Do You Own Foreign Mutual Funds?

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Due to buoyancy in foreign stock markets coupled with weakness of US dollar against the foreign currencies, it has become very tempting for the US investors to invest in foreign based mutual funds. In recent past, indeed, the strategy seems to have paid off.

Many investors however, do not realize that the investment in foreign mutual funds has a flip side too. These mutual finds are generally called “Passive Foreign Investment Companies” according to Internal Revenue Code which contains not so friendly rules. If the rules are not carefully followed, it may result in high tax liability.

Passive foreign investment companies (PFICs) are foreign corporations that satisfy either of two tests. The first test is an income test. Under the income test, 75 percent or more of the gross income for the taxable year is passive income. The second test is the asset test. Under the asset test, 50 percent of the assets held by the foreign corporation during the taxable year must be held to produce passive income. Passive income is essentially dividends, interest, rents, royalties, annuities and certain gains. Foreign mutual funds are generally covered by the definition and are considered PFICs.

How do the rules apply to you if you have invested in a PFIC? If a foreign corporation is PFIC, U.S. shareholders are taxed on the passive income regardless of their individual or combined ownership in the foreign corporation. When a shareholder disposes of an interest in a PFIC, the shareholder is taxed on the value of the accumulated earnings in that interest, and not just on gain. In addition, interest on the tax is calculated as if the taxable amount were distributed during the shareholder's holding period.


Grandma is a U.S. citizen who likes to invest in mutual funds. On the advice of her broker, on January 1, 2006, she buys 1% of FORmut, a mutual fund incorporated in a tax-haven entity. Because FORmut only earns passive income on passive assets, FORmut is a PFIC. Not having any knowledge of international tax or the PFIC rules, Grandma and her accountant fail to comply with the reporting requirements and miss certain tax saving opportunities. Due to this, when the FORmut paid the dividend, Grandma was required to pay tax on dividend at the highest rate in effect for that year with interest. It is easy to envision significantly more complex scenarios.

Needless to say, US investors who are shareholders in foreign incorporated mutual funds must consult with the international tax advisor as soon as they decide to invest in such funds to avoid any unpleasant surprises.

The publication is not intended to provide tax advice. Please consult your international tax advisor for more information.

Foreign Students, Trainees and Researchers - Residents?

Article 1

Generally, US taxpayers are divided into two categories, namely, Residents and Non-residents. Residents include US citizens and Green Card holders. Whether Non Resident aliens are residents for US tax purposes depend on their immigration status and days of U.S. presence over a three-calendar year period. U.S. tax residency status helps to determine whether and how the federal tax returns must be filed, and whether any withholding and reporting is required by US payers.

Non immigrants are considered resident aliens if they are physically present in the United States for at least 31 days in a calendar year, and their U.S. presence over a three-calendar-year period meets the 183-day residency formula, unless an exception to the contrary applies. This article discusses the tax obligation for visitors on J visas that are typically granted to certain researchers and students.

Two exceptions apply to visitors on J visa regarding the general rule of residency status based on physical presence. Foreign nationals in J visa status are exempted from counting their days of U.S. presence for purposes of the 183-day residency formula for a specified number of calendar years. The exception allows them to remain non resident aliens for U.S. income tax purposes longer than most other categories of non immigrants. These individuals are referred to as “exempt individuals” for the periods that they are exempt from counting days for purposes of the 183-day residency formula.

There are generally two different kinds of rules for the individuals on J-1 visa category. One rule applies to “students” and another rule applies to “teachers and trainees.” These exceptions also apply to spouses and other dependents. A special 5-calendar year rule applies to maintain non residency status for students on J visas. They are exempt from counting U.S. days for purposes of the 183-day residency formula for 5 calendar years. Students on J visas must generally begin counting U.S. days for purposes of the 183-day residency formula after 5 calendar years. Just one U.S. day in the calendar year counts as one calendar year for purposes of determining exempt years. The rules allow students to continue to be exempt from counting days for purposes of the 183-day residency formula if they can prove to the IRS their intent not to reside permanently in the United States.

A special 2-out-of-7 calendar year rule exempts non students on J visas such as trainees and short-term researchers from counting days for purposes of the 183-day residency formula. Under this exception, non student who has not been in the US as an exempt individual at any time in the prior 6 calendar years is a nonresident alien for tax purposes. Accordingly, a non student on J visa is a nonresident alien for two calendar years in the United States. The non students who are in the US for two years or longer become resident aliens in their 3rd calendar year when they are present for 183 days in US Non students on J visas who have been in the US as exempt individuals before, for example on F-1 or J-1 visas, may become US tax residents sooner.

It is therefore important to determine the visa status of the non residents as this may lead to different tax obligations.

The publication is not intended to provide tax advice. Please consult your international tax advisor for more information