Summary: The Obama administration is pushing through legislation and administrative changes designed to increase tax compliance among American citizens living abroad. For most expats who properly file their taxes, the implications are minimal with the exception of taxation on investments of non-US mutual funds, hedge funds and other types of pooled investments.

If you are a US citizen or a US permanent resident who has been living and working outside the US and investing your savings through a non-US financial institution, you need to learn what a Passive Foreign Investment Company (PFIC) is very quickly. Why? Because the Obama Administration and its allies in Congress are pushing through legislative and administrative changes designed to increase tax compliance among American citizens living abroad. For the typical American expatriate who is properly reporting and paying taxes on their global income, the impact of the legislation will be minimal, with one potentially very consequential exception: taxation of investments in non-US mutual funds, hedge funds, and any other type of 'pooled investment.' Non-US incorporated pooled investments typically meet the definition of what the tax code defines as Foreign Passive Investment Companies. Although too complex to fully elaborate on here, the tax treatment of PFICs is extremely punitive compare to the tax treatment of similar 'pooled investments' that are incorporated in the U.S. For example, an American holder of a U.S. incorporated mutual fund invested in European stocks pays the low long-term capital gains rate of 15% if held for more than one year. The same American investor who buys a nearly identical fund listed in the UK or in Switzerland (or anyplace outside the U.S.) will find their investment subject to the PFIC taxation regime which counts all income (including capital gains) as ordinary income and automatically taxes it at the top individual tax rate (35%). In some cases, the total tax on a PFIC investment may rise to well above 50%. Furthermore, capital losses cannot be carried forward or used to offset other capital gains.

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About the Author David Kuenzi is the founder of Thun Financial Advisors. He is a Certified Financial Planner® and has previously held positions with Chase Manhattan Bank, Deutsche Bank and Bank Austria. His financial industry career included postings in New York, London and Moscow. Kuenzi grew up in Wisconsin but spent most of his professional career in New York City and in Europe, before returning to the Midwest in 2005. He received his undergraduate degree from the University of Wisconsin and completed graduate work in politics and economics at Columbia University and Harvard University before launching a career in finance.

First Published: Jun 17, 2009