Reporting Canadian PFICs to the IRS
Author: Brad Howland
First Posted: Dec. 8, 2014
U.S. citizens and resident aliens who have funds in Canadian “Passive Foreign Investment Companies” (PFICs) are now required to file an information return with the IRS: Form 8621 Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund. Canadian mutual funds and certain other investments are considered PFICs and Form 8621 should be filed to report them.
Form 8621 is filed by attaching it to your tax return, and filing both by the due date for the return. U.S. citizens or resident aliens living outside the United States generally have an automatic two-month extension of time to file 1040 returns, which would make the due date June 15, 2015 for a 2014 Form 8621.
The instructions for Form 8621 are insanely complicated. The IRS estimates it could take more than 46 hours to complete and file the form (15 hours of record-keeping, 11 hours of study, and 20 hours of preparation). I don't pretend to fully understand every aspect of it, but here are some of the key points:
- An investment entity is considered a PFIC if 75% or more of its gross income is passive in nature (i.e. interest, dividends, capital gains, rental income, etc.), or at least 50% of its assets produce passive income. These rules suggest that most Canadian mutual funds, income trusts, real estate investment trusts (REITs), and exchange traded funds (ETFs) would be considered PFICs.
- PFICs that are held in a registered pension plan (i.e. RRSP, RRIF, or RPP) are exempt from reporting on Form 8621.
- You need to file a separate Form 8621 for each individual PFIC held outside a registered pension plan.
- You are not required to file Form 8621 for a tax year if there are no distributions from your PFICs and no dispositions of your PFICs during the year, unless you want to make one of the elections described below. However, Canadian PFICs generally make regular distributions, and the elections are beneficial if you can make them.
- You are not required to file Form 8621 if the value of all PFICs held is less than $25,000 at the end of the year ($50,000 if filing a joint tax return), and there were no distributions or dispositions during the year. However, if you want to make one of the elections described below you need to file Form 8621.
- If you have an RESP or TFSA account, and there are PFICs in them, you are considered to own the PFICs indirectly and must file Form 8621 to report them.
- However, you are not required to file Form 8621 for an individual PFIC that you hold indirectly in an RESP or TFSA, if your share of its value is less than $5,000 at the end of the year, and there were no distributions or dispositions during the year. Again though, if you want to make one of the elections described below you need to file Form 8621.
Elections
- You can make an election on Form 8621 to treat a PFIC as a Qualified Electing Fund (QEF). Electing to treat a PFIC as a QEF is the preferred method of taxation, as it should be closest to the way mutual funds are taxed in Canada. You can only make this election if the PFIC sends you a “PFIC Annual Information Statement.” At the time of this writing I am aware of two Canadian mutual fund companies that are providing these statements (there may be others).
- A QEF election is supposed to be made in the first year of ownership of the PFIC. There are a couple of options though for making a retroactive election described in the instructions for Form 8621.
- If unable to make the QEF election above, you may be able to make an election to tax certain PFICs using a Mark-to-Market method. Mark-to-Market is probably the next best thing to a QEF election, but you can only make this election for PFICs that are traded on a regulated, foreign stock exchange (i.e. the Toronto Stock Exchange). You can therefore make this election for EFTs, REITs, or other publically-traded investment trusts, but not for mutual funds.
- There are a few other esoteric elections available on Form 8621 that are probably not applicable to most taxpayers. Making one of them would likely require careful reading of the IRS Treasury Regulations.
Non-Elections
- PFICs not making an election (QEF, Mark-to-Market, or other) must file Form 8621 if there are distributions or dispositions during the year. Distributions that exceed 125% of average annual distributions (calculated using the three years prior to the current year, or a shorter period if not held that long) are considered “excess distributions.” All gains from dispositions are considered “excess distributions.” Excess distributions receive punishing tax treatment. The general method is to allocate a portion of the excess distributions to each year the taxpayer held the PFIC, then tax each portion as ordinary income at the highest rate for each year. Then interest is added, as if the income was earned in those prior years and is being reported late.
- There may be some foreign tax credit relief available against the above tax on excess distributions. The rules for claiming it are somewhat different than the normal foreign tax credit rules (i.e. no carryovers allowed).
Many U.S. taxpayers living in Canada, after reading the above, will be understandably nervous about their U.S. returns. Form 8621 may or may not cause an increase of overall U.S. tax. It depends on the circumstances of the individual taxpayer: what the primary income type is (earned, investment, retirement, etc.), and what kind of investments are held. It is probably more important now than ever before to consult with a U.S./Canada tax preparation expert. We are unfortunately booked up at the moment and not taking on new clients.