’ the IRS will tax you on the capital gain and income distributions that your account received each calendar year. This is very disheartening, considering you don’t have access to those benefits yet you’re still liable for the growth of the account.
The ‘Atlas Wealth’ Solution
Over the past three years, we have worked closely with tax attorney’s and accountant’s who focus on these sorts of cross-jurisdictional issues and we have been able to design and construct a portfolio which is sympathetic to the above issues. It’s called the Pan Pacific Portfolio and through it, we are able to control the turnover of the client’s investments within the portfolio. Therefore we are minimising the US tax liability by reducing the crystallisation of capital gains, whilst also steering clear of any PFIC’s.
If you think the above might be relevant to your circumstances, you will need a professional review to make sure you are staying in between the ‘Red and Yellow Flags’ and aren’t going to be caught out by the IRS Tax Man.