Basic PFIC Rules and Reporting Guidelines You Need to Know as an Expat

Video Script

In this video, I’m going to go over PFICs and how to avoid the major pitfalls that come with owning PFICs if you’re an American living in Canada. PFICs can be costly and cause your income tax return to become very complicated. So it’s typically something you’ll want to avoid as a US person living in Canada.

Stay to the end of this video to find out the two rules you need to know to determine if you’re about to invest in a PFIC and who needs to do a PIFC statement.

I’m Tiffany Woodfield, a Cross-border Financial Advisor and the co-founder of SWAN Wealth Management.

I help my clients in the US and Canada optimize their investments so that they can live a work-optional lifestyle. One of the reasons we make these videos is that we’ve had so many clients come to us after already making costly mistakes. It’s so frustrating to see people who’ve worked hard and tried to do the right thing, only to accidentally fall into a tax trap because they didn’t have the right information or advice.

This video will help you avoid one of the biggest mistakes I see, which is investing in PFICs! So let’s get into it!

First, what is a PFIC?

PFIC stands for Passive Foreign Investment Company.

Some common examples of PFICs are Canadian ETFs, Canadian mutual fund companies and Canadian money market funds.

It’s common for Americans living in Canada to accidentally invest in PFICs because many regular investment tools are considered PFICs.

At the end of the video, I’ll go over the main rules that the IRS uses to determine what a PFIC is. But first, let’s talk about the pitfalls.

Why is owning PFICs bad if you’re an American living in Canada?

If you own shares in a PFIC, you’ll have to deal with extremely complicated tax guidelines. The IRS will require that you file a form 8621. This form is time-consuming to complete. Because it’s time-consuming, you can expect to pay your accountant quite a bit more than normal to do your taxes.

On many occasions, clients have come to us after they’ve already been living in Canada for a year or two. They’re frustrated because their financial advisor put them into Canadian mutual funds, and they got a huge accounting bill. Dealing with PFICs is complicated for your accountant, and your bill will reflect that.

Now, you might be thinking that you could just do the PFIC reporting on your own.

And while you can, it’s going to be even more complicated for you than for your accountant because you don’t have the experience dealing with this level of tax complexity.

Some of our clients say that they tried to do the PFIC reporting on their own rather than work with an accountant, and it took them over 30 hours. So I don’t recommend this route unless you have time to spare and enjoy filling out complex forms.

So, how can you get around this?

I recommend that you seek out the services of a cross-border financial advisor who will ensure that you’re not invested in PFICs.

If you’re doing all of this on your own, get advice and invest in stocks and other investments that are traded on an exchange rather than packaged products such as mutual funds. Make sure you’re not invested in PFICs, and you won’t have to do any PFIC reporting. It’s that simple! This will make tax time much easier.

Also, if you have substantial assets, I recommend you schedule a call with a cross-border financial advisor as soon as possible. PFIC pitfalls are just one part of the cross-border financial planning picture that your dual-licensed advisor will be able to help you with.

Many of my cross-border clients come to me worried about owning individual stocks rather than mutual funds. You might be feeling the same way. Maybe you think that mutual funds are safer than stocks.

You might even think that PFICs are worth it because at least you’ll still be able to hold Canadian mutual funds even if they are PFICs.

However, you can hold the same stocks in the same proportions as a mutual fund and have a portfolio manager professionally manage it.

This way, your portfolio will be diversified in the same way as if you were holding mutual funds. Diversification is one way to reduce risk. And a professional portfolio manager who has cross-border experience will ensure your portfolio is diversified and optimized for the US and Canada’s tax regimes.

It is definitely possible to have a diversified portfolio without having to deal with PFICs.

That said, if you’re a small investor, this might not be possible for you to achieve. You might not have enough money to purchase all the individual positions. Everyone’s situation is different, which is why I always recommend you speak with a cross-border financial advisor before you move to Canada.

Next, if you know you want to avoid PFICs, you’ll need to know the rules that determine whether something is a PFIC or not.

First, there’s the income test.

If 75% or more of a company’s gross income comes from passive or non-business activities, this is considered a PFIC.

Next, there’s the asset test.

If at least 50% of a company’s average percentage of assets is for the production of passive income, then it’s considered a PFIC.

If you invest in Canadian mutual funds and Canadian ETFs, these will likely be considered PFICs. Your accountant will be able to help you identify which of your investments are PFICs. While your cross-border financial advisor can make sure you’re not invested in PFICs.

So, who needs to do a PFIC statement?

If you’re a US Citizen or long-term Green Card Holder, and you’ve invested in PFICs, you’ll need to file the IRS Form 8621.

Canadians who spend more than 183 days in one calendar year in the US may be considered a US person and subject to PFIC rules.

IRS Form 8621 is called the Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund.

That long title gives you a hint of how complex this form is! If at all possible, try to avoid including PFICs in your portfolio if you’re a US person living in Canada.

Finally, if you’re planning on moving across the border, or you’re a US Person or have US investments, then make sure you speak to a cross-border advisor as soon as possible.

A lot of headaches and tax traps that cost you serious money can be avoided with proper advice and planning.

Being proactive is your best defense when dealing with the many cross-border pitfalls.