Skip to comments.Tax Nightmare: PFIC and Form 8621
Posted on 03/23/2011 1:01:10 PM PDT by E. Pluribus Unum
I recently invested in Central Fund of Canada (CEF) in my IRA and taxable accounts. This fund holds physical gold/silver in a 60%/40% ratio.
I just figured out that this stock is treated by the IRS as a Passive Foreign Investment Company, with punitive tax implications.
Does anybody have any experience with this type of investment? Should I dump it while I have only owned it a couple of months and have a 15% gain?
Any help would be greatly appreciated.
I’ve got an account in the Bank of the Republic of the Marshall Islands and I do not report *squat* on it. When the day comes that I withdraw money from it I’ll pay taxes on it then. Until that time the IRS can bite me.
1. Did you invest U.S. dollars in this fund, or Canadian dollars?
2. Have you been paid any dividends on this investment?
3. Have there been any capital gains reported within the fund?
Income test75% or more of a corporations gross income in a particular year is passive income.
Asset testthe average value of passive assets held by a corporation during a particular year is 50% or more of its total assets. US persons who are shareholders of a PFIC are subject to the PFIC rules regardless of the size of their interest in the PFIC. The rules for PFICs are designed to eliminate the benefits of a tax deferral where a PFIC earns income, but does not distribute it on a current year basis. However, the PFIC rules can apply even if the foreign entity does distribute all of its income on an annual basis.
Taxation of US Shareholders 4.3.1 Excess Distribution Distribution Regime (section 1291) 220.127.116.11 Overview The excess distribution regime is the default regime that applies when a US shareholder in a PFIC has not elected under either the mark to market or QEF regimes. The purpose of this system is to approximate the tax that would have been imposed if the PFIC had distributed all income earned each year on a current year basis. The excess distribution rules are designed, in general, to prevent the accumulation of passive income in a foreign entity in a manner that defers US tax. This is generally considered the most punitive of all of the possible PFIC tax regimes and should be avoided if possible. 18.104.22.168 Inclusion of PFIC Income A tax liability under the excess distribution rules arises only when an actual distribution is made by the PFIC, or when the US investor disposes of his or her investment in the PFIC. The annual distribution from a PFIC will be broken into two parts: 1. amount taxed in the current year as ordinary income, and 2. the excess distribution amount (which includes an interest charge). Calculation of Excess Distribution Amount: The excess distribution amount arises when there is either an actual distribution from the PFIC or when a gain is realized on the disposition of the PFIC stock. All of the gain on a sale is treated as an excess distribution. A loss on a sale is generally not recognized. The rules are applied on a PFIC by PFIC basis (i.e., distributions received by a US investor from more than one PFIC in a year are not aggregated). Also, the calculations are done on a share by share basis. Therefore, adjustments must be made for blocks of shares purchased on different dates. A distribution is an excess distribution only to the extent the total of actual distributions during a year to a shareholder exceeds 125% of the average of actual distributions received in the three preceding years (or if a shorter holding period, the portion of the shareholders holding period before the current year) (i.e., excess distributions are really defined by reference to prior year distributions). The total amount of the excess distribution is allocated on a pro rata basis to all days in the investor's holding period. This can potentially result in an allocation to three periods 1. "pre-PFIC period," (days in the investor's holding period prior to the time the foreign entity was a PFIC); 2. "current-year period," (days in the year in which the excess distribution occurs); and 3. "prior-year PFIC period," (days in the prior years during which the foreign entity was a PFIC). Amounts allocated to the pre-PFIC period and the current-year period are totaled and included in the US investor's income as ordinary income. The amount allocated to the prior-year PFIC period is subject to the highest marginal rate of tax for the year to which allocated, and each of the resulting tax amounts attracts an interest charge as if it were an underpayment of taxes for the year in question. Importantly, amounts allocated to the prior-year PFIC period are never included in the investor's regular income. Instead, the tax and interest determined under these rules (the "deferred tax amount"), is added to the investor's tax liability, without regard to other tax characteristics of the investor. Therefore, the deferred tax amount is a payable tax liability, even where the investor otherwise has a current year loss or loss carryovers. The portion of the excess distribution allocated to the current year does not include an interest charge. The calculation above is done in Part IV of IRS Form 8621 Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund available at http://www.irs.gov/pub/irs-pdf/f8621.pdf. Instructions on completion of the form are available at http://www.irs.gov/pub/irs-pdf/i8621.pdf . Example 1 John, a US person, purchases 100 units of ABC mutual fund on January 1, 2004. ABC is a PFIC for all relevant years. John does not make a QEF or mark to market election with regard to his units in ABC. ABC makes no distributions in 2004. On December 31, 2005, ABC distributes $100 to John. The entire $100 is an excess distribution because Johns base period average is zero. This is because there were no previous distributions from the PFIC to John. The distribution is allocated to all days of John's holding period, up to and including the date of distribution. Consequently, $50 is allocated to 2004, and $50 is allocated to 2005. The $50 allocated to 2005 is included in John's income as "other income and taxed at regular marginal rates. The $50 allocated to 2004 is taxed at the highest individual tax rate for 2004 and attracts an interest charge for the period. Example 2 The facts are the same as in Example 1, except that ABC distributes $100 to John on January 1, 2005 instead of December 31, 2005. The distribution is allocated to the days in the period from January 1, 2004 through January 1, 2005. As a result, virtually all of the distribution is allocated to 2004, ABCs prior year. Instead of $50 being allocated to 2004, almost $100 is allocated to 2004. Tax is imposed at the highest rate for 2004, and that tax draws an interest charge. The base on which the interest is determined is doubled, and the resulting interest charge is doubled, as compared to Example 1. Example 3 (purchases on different dates) A US individual owns 12 shares of FC, a PFIC, acquired as follows: --2 shares on December 31, 2002 (Group 1) --4 shares on December 31, 2003 (Group 2) --6 shares on December 31, 2004 (Group 3) On June 30, 2003 and 2004, FC distributed $10 to each outstanding share. No portion of either distribution was an excess distribution. On June 30, 2005, FC distributed $30 to each outstanding share. For 2005, the excess distribution would be calculated for each group of shares. Group 1The excess distribution is $35 ($60 received less 125% of ((20+20)/2) (2 years of holding prior to distribution). Group 2The excess distribution is $70 ($120 received less 125% of 40) (1 year of holding prior to distribution.) Group 3No excess distribution because the first year of the holding period is 2005, the year of distribution. Avoiding the Excess Distribution Regime: Once a foreign corporation qualifies as a PFIC at any time during the US investors holding period, any subsequent distribution by the PFIC to, or disposition of the PFIC stock by the investor, will be subject to the excess distribution rules, regardless of whether the foreign corporation is a PFIC in the year of the distribution or disposition, unless the US investor elected QEF status on a timely basis. This can be avoided in one of three ways: 1. QEF Election in First Year of PFIC Status (and in subsequent years if certain procedures are followed) (section 4.3.3) 2. Marking PFIC stock to market and treating accrued gain as an excess distribution (section 4.3.2) 3. Recognizing Post-1986 Earnings and Profits of Controlled Foreign Corporations Other: · Once a foreign corporation qualifies as a PFIC, all subsequent distributions or dispositions will be considered to be made by a PFIC regardless of whether the foreign corporation is a PFIC in the particular year (unlike when a QEF election is made). Miscellaneous Items: Deemed distributions or dispositions of indirectly held PFIC stock may also be subject to the excess distribution rules. Return of capital distribution could be classified as an excess distribution. Non-recognition provisions that generally apply to certain transfers of stock do not apply to transfers involving PFIC stock (cost basis adjustments will normally apply). Amounts treated as excess distributions have their own special foreign tax credit rules. No part of a distribution received or deemed received during the first tax year of the shareholders holding period will be treated as an excess distribution. Its possible that amounts may not be taxable to a shareholder of a PFIC that is a tax exempt organization (e.g. U.S. charity)
Go see a tax advisor
2. No dividends have been paid to me thus far.
3. I don't know if there have been any capital gains reported by the fund. Here is their first quarter 2011 financial statement.
Here is some ancillary information I found:
I know nothing about the Marshall Islands but can tell you from experience that the U.K cooperates fully with our I.R.S.
No part of a distribution received or deemed received during the first tax year of the shareholders holding period will be treated as an excess distribution.
If I dump it this year, it's ordinary income. I was planning on holding it as a long-term investment, but screw that.
“Ive got an account in the Bank of the Republic of the Marshall Islands and I do not report *squat* on it.”
Years ago, same here. (Roi Rat) I’ve since moved everything to another foreign bank just to keep the IRS’s paws off of it.
Question #5: If you are interested in investing in a gold/silver company and you are investing U.S. dollars, what made you select a Canadian company for this? (I don't mean this wasn't a wise move, just that it seems to add a degree of complexity that may be unnecessary for a simple gold/silver investment strategy.)
5. Unlike GLD and other gold/silver ETFs, CEF owns physical metal and is required to be 90% invested at all times. It is the next best thing to owning physical gold, which I have no desire to do, for a number of reason. Plus, it's been around since 1961, much longer than the other precious metal ETFs.
Inland Revenue cooperates with the IRS mostly to obtain the benefit of taxing corporations like Grand Metropolitan who moved from the UK to the US as a tax shelter. The IRS cooperates with Inland Revenue so the US can better track money laundering operations by terrorists.
I believe that if its in an IRA or 401K, you don’t have to pay any special taxes other than the normal income taxes when it is withdrawn.
I’ve transferred all I can into Roth accounts so I don’t have to worry about any taxes.
Like anything to do with the IRS, it's not all that clear from what I have been reading.
After April 15th I am going to contact the IRS and get a definitive answer. If I dump it in the same year I bought it, it's all moot. Much as I don't want to do that, I don't want to leave an opening for the IRS to screw me.
I told my daughter about this fund she is using it for Ira and 401k investments.
Is this how you are using the fund?
I see. I’m wondering how you get any dividends out of an investment like that. If they own physical gold and silver, how do they generate income other than through sales of the metals?
Your profit comes when you sell the stock at a higher price than you bought it.
I don't want to have to worry about storing and securing thousands of dollars of gold.
If that's the case, then you may very well have $0 in taxable income until you sell your shares -- at which point you'll report a capital gain or loss on your U.S. tax return. You don't owe any taxes on an investment unless one of two things happens: (1) it produces income for you (in the form of a dividend that's paid directly to you or a dividend that is reported and then re-invested automatically in the asset); or (2) you sell the asset and realize a gain on your sale.
CEF is not what was intended to be targeted, but it is passive because all it does is hold gold.
Basically, you have to file that form every year to pay the taxes as if you had sold it. It's easier just to sell it at the end of the year and buy it back.
I believe I am OK in my IRAs, but I am going to sell it before the end of the year in my taxable account. No need to be in a hurry though.
Thanks for your interest and input.
These guys look like the understand the implications
Here is a discussion on Canadian stock
Here is a CPA forum. Be careful they tend to be overly cautious
Here are two that discusses a retirement platform
Hello E. Pluribus Unum:
Thank you for your interest in Central Fund of Canada Limited.
Please go to our website, www.centralfund.com and click on "Financials".
Down the page, you'll come to Notice of U.S. Tax Information for U.S.
Persons. This is a statement we send out to brokers and shareholders to
inform you that Central Fund has No Ordinary Earnings and No Net Capital
Gains to pass onto our shareholders because we do not sell our bullion.
At the bottom of this statement , you will find a link to the IRS Form 8621
and instructions for completing it. You should file the IRS Form 8621 in
the first year that you hold CEF and in the year that you realize any gains
on the sale of the shares. The Form 8621 simply tells the IRS that you have
invested in a Passive Foreign Investment Company (PFIC) which has no income
and no capital gains from its holdings.
Just check off Box A of Part I (QEF Election) and then in Part II, 1a, b and
c AND 2a, b and c are all 'zero'. The zero comes from the Statement telling
you that Central Fund has NO ordinary earnings and NO capital gains.
Central Fund is a Canadian company and you can ask your US tax advisor for
help with this if need be.
Please get in touch if you have further questions.
Marda Jeffrey, Investor Services
Central Fund of Canada Limited
I suggest you check into the rule that IRA’s cannot invest in collectibles, including metals like gold and silver bullion unless they are in the custody of a qualified trustee as described in Internal Revenue Code Section 408(m). Such investments are taxed as immediate distributions from your IRA. It appears to me that holding a PFIC stock that holds bullion may fall within this rule.
In general, PFICs held in a Traditional or Roth IRA don’t have any consequence to your since they’re tax-deferred anyway.
However, for the PFIC shares held in the taxable account, you’ll want to:
(1) Report your holding each year on Form 8621;
(2) Make a QEF election under Part II or a “Mark to Market” election under Part III of Form 8621. If you don’t make one of those elections, you’ll get whacked with the punitive “interest charge” upon disposition.
Correction: I was able to find out that holding gold/silver bullion in the PFIC form of ownership will NOT trigger the Sec 408(m) collectibles rule, so you don’t have to worry about that.