A year on from the Brexit vote, Ephraim Moss and Joshua Ashman, co-founders of Expat Tax Professionals LLC, consider the opportunities for US expats who have investments treated as passive foreign investment companies (PFICs).
One of the major economic fallouts of last year's Brexit referendum was the sudden and significant depreciation of the British pound.
More recently, the pound fell sharply again following the results of the UK election, which show the Conservative party currently in power failed to reach a majority in the British Parliament.
What does this mean from a tax perspective for US expats living in the UK?
Aside from the general exchange gain or loss implications for US citizens transacting in non-US currency, the weaker British pound actually provides an important opportunity for US expats who have investments treated as passive foreign investment companies (PFICs) for US tax purposes.
PFICs - an overview
The PFIC rules, while complex, are important to understand because they affect many UK investments made by expats after moving abroad, both from a tax and reporting perspective.
Unbeknown to many expats, most foreign mutual funds, for instance, fall within the definition of a PFIC.
This can be the case even if such funds are held through a tax-deferred savings account (for instance, UK ISAs) or a UK pension that is not covered by the US-UK tax treaty.
Technically, a PFIC is a foreign corporation that has one of the following attributes:
• At least 75% of its income is considered "passive" (e.g., interest, dividends, royalties), or
• At least 50% of its assets are passive-income producing assets.
A US person that holds any interest in a PFIC, directly or indirectly, is subject to the PFIC rules.
Under the PFIC default rules under Section 1291 of the Internal Revenue Code, investment income resulting from certain distributions from a PFIC or gain from the sale of a PFIC interest is generally subject to highly punitive US federal tax rates, namely the highest marginal tax rate that can be imposed on an individual taxpayer (regardless of whether capital gains tax rates would normally apply).
A significant (and non-deductible) penalty interest charge, which compounds regularly while holding an interest in a PFIC, is also triggered upon certain distributions from a PFIC or gain from the sale of a PFIC interest.
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