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Tax time - first year resident, ISA/PFICs

Tax time - first year resident, ISA/PFICs

Old Jan 15th 2024, 7:41 pm
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Question Tax time - first year resident, ISA/PFICs

Hi, I know that PFICs have been discussed extensively before. I've read the historic threads I've found here, but I'm still struggling to get my head around what I need to do.

Background:
  • Relocated from UK to US (California) in July 2023 on a spousal visa to join my wife (USC). Now a permanent resident/green card holder. Will be remaining here for the foreseeable i.e. not looking to leave the US again in the near future or split time overseas, etc.
  • I held both a stocks and shares ISA and a lifetime ISA in the UK
  • Closed the stocks and shares ISA before relocating
  • Transferred lifetime ISA to a cash ISA before relocating (will likely liquidate this at some point but I know there will be penalty fees and haven't got around to it yet)
  • Earned income as a limited company contractor in the UK before relocating, but did not work in the US in 2023, although I continued to receive a small income from my personal UK limited company as salary.

I believe that I broadly have two options for US taxes:
  1. dual status - file as married/separate for 2023 and treat my US residency as starting on my arrival date in July 2023. This is the simpler option, but means we cannot file jointly or claim the standard deduction for me. Big attraction here is avoiding 8621 as the PFICs were disposed of prior to my arrival.
  2. elect to be treated as a full year US resident for 2023 so that we can file jointly and claim the joint standard deduction, utilise foreign-earned income exclusion/foreign tax credits, etc. But this brings my stocks/shares and lifetime ISAs into scope when they were still PFICs.

I am trying to work out if there will be an advantage in electing to be treated as a full year resident and taking the standard deduction etc. Given that would bring my ISAs into scope, I need to understand how to file 8621 correctly and whether it's worth the hassle.

The S+S ISA was a single fund with a UK ISA provider. It had holdings in 17 funds. The overall ISA had increased in value due to dividends/gains etc. by approx. £1,000.00 from 1 Jan 2023 to when I sold it in July 2023 (before entering the US). The total value of the ISA would be over the $25k threshold for reporting PFIC. Any dividends were automatically reinvested in the fund by the provider rather than being disbursed to me as they arose.

The Lifetime ISA was S+S, again a single fund with a UK ISA provider, and it seems it had holdings in 4 funds. I don't have any realised gains here as I haven't withdrawn from it, although it did increase in value in 2023 due to dividends/gains. Again it would be over the $25k threshold. Again dividends were automatically reinvested in the fund.

Am I right in understanding that I would need to complete:
  1. a separate 8621 form for each holding within the stocks and shares ISA (so 17 copies of the form, one for each holding), including a determination of how much realised gain per fund and how to treat it (1291 vs QEF vs mark to market), and
  2. a further set of 8621 forms for each holding within the stocks and shares lifetime ISA (4), including a determination of how much each fund gained in value and how to treat it? Also I did receive a government bonus in 2023 (I believe) which can't be tied to any particular holding.
  3. if so, do I also need to complete separate 8621 forms for the ISAs themselves, i.e. the overall accounts?
Or can I actually simply complete a total of 1x 8621 for each overall ISA fund, which obviously makes things quite a lot simpler?

My apologies if this has been covered elsewhere, I have had a pretty good look through the forums and I am making my way through 8621 and the instructions, but this is not my area of strength and in particular the 8621 instructions are just not that easy for me to understand. Any help or insights greatly appreciated.
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Old Jan 15th 2024, 11:54 pm
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Default Re: Tax time - first year resident, ISA/PFICs

You only have to file Form 8621 for each fund that you own directly. It sounds like you owned what is commonly known as a fund of funds where you invested into a single fund that invested into other funds and therefore you did not directly own the underlying funds. If that is so, then you would have had one account number for the wrapper fund and that is all you have to report on. If you had directly held the underlying funds in your ISAs then you would have had to submit one for each fund.

The default PFIC taxation is to tax all realized profits at the highest published income tax rate, currently 37%, and to apply compound interest to the profits prorata’d back to the date of purchase, plus state and city tax. I believe you can largely escape default PFIC taxation by invoking what is called the Inbound Transition Rule. More details here https://hodgen.com/inbound-transitio...-mtm-election/ but in summary it means that new immigrants electing MTM taxation of PFICs can protect unrealized profits from default PFIC taxation up until the date the individual meets the substantial presence test. Tax still has to be paid on those profits when realized but at normal capital gains rates. All unrealized profits after the individual meets the substantial presence test will be taxed at ordinary income rates (effectively your highest marginal tax rate. I don’t know what date would be used for the substantial presence test but worst case is Jan 1st in which case profits attained before that date will be taxed as capital gains when sold, and after that date as ordinary income even though they are unrealized gains. You will get credit for any capital gains paid to the UK but will have to pay any difference to the US if the US tax is higher. Even though you did not withdraw from your cash ISA any profits you realized when you sold the fund are taxable in the US because they do not recognize the ISA.

The challenge you will face either way is completing Form 8621. As you have found out that is not a simple task. The IRS estimate 20 hours to complete each form plus substantial amounts of time for learning about the law and record keeping. I think those estimates are excessive but regardless it will take many hours to complete each one. Because you have to very careful to correctly elect MTM taxation you should likely use someone familiar with doing so. Those guys are specialists and charge accordingly.

My advice to you would be to take your Option (1) to file as a dual status alien, and avoid the significant work (and risk) involved if you bring the PFICs into scope under Option (2). The professional fees incurred will far exceed any savings you make on your tax return, and if you do it yourself you could make a very expensive mistake. You did yourself a massive favor by selling the funds before moving over here.

Last edited by Glasgow Girl; Jan 16th 2024 at 1:18 am. Reason: Corrected the taxation of PFICs.
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Old Jan 16th 2024, 5:06 am
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Default Re: Tax time - first year resident, ISA/PFICs

Personal UK limited company - the IRS consider this to be a foreign corporation and has significant reporting requirements as part of your personal tax return. You need to file Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations.

Ideally you would have closed the company before becoming subject to US tax. Form 5471 is not a simple form to complete, I recommend obtaining professional assistance to prepare the first year. It is not a form that most tax prepares will have encountered previously so assistance may not be cheap.
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Old Jan 16th 2024, 4:48 pm
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Default Re: Tax time - first year resident, ISA/PFICs

Originally Posted by Glasgow Girl
You only have to file Form 8621 for each fund that you own directly. It sounds like you owned what is commonly known as a fund of funds where you invested into a single fund that invested into other funds and therefore you did not directly own the underlying funds. If that is so, then you would have had one account number for the wrapper fund and that is all you have to report on. If you had directly held the underlying funds in your ISAs then you would have had to submit one for each fund.

The default PFIC taxation is to tax all realized profits at the highest published income tax rate, currently 37%, and to apply compound interest to the profits prorata’d back to the date of purchase, plus state and city tax. I believe you can largely escape default PFIC taxation by invoking what is called the Inbound Transition Rule. More details here https://hodgen.com/inbound-transitio...-mtm-election/ but in summary it means that new immigrants electing MTM taxation of PFICs can protect unrealized profits from default PFIC taxation up until the date the individual meets the substantial presence test. Tax still has to be paid on those profits when realized but at normal capital gains rates. All unrealized profits after the individual meets the substantial presence test will be taxed at ordinary income rates (effectively your highest marginal tax rate. I don’t know what date would be used for the substantial presence test but worst case is Jan 1st in which case profits attained before that date will be taxed as capital gains when sold, and after that date as ordinary income even though they are unrealized gains. You will get credit for any capital gains paid to the UK but will have to pay any difference to the US if the US tax is higher. Even though you did not withdraw from your cash ISA any profits you realized when you sold the fund are taxable in the US because they do not recognize the ISA.

The challenge you will face either way is completing Form 8621. As you have found out that is not a simple task. The IRS estimate 20 hours to complete each form plus substantial amounts of time for learning about the law and record keeping. I think those estimates are excessive but regardless it will take many hours to complete each one. Because you have to very careful to correctly elect MTM taxation you should likely use someone familiar with doing so. Those guys are specialists and charge accordingly.

My advice to you would be to take your Option (1) to file as a dual status alien, and avoid the significant work (and risk) involved if you bring the PFICs into scope under Option (2). The professional fees incurred will far exceed any savings you make on your tax return, and if you do it yourself you could make a very expensive mistake. You did yourself a massive favor by selling the funds before moving over here.
Thanks, that's really useful. I'll think on this.
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Old Jan 16th 2024, 5:05 pm
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Default Re: Tax time - first year resident, ISA/PFICs

Originally Posted by zisaai
Personal UK limited company - the IRS consider this to be a foreign corporation and has significant reporting requirements as part of your personal tax return. You need to file Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations.

Ideally you would have closed the company before becoming subject to US tax. Form 5471 is not a simple form to complete, I recommend obtaining professional assistance to prepare the first year. It is not a form that most tax prepares will have encountered previously so assistance may not be cheap.
Hmm. So I was broadly aware of this, but it's a private LLC that I used for contracting in the UK (I was sole shareholder/director/employee). My plan was to elect to treat it as a foreign disregarded entity via form 8832. I couldn't wind it up before arriving in the US in any case, as I was working on a contract nearly up until my date of departure from the UK, and it wasn't possible to obtain settlement for my outstanding invoices and then close down the company before I left.

However, it now appears that such an election (to treat it as a foreign disregarded entity) can be retroactive by no more than 75 days, which seems like it means I can't go that route after all. I hadn't caught that earlier. What a nightmare.
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Old Jan 16th 2024, 5:27 pm
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Default Re: Tax time - first year resident, ISA/PFICs

Originally Posted by raggedyak
Hmm. So I was broadly aware of this, but it's a private LLC that I used for contracting in the UK (I was sole shareholder/director/employee). My plan was to elect to treat it as a foreign disregarded entity via form 8832. I couldn't wind it up before arriving in the US in any case, as I was working on a contract nearly up until my date of departure from the UK, and it wasn't possible to obtain settlement for my outstanding invoices and then close down the company before I left.

However, it now appears that such an election (to treat it as a foreign disregarded entity) can be retroactive by no more than 75 days, which seems like it means I can't go that route after all. I hadn't caught that earlier. What a nightmare.
Looking further, it appears that there is actually relief for late election under Rev. Proc. 2009-41 - https://www.irs.gov/pub/irs-drop/rp-09-41.pdf which states that a late election (within 3 years and 75 days of a foreign entity becoming relevant) can be made, if the only reason for the election not being made was a failure to file 8832 in time.

Additional info here: https://www.journalofaccountancy.com.../20092115.html

(Mostly posting this for posterity in case it's useful for anyone in future)
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Old Jan 17th 2024, 1:07 am
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Default Re: Tax time - first year resident, ISA/PFICs

If your make the election to treat it as a foreign disregarded entity then you file form 8858 instead of 5471. That is a much simpler form to complete.
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Old Jan 17th 2024, 3:13 pm
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Default Re: Tax time - first year resident, ISA/PFICs

Originally Posted by zisaai
If your make the election to treat it as a foreign disregarded entity then you file form 8858 instead of 5471. That is a much simpler form to complete.
Yep, exactly.
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Old Mar 5th 2024, 9:46 pm
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Question Re: Tax time - first year resident, ISA/PFICs

Originally Posted by Glasgow Girl
You only have to file Form 8621 for each fund that you own directly. It sounds like you owned what is commonly known as a fund of funds where you invested into a single fund that invested into other funds and therefore you did not directly own the underlying funds. If that is so, then you would have had one account number for the wrapper fund and that is all you have to report on. If you had directly held the underlying funds in your ISAs then you would have had to submit one for each fund.

The default PFIC taxation is to tax all realized profits at the highest published income tax rate, currently 37%, and to apply compound interest to the profits prorata’d back to the date of purchase, plus state and city tax. I believe you can largely escape default PFIC taxation by invoking what is called the Inbound Transition Rule. More details here https://hodgen.com/inbound-transitio...-mtm-election/ but in summary it means that new immigrants electing MTM taxation of PFICs can protect unrealized profits from default PFIC taxation up until the date the individual meets the substantial presence test. Tax still has to be paid on those profits when realized but at normal capital gains rates. All unrealized profits after the individual meets the substantial presence test will be taxed at ordinary income rates (effectively your highest marginal tax rate. I don’t know what date would be used for the substantial presence test but worst case is Jan 1st in which case profits attained before that date will be taxed as capital gains when sold, and after that date as ordinary income even though they are unrealized gains. You will get credit for any capital gains paid to the UK but will have to pay any difference to the US if the US tax is higher. Even though you did not withdraw from your cash ISA any profits you realized when you sold the fund are taxable in the US because they do not recognize the ISA.

The challenge you will face either way is completing Form 8621. As you have found out that is not a simple task. The IRS estimate 20 hours to complete each form plus substantial amounts of time for learning about the law and record keeping. I think those estimates are excessive but regardless it will take many hours to complete each one. Because you have to very careful to correctly elect MTM taxation you should likely use someone familiar with doing so. Those guys are specialists and charge accordingly.

My advice to you would be to take your Option (1) to file as a dual status alien, and avoid the significant work (and risk) involved if you bring the PFICs into scope under Option (2). The professional fees incurred will far exceed any savings you make on your tax return, and if you do it yourself you could make a very expensive mistake. You did yourself a massive favor by selling the funds before moving over here.
Coming back to this, and after extensive rabbit-holing I am looking to elect to be treated as a US resident for all of 2023 and file jointly. If we don't go this way, my wife (already resident USC) can't take the standard deduction and we'll end up getting hit with a medium-sized tax bill on that front.

So, it looks like I am unfortunately going to need to complete an 8621 for my stocks+shares ISA. I only realised about £1k gain on it when I liquidated it, so even if it's punitively taxed then it's not the end of the world.

But the crux is in filling out the damn 8621 form correctly.
  1. it was a single S+S ISA run by a mainstream UK investment company
  2. at 1 Jan 2023 it was actually running at about a £2-3k loss
  3. by the time I liquidated it in July 2023 it was running at about a £1k gain
  4. underneath the total value of the account, the fund managers were buying and selling shares of 17 different funds, and the fund also appears to have received some interest and dividends also (which were reinvested)
  5. given that I am electing to be treated as a US resident for the full year, I am assuming that any mark to market/inbound transition would apply to 1 Jan 2023.
It's really frustrating to have to look at so much extra paperwork for the sake of really not a lot of money... I care more about accurate filing than the tax exposure on this one.

Glasgow Girl it sounds like you have some experience with all this... the 8621 form talks about the 'value of the applicable stock' - I'm thinking that I can simply use the overall balance of the S+S ISA at a given point in time for this value, right? And just complete one 8621. Your previous post implied as much re: this being a 'fund of funds' but I just want to double check I understood you correctly.
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Old Mar 5th 2024, 11:38 pm
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Default Re: Tax time - first year resident, ISA/PFICs

You should only have to submit one Form 8621 (because you did not directly own any of the underlying funds).

if you elect MTM taxation I believe you can identify the value of the fund on Jan 1st as the higher of the cost basis or the fair market value, and in your case it sounds like the cost basis will be the better option. The tax on the sale will be the profit based upon the sale price minus the Jan1st valuation taxed as ordinary income at your personal highest marginal tax rate. Normal capital gains taxes would be applied to any theoretical profit gained before Jan 1st but that would be zero under this scenario, and so irrelevant. Because this was an ISA you won’t have any credit for UK tax paid, but if you paid UK tax on an any other passive income then you may get credit for that.

Using the default method would result in a worse outcome, because the tax would be calculated on the same profit (sale minus cost) but would be taxed at 37% plus compound interest for the prorated amount of profit applied to each year that you held the fund.

Either way it’s harsh for what was initially a tax free investment but it is what it is, and as you stated the bigger problem is completing Form 8621 itself. Do the best you can, it’s complex and I doubt there are more than a handful of IRS agents out of the many thousands that can advise knowledgeably on it. Have a reasonable rational for any assumptions that you make (and you likely will have to make some). It is very likely they will accept the form as submitted without a human ever looking at it, but if challenged they know it is exceedingly complex and so long as you can demonstrate that you made a good faith attempt to get it right you should survive just fine.
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Old Mar 5th 2024, 11:45 pm
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Question Re: Tax time - first year resident, ISA/PFICs

Originally Posted by Glasgow Girl
You should only have to submit one Form 8621 (because you did not directly own any of the underlying funds).

if you elect MTM taxation I believe you can identify the value of the fund on Jan 1st as the higher of the cost basis or the fair market value, and in your case it sounds like the cost basis will be the better option. The tax on the sale will be the profit based upon the sale price minus the Jan1st valuation taxed as ordinary income at your personal highest marginal tax rate. Normal capital gains taxes would be applied to any theoretical profit gained before Jan 1st but that would be zero under this scenario, and so irrelevant. Because this was an ISA you won’t have any credit for UK tax paid, but if you paid UK tax on an any other passive income then you may get credit for that.

Using the default method would result in a worse outcome, because the tax would be calculated on the same profit (sale minus cost) but would be taxed at 37% plus compound interest for the prorated amount of profit applied to each year that you held the fund.

Either way it’s harsh for what was initially a tax free investment but it is what it is, and as you stated the bigger problem is completing Form 8621 itself. Do the best you can, it’s complex and I doubt there are more than a handful of IRS agents out of the many thousands that can advise knowledgeably on it. Have a reasonable rational for any assumptions that you make (and you likely will have to make some). It is very likely they will accept the form as submitted without a human ever looking at it, but if challenged they know it is exceedingly complex and so long as you can demonstrate that you made a good faith attempt to get it right you should survive just fine.
Thank you, you've been really helpful in this thread and in others that I've read - much appreciate it! I'll have a crack.
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Old Mar 5th 2024, 11:58 pm
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Default Re: Tax time - first year resident, ISA/PFICs

Your welcome. Just remember that I am not a financial professional but have helped quite a few others through the mess associated with foreign accounts and so have some layman’s knowledge.
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