PFIC - Investment in foreign mutual funds and foreign corporation

PFIC - Investment in foreign mutual funds and foreign corporation


PFIC - Investment in foreign mutual funds and foreign corporations  
מאת:  Ehud Kisch CPA  עודכן בתאריך:  02/11/2010  



Estate tax on Israeli Investments in the U.S
מאת:  Murrel Kohn CPA   עודכן בתאריך:  10/03/2009  


 
Kisch & Co. CPAs
30 Tuval St.  Ramat-Gan
Israel 52522
Tel: +972 3 612 6742 Fax: +972 3 612 6743
 
 
U.S. Estate Tax on Israeli investments in the United States
With the advent of globalization and the free movement of capital into and out of Israel, many Israeli investors have sought more attractive returns beyond the shores of their country with its relatively small economy.  While many have realized the potential in Eastern Europe, others have been drawn to the USA.

Income Taxes
Obviously, besides the normal due diligence required for any real estate investment, taxes must be considered.  Without going into great detail, suffice it to say that the Israeli as a NRA (non-resident alien) or foreign company has the option to be taxed as a US person, which greatly reduces the income tax liability.  As Israel now taxes its residents on world-wide income, it is important to ensure the ability to take credit for foreign taxes.

The US income tax on investments in securities is limited or exempted by the tax treaty with the USA.

Estate Taxes
Whereas most investors are aware that they may incur an income tax liability, they are NOT aware of their exposure to US Federal and State Estate Taxes.  This is a tax that applies to the value of one’s estate as of the date of his death or alternatively six months later, the lesser of the two.

What is Taxable?
The NRA is subject to this tax on real estate investments in the USA and other property (personal, tangible or intangible) situated in the USA (IRC Section 2103).

Situated in the USA means shares in a US company regardless of where the share certificates are held (IRC Section 2104(a)), deposits in the US branch of a foreign corporation (IRC Section 2104(c)), etc.

Exempt Property
Whereas as notes and bonds of US persons including the US Government are taxable (IRC Section 2104(c)), they are exempt from estate tax if their interest is considered portfolio interest that is exempt from US income tax (IRC Section 2105(b)(3)).

Also exempt from estate tax are deposits in banks and savings and loan associations and their foreign branches (IRC Sec. 2105(b)), funds held by life insurance companies, proceeds of life insurance of the deceased, and obligations that produce short-term original issue discount not effectively connected with the conduct of a US trade or business.

Deductions

In computing the taxable estate, expenses of the funeral of the deceased, his US debts, contributions to US charities,state estate tax and the administration of the Estate including the filing of the tax returns may be deducted.

Rates

The unified estate and gift tax rates are as follows:

 

Taxable Gift or Estate

Tentative Tax

 FROM

TO

Tax on Col. 1

Tax Rate on Excess

 $0

$11,000

$0

18%

11,000

20,000

1,800

20%

20,000

40,000

3,800

22%

40,000

60,000

8,200

24%

60,000

80,000

13,000

26%

80,000

100,000

18,200

28%

100,000

150,000

23,800

30%

150,000

250,000

38,800

32%

250,000

500,000

70,800

34%

500,000

750,000

155,800

37%

750,000

1,000,000

248,300

39%

1,000,000

1,250,000

345,800

41%

1,250,000

1,500,000

448,300

43%

1,500,000

2,000,000

555,800

45%

2,000,000

+

780,800

46%


 



Credits

Against this tax, the NRA is entitled to a life-time credit of $13,000, which is equivalent to exempting the first $60,000 of the taxable estate.  
 
Tax Returns
The US estate tax return must be filed within nine months of the death of the deceased.  An extension may be obtained for filing the estate tax return, but interest is incurred on any tax due after the nine months.

In addition to the US Federal Estate Tax, the various states also may tax property situated in their state, allowing deductions as for Federal above.  The state estate tax rates are considerably lower than the Federal rates.

Estate Tax Planning

Depending on the individual situation, there are several avenues one may take to reduce or avoid US Estate taxes.  If held as individuals and both are NRAs, holding it jointly will double the credit/exemption.  If the spouse of the NRA is a US citizen/resident, putting the ownership in their name might eliminate the tax as their exemption from US Estate Tax is $1.5 million in 2011 and 2012.  The use of foreign companies/trusts/foundations should be considered for ownership of the property remembering the income tax and foreign tax credits considerations discussed at the outset.

The US Gift Tax exemption remainsfor gifts to non - us sitizen spouse is $136,000 for 2011 and the annual exemption is $13,000 per person.

Conclusion

The area of Estate and Gift Tax is complex.  The potential Israeli investor would be well advised to seek competent professional advice before investing in the USA. This includes designating the ownership of bank accounts.

 

This article is a general summery of the subject and can not substitute specific professional advice.
 
Murrel Kohn, CPA (USA, Isr.)
Kisch & Co. Certified Public Accountants
 
translation localization




US Taxation under the PFIC Regime


For Many US persons investment in offshore mutual funds or foreign corporations may seem attractive at first. This is because no tax or low tax may exist in the foreign jurisdiction. And also because the US investor acts under the wrong assumption that earnings are subject to regular taxation in the US when they are repatriated in the form of dividends or sale of the stocks. This approach can be quite costly when considering that certain foreign corporations and foreign mutual funds are treated under US taxation as "Passive foreign Investment Companies" (PFIC).



What is a PFIC
A PFIC is any foreign corporation that either 75% or more of the it´s income is derived from passive activities or at least 50% of the fair market value of it´s assets are passive assets (such as investments). Simply put, almost all of the income of mutual funds is passive income and therefore mutual funds are usually PFIC and subject to the special rules of the PFIC regime with respect to the US investors in such funds.

What is the PFIC Regime

Foreign mutual funds used to offer tax deferral benefits to US investors. After the enactment of the PFIC regime in 1986 the foreign offshore funds offer no tax benefits to US investors. The PFIC regime provides three alternative forms of taxation for the US shareholders of a PFIC:

Excess Distributions Method (Code Sec. 1291)
Qualified Electing Fund Method - QEF (Code Sec. 1293 and 1295).
Mark to Market method - (Code Sec. 1296).

Excess Distribution Method

This is the default method which is used unless one of the other two methods is elected. Under this method the US shareholders of the PFIC are subject to special rules when they receive a distribution or dispose of PFIC stock. In these cases part of the distribution is taxed at the highest tax rate plus interest, and the tax consequences may be staggering. Although the rules are quite complex it essentially means that distributions are divided into the shareholders holding period of the stock. The part of the distribution that is allocated to the current year and years before the corporation was considered a PFIC are taxed as ordinary income, not as capital gain. The amount allocated to any other tax year is taxed at the highest rate applicable for that year plus interest compounded from the due date of the taxpayer´s return for that year.


QEF

If the PFIC meets certain accounting and reporting requirements a US shareholder may elect to treat the PFIC as a QEF. Under this election the shareholder must include each year in gross income the pro rata share of earnings of the QEF and include as long term capital gain the pro rata share of net capital gain of the QEF.


Mark to Market Method

Under this election the Shareholder must include each year as ordinary income the excess of the fair market value of the PFIC stock as of the close of the tax year over it´s adjusted basis in the shareholder´s books. If the stock has declined in value, an ordinary loss deduction is allowed, but it is limited to the amount of gain previously included in income.


Reporting Requirements

Under the "Hire Act" which was enacted in March 2010 - starting from tax year 2010 US persons who own shares in a PFIC have to file an annual report to the IRS regarding their holdings in the PFIC.


Conclusion

The investment in foreign mutual funds has no tax benefits for US investors over the investment in US domestic funds. And even more so, investment in foreign mutual funds or certain foreign corporations may be very costly due to punitive taxation under the PFIC regime. Also it is important to note that even if a foreign corporation is no a PFIC there may be other US tax implications for the US investor. Therefore the prudent US investor should obtain professional tax advice before investing in foreign mutual funds or any foreign corporation for that matter.
 
This article contains highly abbreviated information and can not be a substitute for specific professional advice.

 
 
 
Ehud Kisch, CPA (USA, Israel)

Kisch & Co. Certified Public Accountants