Child capital gains, ETF, PFIC regulations

17 posts in this topic

Hi all,

 

Dual citizen (USA/Germany), residing in Germany.

 

I thought I was doing something great for my US-citizen child and set up a German Junior-Depot (Custodial account as called in USA). I liked the idea of them having some starting capital when they are 18, being tax exempt on capital gains, dividends, interests, as well as being able to teach them how passive income works. I thus opened an account and purchased an EU based ETF with a 25€ monthly payment.

 

Now good news/bad news situation: Good news I read about PFIC (Passive Foreign Income Company) challenges now when the account has been active for only 6 months, bad news, I am now faced with a form 8621 for the 2021 tax year. 2020 the account didn't have any gains, nor  did it fail the De minimis Exception of $25k account value (at least that's how I understand the law).

 

So the way I see it, I best close the ETF immediately and go through the trouble of filling the 8621 form for that $10 gain (or wait, hope the stock market loses money, and if the fund loses money, can ignore the ETF ever having been purchased). I would assume I could continue with the ETF and it would remain tax free, due to my child's threshold, however I would be causing myself unnecessary bureaucratic challenge and likely fill out the form incorrectly.

 

So question #1: Please correct any miss information above.

 

Now I face the challenge of wanting to still leave my child with a tax exempt starting capital. I cannot open a US custodial account, as it's governed by state law and we don't have a US address. Therefore, I cannot purchase a US based ETF - I don't think DE brokers offer them either. Furthermore, if I buy individual stocks, I risk losing money, as I am putting all eggs in one nest.

 

So question #2: Does anyone have any good ideas for investment opportunities that aren't classified as PFIC, nor do they involve purchase of individual stocks, but could still allow me to get my child started with passive earned income?

 

Q#3: Also, just to confirm, as this PFIC regulation through me off and really caused for concern, the US doesn't care if I invest in a US stock on the Frankfurt exchange, right? It's only these ETF's that are EU company funds, that have the major challenge with high tax rates and form 8621?

 

Help on this would be much appreciated and hopefully there is some helpful information in here, for anyone looking into something similar.

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7 hours ago, smojim said:

Now good news/bad news situation: Good news I read about PFIC (Passive Foreign Income Company) challenges now when the account has been active for only 6 months, bad news, I am now faced with a form 8621 for the 2021 tax year. 2020 the account didn't have any gains, nor  did it fail the De minimis Exception of $25k account value (at least that's how I understand the law).

 

So the way I see it, I best close the ETF immediately and go through the trouble of filling the 8621 form for that $10 gain (or wait, hope the stock market loses money, and if the fund loses money, can ignore the ETF ever having been purchased). I would assume I could continue with the ETF and it would remain tax free, due to my child's threshold, however I would be causing myself unnecessary bureaucratic challenge and likely fill out the form incorrectly.

 

So question #1: Please correct any miss information above.

 

No offense but the above is too garbled to tell whether your understanding is correct or not but read on:

 

If you initiated the position in 2020, you still have time to "pull the teeth" on the adverse tax consequences by having your child file a Form 8621 with their 2020 tax return and electing mark to market treatment for the fund shares.  (They must be publicly traded to qualify for this) This is also referred to as a §1296 election and can only be made by filing a Form 8621. Same deal for any shares acquired in 2021 or subsequent years.  It would mean, of course, that your child would have to file a US tax return and Form 8621 (and FBAR if the account(s) exceed $10,000) every year and pay tax on the difference between the value of the fund shares (in USD) at the end of the year from the beginning of the year (or if you bought them mid-year then from that point.)  By doing this you eliminate the potentially horrendous tax consequences of holding PFICs until the date you finally actually sell them.

 

(If your child understands all this, of course, you risk the possibility that he/she will insist on returning to the womb.)

 

 

Quote

 

So question #2: Does anyone have any good ideas for investment opportunities that aren't classified as PFIC, nor do they involve purchase of individual stocks, but could still allow me to get my child started with passive earned income?#

 

Sure.  A simple, safe, widely diversified and inexpensive surrogate for the broader world equities market and that can be purchased on any exchange in the world without restriction:  Berkshire Hathaway B shares:  BRK-B.  Also:  no dividends to fuss with so no problems with the US "kiddy tax".

 

 

Quote

 

Q#3: Also, just to confirm, as this PFIC regulation through me off and really caused for concern, the US doesn't care if I invest in a US stock on the Frankfurt exchange, right? It's only these ETF's that are EU company funds, that have the major challenge with high tax rates and form 8621?

 

 

Right.

 

Foreign stocks and bonds:  OK

PFICs:  nasty

 

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28 minutes ago, Straightpoop said:

 

No offense but the above is too garbled to tell whether your understanding is correct or not but read on:

 

If you initiated the position in 2020, you still have time to "pull the teeth" on the adverse tax consequences by having your child file a Form 8621 with their 2020 tax return and electing mark to market treatment for the fund shares.  (They must be publicly traded to qualify for this) This is also referred to as a §1296 election and can only be made by filing a Form 8621. Same deal for any shares acquired in 2021 or subsequent years.  It would mean, of course, that your child would have to file a US tax return and Form 8621 (and FBAR if the account(s) exceed $10,000) every year and pay tax on the difference between the value of the fund shares (in USD) at the end of the year from the beginning of the year (or if you bought them mid-year then from that point.)  By doing this you eliminate the potentially horrendous tax consequences of holding PFICs until the date you finally actually sell them.

 

(If your child understands all this, of course, you risk the possibility that he/she will insist on returning to the womb.)

 

 

Again amazing response. Thanks! and absolutely no offense taken. I try my best :)

 

This is very helpful, as much as part of me is screaming, "challenge accepted!" to continue with the ETF, as I would think he would be tax exempt on everything anyway, I'd probably be best to close the position; go through the trouble of doing his taxes for 2020 and 2021; and then putting it in something similar like the BRK fund, you mentioned.

 

To confirm, I cannot omit filing a 2020 return for him (even though the holding was far below $1,000), as I would forgo my opportunity to treat the fund as a mark to market fund, which can only be done in the first year of purchase?

 

31 minutes ago, Straightpoop said:

(If your child understands all this, of course, you risk the possibility that he/she will insist on returning to the womb.

 

As much as I'm learning about the intricacies of the US tax code, and part of me is enjoying the challenge of teaching myself how to fish, I'll probably be doing their taxes for a long time :)

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1 hour ago, smojim said:

To confirm, I cannot omit filing a 2020 return for him (even though the holding was far below $1,000), as I would forgo my opportunity to treat the fund as a mark to market fund, which can only be done in the first year of purchase?

 

Exactly.

 

Technically, you can make the M2M election in any year but you can do so effectively (i.e. avoid the harmful tax effects) only by doing so on the tax return for the year of purchase.  Here is the warning from the IRS on p.7 of the instructions to Form 8621:

 

  • [W]hen a shareholder makes a mark‐to‐market election for PFIC stock in a year other than the first year in which the shareholder holds stock in the PFIC and no QEF election is in effect, the PFIC stock is treated as sold at fair market value on the last day of the tax year for which the election is made, and the gain is treated as an excess distribution subject to section 1291. In addition, any distributions made during the year with respect to the PFIC stock are subject to section 1291.

 

NB:  Technically, each separate block of PFIC stock constitutes a separate PFIC for reporting purposes; with a separate USD cost and separate "vintage", i.e. purchase date.   Technically, a separate Form 8621 will be required for each such separate block of stock. The reason is because each will have a different cost basis (however minute) for purpose of computing gain or loss when marked to market or sold.  Technically, losses from one block cannot offset gain from the other.  (Losses are a sticky wicket. They can only be claimed to the extent of previously "unreversed inclusions", i.e. mark to market gains reported previously.)  Practically, you will be doing no violence to the spirit of the PFIC rules if, for such minuscule amounts involved to date, you simply tote up the total shares of the same fund and total USD price paid for them in 2020 and report them as a single "vintage" block on your 2020 Form 8621.  Assuming you do make the timely election the exact date of purchase will be irrelevant for PFICs marked to market since the "holding period" will not have any influence on the tax consequences.

 

If you want to be shed of these things properly and for the least amount of annoyance I would suggest the following:

 

1.  File a group or "vintage" 8621 for all of the shares of each different fund acquired in 2020 and check the box to mark them to market.

2.  Don't buy any more of these things in 2021

3.  Sell the whole kit and kaboodle at an opportune time in 2021 but not later than 31.12.2021.

4. File a "vintage" 8621 in 2022 reporting the proceeds of the 2021 sale.  Since, by definition, there will be no "excess distribution" on 2020 vintage (because they were M2M) and on the 2021 (because they were sold in the same year of acquisition), there will likely be only a smidgeon of income/loss to report.

 

Then, go and sin no more.

 

 

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15 hours ago, Straightpoop said:

 

Exactly.

 

Technically, you can make the M2M election in any year but you can do so effectively (i.e. avoid the harmful tax effects) only by doing so on the tax return for the year of purchase.  Here is the warning from the IRS on p.7 of the instructions to Form 8621:

 

  • [W]hen a shareholder makes a mark‐to‐market election for PFIC stock in a year other than the first year in which the shareholder holds stock in the PFIC and no QEF election is in effect, the PFIC stock is treated as sold at fair market value on the last day of the tax year for which the election is made, and the gain is treated as an excess distribution subject to section 1291. In addition, any distributions made during the year with respect to the PFIC stock are subject to section 1291.

 

NB:  Technically, each separate block of PFIC stock constitutes a separate PFIC for reporting purposes; with a separate USD cost and separate "vintage", i.e. purchase date.   Technically, a separate Form 8621 will be required for each such separate block of stock. The reason is because each will have a different cost basis (however minute) for purpose of computing gain or loss when marked to market or sold.  Technically, losses from one block cannot offset gain from the other.  (Losses are a sticky wicket. They can only be claimed to the extent of previously "unreversed inclusions", i.e. mark to market gains reported previously.)  Practically, you will be doing no violence to the spirit of the PFIC rules if, for such minuscule amounts involved to date, you simply tote up the total shares of the same fund and total USD price paid for them in 2020 and report them as a single "vintage" block on your 2020 Form 8621.  Assuming you do make the timely election the exact date of purchase will be irrelevant for PFICs marked to market since the "holding period" will not have any influence on the tax consequences.

 

If you want to be shed of these things properly and for the least amount of annoyance I would suggest the following:

 

1.  File a group or "vintage" 8621 for all of the shares of each different fund acquired in 2020 and check the box to mark them to market.

2.  Don't buy any more of these things in 2021

3.  Sell the whole kit and kaboodle at an opportune time in 2021 but not later than 31.12.2021.

4. File a "vintage" 8621 in 2022 reporting the proceeds of the 2021 sale.  Since, by definition, there will be no "excess distribution" on 2020 vintage (because they were M2M) and on the 2021 (because they were sold in the same year of acquisition), there will likely be only a smidgeon of income/loss to report.

 

Then, go and sin no more.

 

 

Thanks, spent 2 hours on the form/instructions today and realized, I never want to see it again...challenge not accepted.

 

I have a gain of 1$... in 2020

 

They will also eventually kick out some dividends, so I think the opportune time is before this happens.

 

Last question:

- So Part 1: Line 5 stays blank for 2020/2021 - I think you answer this with Point 4 above (i.e. no distribution).

- only Part IV needs to be filled out, as the instructions say, Part V needs to be filled out in some cases?

- If I want to gift these ETF's to a German citizen (e.g. wife), to avoid the unnecessary loss by buying and selling (i.e. commission fees) in a short period of time, I am also ridding myself of further harm and can thus, for the consideration of the IRS, consider these kaboodled, right?

 

Again, many many thanks!

 

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4 hours ago, smojim said:

I have a gain of 1$... in 2020

 

Whoa!  Don't spend it all at once.

 

4 hours ago, smojim said:

They will also eventually kick out some dividends, so I think the opportune time is before this happens.

 

No big deal.  Since you'll have to file the 8621 again this time next year it will simply be avoiding a bit of income.

 

4 hours ago, smojim said:

 

Last question:

- So Part 1: Line 5 stays blank for 2020/2021 - I think you answer this with Point 4 above (i.e. no distribution).

 

No excess distribution to report on Line 5c.  But if there was any other distribution on a M2M fund that will be entered on line 15a and then carried to Line 5 of Schedule B of your 1040 where it will ultimately end up on Line 3b of Page 1 of the 1040.

 

4 hours ago, smojim said:

- only Part IV needs to be filled out, as the instructions say, Part V needs to be filled out in some cases?

 

If no distributions of any kind to report then only Part IV.  If non-excess distributions then Line 15a under Part V (see above).

 

4 hours ago, smojim said:

- If I want to gift these ETF's to a German citizen (e.g. wife), to avoid the unnecessary loss by buying and selling (i.e. commission fees) in a short period of time, I am also ridding myself of further harm and can thus, for the consideration of the IRS, consider these kaboodled, right?

 

 

A gift of a PFIC is regarded as a sale/disposition and is reported as such.

 

Assuming your child wishes to make a gift of his/her shares to Mom, the administrative headache of effecting the gift through the bank may not be worth the cost of simply selling them.

 

Mom would take child's (German) tax basis but that info would not necessarily accompany the gift so records would have to be kept, etc. etc.

 

Charles Schwab appears to be actively encouraging GFs (Godless Furriners) and US expats to open an "International Schwab One" brokerage account.  They don't allow TOD arrangements with such accounts but I was able to add my NRA spouse to such an account in JTWROS without muss or fuss.  Schwab definitely offers custodial accounts for minors but I did not check to see if that applied to the international version; possibly not if the custodial arrangement is reliant on US state law (UTMA, etc.).  Still might be worth looking into.

 

 

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5 hours ago, Straightpoop said:

Charles Schwab appears to be actively encouraging GFs (Godless Furriners) and US expats to open an "International Schwab One" brokerage account.  They don't allow TOD arrangements with such accounts but I was able to add my NRA spouse to such an account in JTWROS without muss or fuss.  Schwab definitely offers custodial accounts for minors but I did not check to see if that applied to the international version; possibly not if the custodial arrangement is reliant on US state law (UTMA, etc.).  Still might be worth looking into.

 

 


Good to know. I’ll look into this. Are there any adverse consequences in terms of the German tax forms on US located ETF’s? From what I read, Germans are advised against it, as they may be subject to an overtaxation and possible double taxation due to US tax withholdings. I would think however, that this would not be an issue for a US citizen that has to file a US return anyway, as taxes would not be withheld as per W9. 

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9 hours ago, smojim said:

Are there any adverse consequences in terms of the German tax forms on US located ETF’s? 

 

Nope.  Schwab (and now almost all US retail brokers of my acquaintance) will no longer allow non-residents - US citizens or otherwise - to purchase US ETFs (and some, e.g. E*trade) won't even allow you to buy REITs due to lack of a KIID (Key Investor Information Document) for most US-based ETFs.

 

Maybe a blessing in disguise considering the admin effort required to accurately report German tax income from these investments.

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3 hours ago, Straightpoop said:

 

Nope.  Schwab (and now almost all US retail brokers of my acquaintance) will no longer allow non-residents - US citizens or otherwise - to purchase US ETFs (and some, e.g. E*trade) won't even allow you to buy REITs due to lack of a KIID (Key Investor Information Document) for most US-based ETFs.

 

Maybe a blessing in disguise considering the admin effort required to accurately report German tax income from these investments.

 

So basically what you are saying is that a US citizen not living in USA, can forget about most forms of investment other than regular stocks. Frustrating!

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58 minutes ago, smojim said:

So basically what you are saying is that a US citizen not living in USA, can forget about most forms of investment other than regular stocks.

 

Yep.

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What would be a good article on PFICs for someone new to the topic? I am not following half of this stuff...

On 3/5/2021, 6:28:45, Straightpoop said:

 

Yep.

 

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On 05/03/2021, 07:59:10, Straightpoop said:

 

Nope.  Schwab (and now almost all US retail brokers of my acquaintance) will no longer allow non-residents - US citizens or otherwise - to purchase US ETFs (and some, e.g. E*trade) won't even allow you to buy REITs due to lack of a KIID (Key Investor Information Document) for most US-based ETFs.

 

Maybe a blessing in disguise considering the admin effort required to accurately report German tax income from these investments.

Contacted them about to weeks ago to open an account, and was told the same thing.

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2 hours ago, MikeMelga said:

Out of curiosity, if one leaves Germany and sells stock after registering in another country, are any taxes due in Germany?

 

A friend told me that when you leave ( he was leaving for UK), that you have to sell and pay the capitol gains on those stocks.

 

Not sure its true, I would cheque with a tax accountant

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22 hours ago, yesterday said:

Not sure its true

 

It's not.

 

§ 49 EStG lists the items of income upon which a non-resident of Germany can be taxed under German domestic tax law. 

 

The list does not include gain from the sale of common stock or corporate bonds regardless of the domicile of the corporate issuer. Moreover, if the country of residence has a tax treaty with Germany the provisions of that treaty will almost certainly grant the country of residence the exclusive right to tax such gains.

 

There are two major exceptions I am aware of but they are unlikely to affect most individuals:

 

1.  gains from the sale of a greater than 1% interest in a German domestic corporation can be considered business income taxable to a non-resident seller.

 

2.  gains from the sale of certain securities that hold German real estate interests can be taxed as if they were real estate equivalents.

 

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Ok, so in theory I could move for half a year to a low capital tax country and cash in on stocks gains, right?

Of course that only makes sense if there is a significant value to be saved...

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22 hours ago, MikeMelga said:

Ok, so in theory I could move for half a year to a low capital tax country and cash in on stocks gains, right?

 

Depends on what "move" entails.

 

Merely acquiring a tax residence in another country through physical presence there will not necessarily cancel or suspend your tax residence in Germany.

Mere physical absence from Germany will not necessarily cancel or suspend your tax residence in Germany.

Merely deregistering (abmelden) in Germany will also not necessarily cancel or suspend your tax residence in Germany.

 

22 hours ago, MikeMelga said:

Of course that only makes sense if there is a significant value to be saved

 

Indeed.

 

The savings must be enough to offset the costs of effectively terminating your German residence under both §§ 8 and 9 of the AO (Fiscal Code).

 

Not easy and not cheap.

 

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