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USTaxAdvising
USTaxAdvising, CPA
Category: Tax
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Experience:  US Taxation specialist.
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I am a US resident Alien (as of March 2012) from Australia.

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I am a US resident Alien (as of March 2012) from Australia. Here on temporary E3 visa. Are my investments in Australian mutual funds viewed as PFIC's? According to my tax preparer, they are. Apparently I have to choose to elect between default or mark-to-market taxation methods. My tax preparer will not offer advice (or even really explain this to me). Help! What info do I need to evaluate and make a decision?

Hello,

 

Unfortunately, YES, your Australian mutual funds would be classified as PFICs under US federal income tax principles. I won't get into what a PFIC is, if you want some "light" reading have a look at the following from wikipedia. http://en.wikipedia.org/wiki/Passive_foreign_investment_company

 

The PFIC regime has three methods of taxation. (1) the deferred interest method, (2) Qualified Electing fund method and (3) Mark to market method.

 

I won't get into the three methods as they are quite complex. If you have questions on them please feel free to ask.

 

If the mutual funds are publicly traded on the Australian stock exchange then you should qualify to make the Mark to Market election.The mark to market election is generally most desirable and least complex from an administrative standpoint. You basically include any increase in fair market value in your current year taxable income, any years you experience a decrease in value you will include that as well (but only to the extent of previously recognized income).

 

I hope this provides the clarity and assurance you were looking for. The Mark to Market election would generally be most desirable. The PFIC regime is one of the most complex of the Internal Revenue Code. Let me know if you have any further questions.

Customer: replied 3 years ago.

Thanks for your advice. I'm still not quite clear. Below is an excerpt from comments from our tax preparer, and my comments/laments in capitals. Not sure if this is beyond the scope of my original question with you. So I"m happy with your answer and will rate, but wondered if you could comment on questions below, or do I need to resubmit as another question?


 


PFIC – does it only become as PFIC on the date that I became a US resident? (March 20, 2012) I only bought it 1 month prior to moving here (Feb 2012). This is the info provided to me by my tax preparer:



Default method (excess distribution) - the current year distribution is weighed against the average distribution of the prior 3 years. If the current year distribution is over 125% of the average amount, an excess distribution has occurred. The normal distribution is taxed at your ordinary (marginal) tax rate and the excess amount would be taxed based on the respective prior year's highest tax rate. Interest may be applied on the excess distribution. In your particular case, any distribution during 2012 tax year from each fund will be taxed as ordinary tax rate as 2012 was the first year of investment for each fund. A review of these funds is necessary every year with which you have a distribution (actual or deemed distribution) while maintaining these foreign investments.


You may also consider the mark to market election for each fund in the first year these are deemed PFIC. Under this approach, you report the growth of the fund every year - regardless if the gain is realized or not. Losses incurred under the mark to market method may be taken to the extent the growth within the funds had previously been taxed.


So this is more favourable? I have no idea why. This whole thing seems so horrible that I think I should sell the mutual funds and move the money into my Australian superannuation. Would that affect my choice to go M2M?


 


Lastly, any gain from the dispositions (sale) of shares from these funds are automatically treated as excess distribution. Losses are considered capital losses for US purposes and the deduction is limited to the lower of the actual loss incurred or $3,000 ($1,500 if filing with MFS status). Any unused/excess capital losses may be carried over into the next US tax year for continued use.


 


I’m thinking that PFIC are a nightmare and someone should have warned be about this before I took a short term position over here! So, although I’m not paying tax in Australia on these investments (due to the combination of – carry over of capital losses, franking credits, and payment of withholding tax), it seems like I will end up paying quite a lot of tax in the US, and some of it is double taxation. Are these PSICs generally viewed as punitive to short-term visa workers like us, or am I over-reacting because I don’t really understand it? I was planning to be in the US for four more years and then return to Australia.

Hello Jennifer,

 

does it only become as PFIC on the date that I became a US resident? - Yes, in a way. It is always a PFIC but it only becomes reportable by you the date in which you became a US resident/citizen.

 

So this is more favourable? I have no idea why. This whole thing seems so horrible that I think I should sell the mutual funds and move the money into my Australian superannuation. Would that affect my choice to go M2M? - Yes, the MTM regime is more favorable because it does not charge an interest penalty. The excess distribution regime is complex to calculate and also carries an interest charge. The PFIC regime is intended to defer Americans from investing offshore. (which is why it is horrible). Although some folks may like the PFIC regime, it depends on their individual facts and circumstances.

 

Lastly, any gain from the dispositions (sale) of shares from these funds are automatically treated as excess distribution. Losses are considered capital losses for US purposes and the deduction is limited to the lower of the actual loss incurred or $3,000 ($1,500 if filing with MFS status). Any unused/excess capital losses may be carried over into the next US tax year for continued use. - Basically correct yes.

 

I'm thinking that PFIC are a nightmare and someone should have warned be about this before I took a short term position over here! - Yes, PFICs are generally not fun for U.S. investors. So, although I'm not paying tax in Australia on these investments (due to the combination of - carry over of capital losses, franking credits, and payment of withholding tax), it seems like I will end up paying quite a lot of tax in the US, and some of it is double taxation. Are these PSICs generally viewed as punitive to short-term visa workers like us, or am I over-reacting because I don't really understand it? I was planning to be in the US for four more years and then return to Australia. - You are not really over reacting but you will pay tax in the U.S. on this income whether or not distributed. If you were to pay tax in Australia on the income then you would get to take that tax paid to Australia as a foreign tax credit in the U.S. The foreign tax credit is provided to help minimize double taxation.

 

I hope this helps. Let me know if you have any further questions.

 

Best regards,

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