When becoming a U.S. resident, beware of PFIC rules.

• Author: Whittall, Robert E.
• Position: Passive foreign investment company

As the workforce becomes more mobile, many non-U.S. citizens who become U.S. residents for work reasons have to deal with not only cultural adjustments but also the unanticipated workings of the passive foreign investment company (PFIC) tax regime.

For example, U.K. citizens may have investments in U.K. unit trusts, which for U.K. tax purposes are very similar to. U.S. mutual funds. But as soon as they attain resident alien status in the United States and become subject to the full extent of U.S. tax laws, these funds become subject to the PFIC tax regime. However, these individuals often have no idea that they have fallen afoul of the PFIC tax regime--that is, until they sell their U.K. unit trust shares and think they have a capital gain taxable at a top long-term rate of 15%.

Then their tax adviser has to break the news that they have been ensnared by the PFIC rules. The gain on the sale of the shares is treated as an excess distribution under Sec. 1291(a)(2) and is taxed under the rules for excess distributions in Sec. 1291(a)(1). This item examines what this means and how the sale of U.K. unit trust shares or other PFIC stock is taxed for U.S. tax purposes.

Example 1: B, who is a U.K. citizen, bought 100 shares of a U.K. unit trust on Jan. 1, 2006. He became a U.S. resident alien on July 1, 2009, and sold the shares on April 30, 2012. His total holding period is 2,311 days. The 100 shares cost [pounds sterling]10 each, and he sold them for [pounds sterling]20 each. What are the U.s. tax consequences of the sale?

The issues to consider are:

* Can B step up the basis in his stock to fair market value (FMV) as of the date he became a U.S. resident alien, which would then become its cost basis? No.Rev. Rul. 55-62 provides that no step-up in basis is permitted to the FMV of the asset as of the date that U.S. residency starts. The revenue ruling provides that the taxpayer is taxable on both preresidency and post-residency gain in the United States when a taxable event occurs, e.g., a sale or exchange.

* At what exchange rate is the original cost of the shares translated? For U.S. tax purposes, the exchange rate on the date of purchase is used (see Rev. Ruls. 54-105 and 78-281), i.e., $1.7234:[pounds sterling]1 (midpoint rate on Jan. 1, 2006, per on-line translator at tinyuri.com/4q4gvdm).So B's 100 shares cost $1,723.

* At what exchange rate is the sale price of the shares translated? As with the cost part of the calculation, the exchange...