What is the Sharesies US Tax Trap?
Published on June 21, 2024
by Jeff Patterson
Jeff Patterson is an American living in Scotland and joined the team at Expat Tax Online after experiencing the complexities of living abroad with a family.
Table of Contents
Is the Sharesies a tax trap for US citizens in New Zealand?
Yes, investing in Sharesies can be a tax trap for US citizens residing in New Zealand because many of its investment options are classified as Passive Foreign Investment Companies (PFICs). This triggers complex US tax reporting requirements, resulting in higher taxes and significant penalties if not appropriately managed.
Why Do They Make It So Difficult, You Might Ask?
The US tax code is designed to punish US citizens for not investing their savings in the United States. Non-US investments, specifically where your savings are invested in stock market funds, carry a heavy over-the-top US tax compliance burden, and any gains are heavily taxed, too, even if you haven’t sold the investment and pocketed the profits.
What is Sharesies?
Sharesies is an investment platform that has gained significant popularity in New Zealand due to its user-friendly interface and accessibility to a wide range of investment options.
The platform allows users to invest in various assets, including stocks, ETFs, and managed funds, with the ability to start with minimal money.
What Types of Investments Are Available Through Sharesies?
Sharesies offers a diverse portfolio of investment options:
- Individual Stocks: Investors can buy shares in companies listed on various stock exchanges.
- ETFs (Exchange-Traded Funds): These are funds that track specific indexes and are traded on stock exchanges.
- Managed Funds: Professionals manage these funds and pool money from multiple investors to invest in a diversified portfolio.
What are PFICs, and is Sharesies considered as one?
A Passive Foreign Investment Company (PFIC) is defined by the IRS as a foreign corporation that meets one of the following criteria:
- At least 75% of its gross income is passive income, which includes dividends, interest, rents, royalties, and capital gains.
- At least 50% of its assets produce or are held to produce passive income.
How Do Sharesies Investments Qualify as a PFIC?
Many investment options available through Sharesies, such as stocks, ETFs, and managed funds, fall under the PFIC classification. These investments often generate passive income and are managed by foreign entities, meeting the IRS criteria for PFICs.
Are All Companies PFICs?
No, not all companies are considered PFICs. Companies that actively earn their income through business operations are not classified as PFICs.
Why use the IRS Streamlined Tax Amnesty Program?
It’s for American citizens that didn’t know they had to file U.S. tax returns each year, and have therefore fallen behind. Some more than 30 years! With the IRS Streamlined Procedure, say goodbye to overdue tax returns, late fees, and penalties.
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Why is it important for US taxpayers to know if what they’re investing in is a PFIC?
That’s because PFICs are subject to harsh US tax rules designed to prevent tax deferral and ensure transparency. In essence, when US taxpayers hold PFICs, it can lead to:
- Higher taxes due to interest charges on deferred tax.
- Complicated reporting requirements will require filing additional forms and maintaining detailed records.
- Potential for significant penalties if the reporting requirements are not met.
How does the IRS tax PFICs?
These investments are taxed on their unrealized gains each year, meaning you are taxed on the increase in value of the investment, even if you haven’t sold it. For example, if your PFIC investment increases from US$2,000 to US$3,500 over a year, you may owe taxes on the US$1,500 gain, despite not having sold the investment.
What are the reporting obligations for PFICs?
Each PFIC investment requires its own Form 8621 to be filed annually. The IRS estimates that completing Form 8621 can take around 20-32 hours per PFIC, from start to finish. This process is complex and costly, especially with multiple PFIC investments.
When do you need to report PFICs?
The reporting threshold for PFICs is US$25,000 in combined investments. This means that if you have multiple PFIC investments that collectively exceed this threshold, you must report them. For instance, if you have US$20,000 in one PFIC investment and US$6,000 in Sharesies, you have met the reporting threshold and need to file Form 8621 for each PFIC.
Why Is This Such a Big Deal?
It’s because many investors spread their money across multiple funds, leading to numerous low-value PFIC investments.
Remember that each investment requires separate reporting. For example, having 20 PFIC investments, each worth US$120, can require filing 20 forms.
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