Stocks & Shares ISA / PFIC

I thought I would start a new topic on this separate from the FBAR discussion I started (http://talk.uk-yankee.com/index.php?topic=87606.0) as I have a few specific questions.

To quickly sum up: I'm a dual national with American mother, British father. Born in the UK and have always lived and worked in the UK.

Back in 2009 I had some spare money in a savings account and interest rates were plummeting. A friend recommended to invest it in a Stocks & Shares ISA so I opened one with Hargreaves Lansdown (a fund supermarket) with a fairly small amount of money. This was me being completely oblivious to the US tax rules. Over the years since then I have made further investments into the account when I've had money available. I've tried to diversify and have a mixture of OEICs, investments trusts and individual shares (and I've probably been guilty of over-diversifying as I have quite a few different ones now).

A few weeks ago my sister received a letter from her bank asking her to confirm her nationality and mentioning FATCA. This made us all suddenly aware of the situation and I'm now trying to do streamlined filing to set everything straight.

But this Hargreaves Lansdown ISA is a massive headache. I've looked at Form 8621 to try to understand what it is asking for.

1) Can anyone explain in layman's terms the three different treatments of a PFIC on this form?

2) My intention with the investment was always long-term holding for capital gain, not to draw an income. Hence I've mainly bought accumulation funds as opposed to income funds. The fund managers automatically reinvest dividends back into the fund rather than paying them out and this is reflected in the price of the fund being higher than the equivalent income fund. How does the IRS view these? Can they be treated in the same way as income funds?

3) HL's terms and conditions describes how funds purchased within the ISA are actually held under a nominee account so you are not directly investing in the fund.

A23 - custody
Detailed records of all your investments and assets in your Account will be kept at all times. Investments purchased by HLSB on your behalf or transferred to us will be held in the name or to the order of HL Nominees or any other nominee company in our group or by an approved third party custodian to our order. HL Nominees is a non-trading company set up to hold investments on behalf of our clients. HLAM and/or HLSB are responsible and liable for HL Nominees to the same extent as for their own acts. Investments held on your behalf may be pooled with the investments of other clients, and as a result your holding may not be individually identifiable on the relevant company register.

Does this have any effect on the treatment of these from the perspective of the IRS?

4) HL pays loyalty bonuses to clients for many funds and these go into the income portion of the ISA. Do these just get treated the same way as bank interest? They are identifiable by fund but not a distribution from the fund itself as HL just rebate some of the management fees.

5) HL now deducts management fees as a lump sum from the income account. Should these just be ignored for the tax return or is there some way of offsetting these against the income?

6) I'm doing streamlined filing which requires me to go back to 2012. But I bought about half of the funds prior to that. How does that affect the reporting?

7) Does any of the online software like TaxAct handle PFIC reporting?

I am looking into options for getting professional assistance, something I was initially trying to avoid. Despite all the above I'm not super-rich so I'm extremely concerned about how much it will all cost. I haven't sold much within the ISA. Some funds are showing losses, some gains, but I've not crystallised most of it so it's all notional.

I'll start this post with the following comment: I can not offer any assistance. Therefore, unfortunately, my comments will be general.

As I understand, informational Form 8621 must be filed each and every year one holds a PFIC. The intention to hold the PFIC for an extended period is of no consequence. As you have likely discovered, if you are doing Streamlined, that indicates doing 8621 for 3 years, plus the current year. It's also my understanding that some computations must be made on a daily basis (I could be wrong). I'm sure you've noticed that the time estimated by the IRS for completing the form for one PFIC, combining recordkeeping and preparation only, is 37 hours. An additional 11 hours is recommended for 'learning about the law or the form'.

Both Congress and the IRS are aware of the extreme difficulty of completing this form. It is intentional. If the form is not filed yearly, its' extreme punitive nature and penalties may offset (by up to 100%) any gain made on the investment. Again, this is intentional. Investments in any foreign PFIC are highly discouraged for anyone resident in the US. As a US Citizen, you are automatically considered resident in the US for tax purposes (and I believe you are now aware of this).

The only recorded incidents in online expat forums, of which I am aware, of someone completing 8621 without professional assistance speak of the individual preparing special (and complicated, time consuming) spreadsheets in order to comply. Unless online tax packages such as TurboTax or TaxAct have changed, the assumption must be that the really difficult part, the calculations, must still be completed by the individual. Perhaps someone can comment.

You'll have to decide whether your account with HL counts as only 1 PFIC, or whether each element becomes a separate PFIC. Again, I may be wrong, but the latter seems the most likely.

Aside from the obvious considerations, I would suggest it may be imperative to give sufficient thought to; 1) consider the implications of completing 8621 yearly if you wish to remain US tax compliant, 2) consider discarding any investment which could be considered a PFIC for the future if you wish to remain US tax compliant, 3) consider renouncing US citizenship (but you would then be required to file 5 years of past returns).

I'm sorry if this comes across as brutal. You do have my sympathies, but it might be helpful to hear the raw 'truths' from someone else if only to confirm the options you have (or, it may not be helpful  ).

 

3) consider renouncing US citizenship (but you would then be required to file 5 years of past returns).

Just a small point. Relinquishing US citizenship by renouncing does not require 5 years of past tax returns. Relinquishment takes place with the State Department and has nothing to do with making tax returns to the IRS.

Being compliant with 5 years of returns is only necessary if you wish to tick the "yes" box on Form 8854 where in Part IV A 6 it asks "Do you certify under penalties of perjury that you have complied with all of your tax obligations for the 5 preceding tax years?"

You are given the option to tick "no". You will then be a "covered expatriate". But for some people this is not such a bad thing. If a person's assets are sufficiently small then there will be no exit tax liability, and so there is no downside in being a covered expatriate. I expect there are people who renounce US citizenship but never file Form 8854.

The disadvantages to being a covered expatriate are:
1. No $2 million exemption, so a deemed capital gain on every asset.
2. A deemed vesting of deferred compensation.
3. A liability to US tax for any future US citizen beneficiaries after your death.

Someone with no assets beyond cash, and no US citizen relatives would be fine.

The most understandable explanation of PFIC rules is given by Hodgen and I won't attempt to paraphrase. It will give a good basis for further discussion. The way I see it the default excess distribution rules are the most punitive as you pay tax at marginal income tax rates and also have to pay compounded interest penalty; next is M2M where you calculate the gains each year and pay tax at your marginal income tax rate; and the best is QEF where you at least get to pay capital gains tax rates on capital gains, but it requires documentation that probably won't be forthcoming from most foreign funds.

If you are dealing with PFICs retroactively you have to use the excess distribution method and so you will pay income tax and interest on that income tax to boot.

http://hodgen.com/how-to-make-the-mtm-election-after-owning-a-pfic-for-years/

The excess distribution rules under IRC § 1291 force you to allocate gains and certain portions of distributions over the entire holding period of your PFIC, apply maximum tax rates for each year before the current year, and add a daily compounded interest charge to the tax. This is the default regime when no elections are made.

The MTM rules under IRC § 1296 call for recognition of gain as ordinary income on the unrealized year-to-year appreciation of your PFIC, with strict limitations on losses. The MTM rules only apply if you make the MTM election, which you are only permitted to do if your PFIC is a marketable security under IRC § 1296(e) and your MTM election is timely.

The QEF rules under IRC § 1295 treat your PFIC similarly to a partnership: income retains its character (meaning capital gains are taxed at capital gain tax rates) and is passed through to the shareholder for inclusion in current year income. The QEF rules only apply if you make the QEF election, which you are only permitted to do if you receive a PFIC Annual Information Statement from the PFIC and your QEF election is timely.

Just a small point. Relinquishing US citizenship by renouncing does not require 5 years of past tax returns. Relinquishment takes place with the State Department and has nothing to do with making tax returns to the IRS.

Being compliant with 5 years of returns is only necessary if you wish to tick the "yes" box on Form 8854 where in Part IV A 6 it asks "Do you certify under penalties of perjury that you have complied with all of your tax obligations for the 5 preceding tax years?"

You are given the option to tick "no". You will then be a "covered expatriate". But for some people this is not such a bad thing. If a person's assets are sufficiently small then there will be no exit tax liability, and so there is no downside in being a covered expatriate. I expect there are people who renounce US citizenship but never file Form 8854.

My intention is probably that I will renounce citizenship after all of this.

My understanding is that since I have been a citizen of the UK from birth, pay taxes in the UK and am a permanent resident of the UK then I am exempted from the exit tax.

But I'm assuming that doesn't mean I don't have to file these tax returns?

I do have close relatives in the States and I wish to continue to visit them on vacation every now and again without problems.

If you are dealing with PFICs retroactively you have to use the excess distribution method and so you will pay income tax and interest on that income tax to boot.

http://hodgen.com/how-to-make-the-mtm-election-after-owning-a-pfic-for-years/

Ha this continues to get worse.

So I assume the best thing is to do the excess distribution for 2012-14 then make the MTM election in 2015?

If you elect for M2M you can only do with funds traded on a recognized exchange, and will then give yourself a huge (possibly) tax bill for 2015 as you will recognise all cumulative gains as at 12/31/15 and have no relief for any losses. If you are renouncing (ignoring the remote possibly of the proposed PFIC Regs becoming final) why you want to M2M? 

You more likely have a PFIC tax bill for 2014 because the stock market was higher & you may have converted to clean funds.

My understanding is that since I have been a citizen of the UK from birth, pay taxes in the UK and am a permanent resident of the UK then I am exempted from the exit tax.

Yes, that is correct, as long as you remain a resident of the UK.

But I'm assuming that doesn't mean I don't have to file these tax returns?

If you renounce and wish to NOT be a covered expatriate, then you will have to file 5 previous years worth of returns.

I do have close relatives in the States and I wish to continue to visit them on vacation every now and again without problems.

Currently, those who have renounced USC do not have any problems entering the States via the ESTA system thereafter. There are no guarantees, but it's unlikely this will change and you'll continue to be treated as any other UKC travelling to the States.

If you were to become a 'covered expatriate', then all bets are off. You may or may not be able to travel to the States unhindered. Google the 'Reed Amendment'. Currently (and likely in the future) this legislation is not enforced, although according to the US Dept. of State three people have been denied re-entry. If one becomes a covered expatriate there are more than a few US legislators who, for political reasons, have (or are, or may) attempted to have those who have renounced for 'tax reasons' (any covered expatriate) barred from the US.

If you elect for M2M you can only do with funds traded on a recognized exchange, and will then give yourself a huge (possibly) tax bill for 2015 as you will recognise all cumulative gains as at 12/31/15 and have no relief for any losses. If you are renouncing (ignoring the remote possibly of the proposed PFIC Regs becoming final) why you want to M2M? 

You more likely have a PFIC tax bill for 2014 because the stock market was higher & you may have converted to clean funds.

I was just basing my statement on that Hodgen website which seemed to suggest that M2M was cheaper.

I am intending to do the streamlined process which requires four years of tax returns: 2012-2015. If I want to renounce but they require 5 years of returns then do I have to do 2011 or wait and do 2016?

If I do 2016 am I better selling my funds now or is there no point?

You can do either. You can do 2011,12,13,14,15 and renounce this year, or do 2012,13,14,15,16 and renounce in 2017.

You can do either. You can do 2011,12,13,14,15 and renounce this year, or do 2012,13,14,15,16 and renounce in 2017.

But if you leave coming clean for too long, the IRS might conceivably try to argue that a lengthy delay constituted wilful conduct...