The blog
returns this week after a longer-than-expected unexpected delinquency.
Fortunately, Bituah Leumi is being kind enough to sponsor 11 weeks of paternity
leave which will allow me an extraordinary amount of time to ponder important
financial issues while changing diapers. In fact, I plan to honor this
unprecedented leave from work with a special blog in which I will share my
personal tips on how to save money running your household.
But first, in
this final blog about whether the Keren Hishtalmut is a PFIC, I present you
with Investing by Accident’s not-at-all-proven methods for running away from
the PFIC inside of your Keren Hishtalmut. Also, by a horrible act of ill-luck,
you can also use the same methods to run away from the PFIC inside of your
Israeli pension.
Method #1:
Renounce Your Citizenship
Renouncing
your U.S. citizenship is like selling your
apartment and moving to a big house in a far-off place where no one
wants to live in order to save a lot of money. It is really popular to talk
about with your Friend, but no one actually does it.
Frankly, it
would be very un-American to renounce your citizenship. I can’t even consider
it because there is no one who is more American than me. Well, except perhaps
for Americans who still live in America and don’t talk renouncing their
citizenship on their blog.
In any case,
this would only be a forward looking solution. You would still need to pay
taxes for the years up until you renounce your citizenship.
Method #2:
Temporary Regulations
The
regulations published by
the IRS are “temporary,” which is an English word that is generally used to
refer to something that is not yet permanent. I’m not sure that it means the
same thing in IRS-English, but the bulletin includes a contact phone number: (202)
317-6934.
I suppose
you could call the number and ask them to change the regulations. Please let me
know what they say.
Method #3:
Update the Tax Treaty
I am already
planning to speak with John Kerry about the tax treaty next time he is in the
region. I will ask how he feels about designating Israeli pensions for special
treatment as if they are U.S. qualified plans. If we could this, we could
escape the PFIC inside of the Israeli pension plan. There is no harm in asking
him if we would be open to do the same for the Keren Hishtalmut.
I will
definitely let you know what he says. Until then, there is one option left.
Method #4:
Deal With It
If the money
in your pension or Keren Histhtalmut is a mutual fund, it is a PFIC. According
to the (temporary) regulations, you will need to report it accordingly.
This means
that you need to file PFIC Form 8621 form with your tax return. Your accountant
will not be happy about this. Very likely, he will express his displeasure by charging
you more money to complete your return.
However,
there is a bright side. After you go to the trouble of filing the PFIC form, you
will find that it actually makes no difference in how much tax you owe.
Tax Calculations
As you know
if you didn’t use the skipping tags, there are basically three ways that you
get eaten by a PFIC when you buy a regular Israeli mutual fund in an ordinary taxable
investment account. As it happens, none of these is relevant when the money is
invested inside of an employees’ trust like your Keren Hishtalmut or Israeli
pension.
The first way
that you normally get eaten by PFIC is that the only practical way to report
the income is to use the mark-to-market calculation. This calculation treats
all earnings the same and taxes them at your incremental income tax rate. When
this happens on an ordinary “passive” investment, it costs you money because
you lose out on the lower tax that you would have paid on long term capital
gains and qualified dividends.
However, any
investment gain inside of an employees’ trust is anyway treated as regular
income. I’m not an expert, but it seems to me that it should not matter whether
you report this gain directly on your tax return or via form 8621. In either
case, you should add it as other income earned in connection with your
employment. It is taxed at your ordinary income rate because it is not “passive,”
but that’s ok because it also means that you can apply a credit for Israeli
income tax paid to cover any tax you may owe.
The second
way that you normally get eaten by a PFIC is that the mark-to-market
calculation forces you to realize “pretend” gains (or losses) as the exchange
rate between the dollar and shekel changes. The reason for this is that you report
the value of a PFIC as the change in the investment value – in dollars – between
January 1 and December 31. If the same money was not in a PFIC, you would still
have to report interest, dividends and capital gains in dollars, but you would
do this throughout the year whenever these events occurred.
Also here,
it happens to be that the same thing happens anyway in an employees’ trust,
even if it wasn’t in a PFIC. When you calculate the investment gain to add to
your income each year, you should be using the same dollar-based calculation.
The third
reason that you normally get eaten by PFIC when you invest in an Israeli mutual
fund is that you will need to pay taxes to the United States on the investment
gain every year, but you only need to pay taxes to Israel when you sell your
investment. This could easily cause a situation of double-taxation in which you
pay taxes to the United States on your investment in one year and then pay more
tax on the same money to Israel in the next year.
With money
in your Keren Hishtalmut, double taxation is not a concern for the simple
reason that you never pay tax to Israel on this money anyway. However, interestingly
(or maybe, sadly) this could be a problem with your Israeli pension in certain
cases.
What’s
Next?
The conclusion
is that if you hold a mutual fund inside of your Keren Hishtalmut it is a PFIC.
However, the irony is that this will not make a difference on your tax bill if
you treat the Keren Hishtalmut as an employees’ trust.
However, I
did find in my research that there are two things that may be worth considering
in managing your Keren Hishtalmut and Israeli pension.
The first is that you could avoid the problem of the PFIC (at least for
your Keren Hishtalmut) by moving your Keren Hishtalmut to a self-managed
account. This would allow you to buy individual stocks and bonds and avoid the
PFIC entirely.
You could do
this. Or, you could not do this. It really doesn’t matter that much. As long as you
are treating your Keren Histalmut as an employees’ trust, there is no advantage
in terms of the bottom line on your tax bill. The only reason you may want to
do this is for the peace of mind of knowing that no one will ever ask you to
complete form 8621.
The second thing
I found is very subtle, but very important.
There is a double-edge with the
Keren Hishtalmut and the Israeli pension being employees’ trusts. On the one
hand, the earnings are not “passive” and you can take a credit for Israeli
income tax that you paid. On the other hand, you will pay tax at the rate of
ordinary income on these investments, even if some of the gain comes from
dividends and long-term capital gains.
Generally,
this is not at all a concern because you should have enough credit for the
Israeli income tax that you paid to more than cover any tax due. However, this would
change if you reach a point where the investment gains in your Keren Hishtalmut
and your pension become very large (and/or your income gets very small) to the
point where you actually do not have enough credit.
If this were
to ever happen to you, it would make sense for you to close your Keren
Hishtalmut (and to the extent that you could, your pension) and place these
investments in a regular taxable investment account instead. You could then use
Investing by Accident’s
Tax Equilibrium Calculator to manage these investments and pay only around 25% in taxes.
As my loyal
readers know, I am a bona fide non-expert. This is why I did the only thing a
non-expert could possibly do in this situation. I created a spreadsheet to
calculate when it would make sense to close my Keren Hishtalmut and/or take
money out of my pension. The good news is that this only happens when you are
rather wealthy. The bad news is that this could reasonably be the case as you
get closer to retirement.
Or, maybe
that isn’t bad news. After all, it would be nice to be rather wealthy.
In any case,
if you would like to see the spreadsheet, email me at
donny 'at' investingbyaccident.com and I’ll send it to you.