In my
non-expert assessment, I’m inclined to say that the Keren Hishtalmut and the
Israeli pension are both employees’ trusts. This brings us to the question of what
happens if the money inside of the Keren Hishtalmut or pension is invested in a
PFIC.
Escaping
the PFIC?
On the one
hand, I would like say that the structure of the Keren Hishtalmut or pension
shelters the investments inside of the account in such a way that it longer
matters what the investments are.
The
conceptual support for this approach comes from the way we are reporting the investment
gains for tax purposes. We are taking the gains as income each year (and not as
passive income), regardless of what the gain was from (interest, capital gains
or dividends). It is almost as if the “trust” obfuscates the investments such
that we no longer care if the underlying invest is a PFIC.
This is a
nice line of thinking and it makes me happy to think about the world this way.
However, does it have a basis in the tax regulations?
I think
until recently this was the case. However, since December 2013, we can no
longer use this reasoning.
[Begin
Skipping]
IRS
Regulations on PFIC Ownership
Here is what
it says about foreign pensions:
Foreign pension funds. A United States
person that is treated as the owner of any portion of a trust … that owns,
directly or indirectly, any interest in a PFIC is not required under section
1298(f) and these regulations to file Form 8621 (or successor form) with
respect to the PFIC if the foreign trust is a foreign pension fund … operated
principally to provide pension or retirement benefits, and, pursuant to an
income tax convention to which the United States is a party, income earned by
the pension fund may be taxed as the income of the owner of the trust only when
and to the extent the income is paid to, or for the benefit of, the owner.
I really
want this to mean that an Israeli pension which holds a foreign mutual fund
would not have to deal with a PFIC. However, that is not what it says. The
get-out-of-PFIC-free card only works for a foreign pension that is treated like
a qualified plan according to a tax treaty. In that case, the foreign pension
would have the same status as a U.S. qualified plan in which any PFICs held
within the plan are obfuscated by the trust and do not require any special treatment.
The Israeli
pension is not covered in a tax treaty. Instead, like a Keren Hishtalmut, it is
an employees’ trust. This is a type of nongrantor trust. You know this is the
right term because you eat potato berukas.
In that
case, the following paragraph applies to the Keren Hishtalmut and to the
Israeli pension:
Estates and nongrantor trusts. If a
foreign or domestic estate or nongrantor trust … directly or indirectly owns
stock, each beneficiary of the estate or trust is considered to own a
proportionate amount of such stock.
[End
Skipping]
When you
have a Keren Hishtalmut or the Israeli pension, you are the “beneficiary” of
the trust. The IRS regulations published in December 2013 state that in this
case you are “considered to own a proportionate amount” of any of the stock in
the trust. If the stock is a foreign mutual fund, it means you have ownership
in a PFIC and are required to file form 8621.
What Now?
The bad news
is that in my non-expert opinion, you cannot escape a PFIC with a Keren
Hishtalmut or an Israeli pension.
However, the
good news is that since this PFIC is inside of an employees’ trust, its impact will
be minimized. Next week, I explain the options for dealing with this PFIC.
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