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PFICs (again)

PFICs (again)

Old Dec 5th 2023, 10:15 am
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Default PFICs (again)

My father-in-law, living in UK, is wanting to set up a trust (containing an investment bond that ultimately is invested in various OIECs) to benefit his grandchildren in the event of his death. Our children are US citizens so this has rung all sorts of alarm bells with me. He is not the easiest person to deal with and inclined to do what he wants without taking advice from children or accountants. If he went ahead, despite my objections, is there anything i can do from my end? Any legal document i can create saying that the children do not want to be beneficiaries of a foreign trust and revoke any income or payout from it? Or are we completely screwed?
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Old Dec 7th 2023, 5:19 am
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Default Re: PFICs (again)

Good news and bad news here. It’s possible that if your father in law invests in a bond linked to PFICs versus directly in PFICs that you escape PFIC issues, but it’s hard to say without knowing details of the bond. Regardless, your kids have no IRS obligations or concerns until your father in law passes. At that point they will become subject to foreign account reporting and taxation on their share of the trust assets, which will mean paying income and capital gains tax on their proceeds from the trust. They will need to file Form 3520 in any year that assets are dispersed. FBARs, Form 8938; PFIC taxation and reporting will apply every year after your FILs death unit the trust disposes those assets and is wound up (or the kids revoke the inheritance). Unless the inheritance is trivial it will be worth the effort, although you will likely want to involve a professional to ensure that the right forms are completed, filed, and tax paid. A professional may also be able to suggest methods to reduce taxes, and issue necessary forms on behalf of the trust, so likely value for whatever they charge. Any PFIC taxation and foreign reporting should be relatively easily managed if you can dispose of them in the same US tax year that he passes, or at least in the next US tax year.

The unfortunate aspect of setting up a trust is that your kids will be paying income and capital gains tax on the trust proceeds that would otherwise have been tax free, had it been a simple inheritance. Perhaps you could use that to try and dissuade your father in law from setting up the trust, although of course it depends upon what other benefits he is anticipating from the trust. Your kids will benefit from the stepped up basis that will revalue the cost basis of all assets to the date of your FILs death, so reducing any capital gains and PFIC taxation substantially. Democratic governments would love to eliminate that benefit though, so watch out for that in the future

Last edited by Glasgow Girl; Dec 7th 2023 at 5:22 am.
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Old Dec 7th 2023, 11:54 am
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Default Re: PFICs (again)

Thanks Glasgow Girl that is very helpful, and exposes my misunderstanding of the PFIC reporting. I thought that if the PFIC held shares that increased in value or paid out dividends, then tax and reporting were due even if there were no distributions to the beneficiaries. FWIW to me the investment bond looks like a vehicle to hold OEICS and charge management fees whilst the owner avoids paying income tax.
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Old Dec 7th 2023, 1:45 pm
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Default Re: PFICs (again)

Originally Posted by newadventure
Thanks Glasgow Girl that is very helpful, and exposes my misunderstanding of the PFIC reporting. I thought that if the PFIC held shares that increased in value or paid out dividends, then tax and reporting were due even if there were no distributions to the beneficiaries. FWIW to me the investment bond looks like a vehicle to hold OEICS and charge management fees whilst the owner avoids paying income tax.
So long as the PFICs are held in a foreign trust, your father in law is not a US person, and the kids have no control over the assets until they inherit them, everything mentioned should apply. It could be a different situation if any of those conditions were not met, the rules get quite detailed then. PFICs are manageable to the extent that you can extract yourself from them with limited hassle and expense if you get rid of them in the first year they become subject to IRS taxation. After the first year, the reporting issues and taxes increase exponentially as the years pass, so ditch them as soon as the kids inherit.
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Old Dec 7th 2023, 2:06 pm
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Default Re: PFICs (again)

Thanks again Glasgow Girl - really helpful
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Old Dec 7th 2023, 6:33 pm
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Default Re: PFICs (again)

Whilst you would want/ need a US lawyer to look at this, there is an often persuasive argument that the kind of trust used by insurance bond salespeople in the UK may not meet the US definition of a "trust". If it is not a trust, the beneficiaries named in the policy would still receive distributions from a non_US qualifying insurance policy. This would have no deferral under US law and may lead a lawyer to conclude that the beneficiaries named in the policy own and need to report the underlying investments in the policy. If this were not the case - and it is not a trust - the beneficiaries would still be taxed at some stage on the income in the contract.

Because the investment bond managers are content to sell policies with US person beneficiaries, one assumes that the investment bond managers have a US legal opinion on the US tax consequences. No-body buys an investment bond without a very nice salesperson. I'd see if you could have a quiet word with the salesperson about their risk in selling the product at all.
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Old Dec 8th 2023, 11:01 am
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Default Re: PFICs (again)

Mmmmm - thanks CC. The whole thing is rather opaque and it is difficult to get any information. My impression is that the Investment bond was taken out a while ago by my FIL as an investment and he is the beneficiary. He is wanting to wrap this in a trust where the grandchildren (spread between UK, Ireland and US) are named as beneficiaries. But i may be completely mistaken on this. I know that the grandchildren have not received any income from the bond, but maybe that is not the point. The bond is with Scottish Widows, i might give them a call
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Old Dec 8th 2023, 8:46 pm
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Default Re: PFICs (again)

If the bond is not in a trust then the good news is that your kids would inherit this free of tax in the US. As soon as it goes into a trust that is when the income and capital gains will come into effect (upon the death of your FIL). I would ask Scottish Widows if they would automatically cash in all of the underlying investments and pay the beneficiaries the proceeds from the bond in cash. The key word being automatic. If that is the case and the process is done automatically by Scottish Widows your kids should have no issues with PFIC reporting or taxation. They will of course have to do FBARs and Form 8938 as applicable, but Scottish Widows may be able to pay the proceeds straight into a US bank account in USD which would prevent all foreign account reporting and taxation issues. Even if it is wrapped up in a trust, if the process automatically converts the bond to cash then your kids should have no PFIC issues, just the taxation and foreign account reporting (unless the trust pays out in USD).
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Old Dec 10th 2023, 4:57 pm
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Default Re: PFICs (again)

This IRS tool may assist: Are the Life Insurance Proceeds I Received Taxable? | Internal Revenue Service (irs.gov)
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Old Dec 10th 2023, 5:01 pm
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Default Re: PFICs (again)

This IRS audit guide may assist: foreign_insurance.pdf (irs.gov)
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Old Dec 10th 2023, 5:03 pm
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Default Re: PFICs (again)

If you ignore the section relating to France, this article is the best written discussion I have ever read on the US taxation of non-US insurance products: French Life Insurance Policies: A U.S. Income Tax Perspective (ruchelaw.com)
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