Traditional markets for investment migration advisors have been Asia, the Middle East, Latin America, and the former Soviet countries. In the past few years, partly as a result of dramatically increasing partisan politics in the US, North America is increasingly becoming the new market.
Unlike individuals in the traditional markets, who have been dealing with these issues for decades or even generations, Americans are new to the topic of second citizenships and residences. In this series, which marks the beginning of a new column here in IMI, we hope to explain how the US has its own idiosyncratic complexities as a result of American tax, securities, immigration, and citizenship laws.
From citizenship and green card-based taxation; to FATCA; to issues arising for Americans holding assets abroad; to foreigners acquiring assets and immigration statuses in the US; we will look at it all. In short, we will explain “American Exceptionalism” in the context of investment migration.
Three uniquely American concerns when moving to Portugal
Portugal is fast becoming a top destination for Americans either dipping their toes in international waters or actually permanently relocating. The country offers a friendly local population and low crime levels, as well as large swaths of spectacular Atlantic Ocean coastline and thriving cities. Combined with its relatively warm temperatures, plentiful recreational activities, widespread knowledge of English among many locals, and relatively low cost of living, Portugal is a natural destination for Americans looking to relocate.
The Portuguese Golden Visa program is a way to gain a residence permit that can be renewed at two-year intervals and eventually lead to permanent residence or even Portuguese citizenship after five years. The Portuguese Golden visa program includes different investment options for new or rehabilitated real estate, Venture Capital Funds, and even cultural investments in such areas as film and television production. To date, the real estate option has been the most popular route, accounting for roughly nine in ten applications. Following the January 2022 imposition of geographic restrictions for the real estate investment category, however, many American expats and investors are looking at the fund option.
No matter the particular Portuguese Golden Visa qualification route, understanding the processes involved is necessary to recognize the American issues that arise. One of the first steps that the applicant needs to acquire is a NIF (tax identification number), which is a pre-requisite for submitting a KYC (“know your client”) disclosure statement to open a Portuguese bank account. All qualification routes for the golden visa require that the funds be remitted through this new Portuguese bank account. Both the NIF and account opening generally occur before the actual move to Portugal.
Issue #1 – Foreign Bank Account Reporting to the US
The opening and funding of the Portuguese bank account give rise to the first US tax issue: The obligation to report such an account under a Foreign Bank Account Report (“FBAR”). Under US law, any US citizen or resident (including green card holders) who has a financial interest in – or signature authority over – foreign financial accounts must file an FBAR if the aggregate value of the foreign financial accounts exceeds US$10,000 “on any day” during the calendar year.
Given that any of the Golden Visa Programs require investments in the range of several hundred thousand dollars, the FBAR filing requirement will always arise. If a United States taxpayer’s foreign bank account has an aggregate account balance exceeding US$10,000 during the year, they must file an FBAR, regardless of whether they live in the US or abroad.
Technically, US taxpayers report FBAR by filing electronically with the Treasury Department a FinCEN Form 114. Separately, on their US income tax return (IRS 1040 or IRS 1040NR), on Schedule B, they must answer correctly Questions 7a and 7b inquiring whether the US taxpayer had any foreign bank or other accounts.
If the individual fails to file an FBAR and the non-reporting is found to be willful, the penalty is US$100,000 or 50% of the amount in the account that is unreported, whichever figure is the greater. Given that the fund or new real estate options are at least US$500,000, this means that the penalty could equal or exceed $250,000!
The IRS takes the filing of FBARs very seriously and continues to assert more and more FBAR penalties against US persons. The US Department of Justice (DOJ) has had considerable success in litigating FBAR penalty cases. Significantly, almost every federal court to hear these cases has applied the scope of “willful” broadly to also mean “reckless” or “willful blindness”.
Issue #2 – Annual US PFIC Reporting?
Increasingly, Americans are choosing the Venture Fund option for their Portuguese Golden Visa. This is because the investment amount is fixed and, unlike for real estate, there are no expenses involved in maintaining or protecting the property from the elements or squatters. However, those choosing this path may not realize that the ownership of shares/units in the same may give rise to yet another US tax issue.
Specifically, very few Americans have heard of a PFIC (technically known as a Passive Foreign Investment Company). Some may think that a PFIC bears resemblance to exotic or highly specialized financial instruments. As a result, many Americans automatically assume that they do not own any. For many unsuspecting Americans, such a conclusion is a costly mistake.
PFICs are simply foreign (i.e., Non-US) corporations that either earn more than 75% of their income from passive sources (interest, dividends, capital gains, and rental income) or where more than 50% of their assets are held for the production of passive income. This covers any non-US corporation that’s not engaged in an active business.
Most PFICs are simply “pooled investments” incorporated outside of the US. These include foreign mutual funds, exchange-traded funds (ETFs), closed-end funds, hedge funds, money-market funds, and investments held in some non-US pension plans. In short, Portuguese Golden Visa Venture Funds are PFICs!
The US tax treatment of PFICs is extremely punitive compared to that of similar investments originating in the US. The US tax is generally imposed at ordinary income rates without the lower capital gains tax rate available on the disposition of the PFIC-tainted foreign investment. The total US tax on a PFIC investment may eliminate the amount of the distribution from the PFIC.
There is some “potential” relief from the most punitive tax treatment under an exception to the PFIC default tax regime. If eligible, a US taxpayer can make a so-called Qualified Electing Fund (QEF) election for the year of acquiring the PFIC, which results in your PFIC being taxed in the US, much like a partnership, meaning that income retains its character (i.e., capital gains are taxed as capital gains) and is passed through to the shareholder for current inclusion in income. In general, a US taxpayer pays less tax under the QEF tax regime than under the extremely punitive default rules (known as 1291 Fund treatment).
A US taxpayer will want to make the QEF election – if eligible – because it has the best outcome for a PFIC. However, in order to be eligible to make a QEF election in the year of acquisition of the PFIC, the PFIC sponsor must provide the US shareholder with a PFIC Annual Information Statement, signed by the PFIC or an authorized representative of the PFIC that contains certain information and representations made by the PFIC. The US Treasury Regulations are clear; a US taxpayer must receive the PFIC Annual Statement to make the QEF election. If a US taxpayer does not receive the PFIC Annual Statement, the taxpayer cannot make the QEF election.
Making a QEF election is often cumbersome in practice. In order to properly calculate one’s tax liability under the QEF regime, an electing PFIC shareholder requires a substantial amount of financial and US tax information from the underlying non-US investment company or fund, as determined using US tax accounting principles. It is our experience that many non-US corporations are unwilling or unable to provide this information on a timely and/or accurate basis. Our expectation is that few Portuguese Golden Visa Venture Funds have enough US shareholders to justify their internal cost to generate the required PFIC Annual Statement. The inability to do so will force American shareholders to be stuck with the confiscatory default PFIC tax regime.
The other major PFIC complication is the onerous task of simply complying with IRS reporting rules for PFICs. Ownership of PFICs is most common among expatriate Americans, who must employ accountants specializing in cross-border tax preparation for Americans abroad. Perhaps most problematic is that a separate Form 8621 PFIC must be filed for each PFIC. It does not take long to realize that filing Forms 8621 for multiple PFIC investments might quickly run up a huge tax preparation bill regardless of the value of the underlying investments or their performance over time.
Issue #3 – US Form 8938 FATCA Compliance
Americans choosing the Venture Fund option may have more than PFIC issues to consider. US taxpayers, whether or not they actually leave the US and live overseas, usually also have a Form 8938 filing requirement for their foreign financial accounts.
The Foreign Account Tax Compliance Act (FATCA) obligations using Form 8938 require a bit more discussion. Whether a US person needs to file a Form 8938 will depend on where he or she resides because there are different threshold amounts depending on whether you live in the United States or abroad.
Enacted in 2010, FATCA requires virtually all foreign financial institutions (i.e., any Portuguese bank or financial institution) to report on foreign assets by their US account holders or be subject to withholding on payments to US persons. Form 8938 is different from information reporting found on other US forms such as FBARs. Form 8938 requires reporting by US taxpayers on all types of foreign financial assets, not just foreign bank accounts. Form 8938 is attached to a US individual taxpayer’s annual Form 1040, making it harder for taxpayers or their accountants to claim ignorance as to the requirement to report a foreign asset.
A US person must file Form 8938 along with a tax return if he or she lives overseas and has account balances exceeding the following thresholds:
- Unmarried individuals (or married-filing-separately): Total value of specified foreign financial assets was more than US$200,000 on the last day of the tax year or more than US$300,000 at any time during the year.
- Married individual filing jointly: Total value of assets was more than US$400,000 on the last day of the tax year or more than US$600,000 at any time during the year.
A US person is considered to live abroad if he is either a bona fide resident of a foreign country such as Portugal for an entire tax year, or spends 330 days outside of the United States during a 12-month period that ends during the relevant tax year. Taxpayers who live in the United States have lower threshold amounts that trigger a Form 8938 filing requirement.
To be clear, a Form 8938 reporting obligation does not replace a taxpayer’s obligation to file FBAR or PFIC returns and other US international reporting forms. Form 8938 filing applies even if there is no gain or loss from the foreign financial asset for the tax year at issue. IRS takes the position that there is no running of the statute of limitations if you do not file Form 8938.
Clearly, Americans not paying attention to US issues can quickly turn their dream move to Portugal (or elsewhere) a nightmare. In the second and third parts of this article, we will examine other universal issues and also discuss issues specific to using a residence or citizenship by Investment vehicle, such as the Portuguese Golden Visa, as part of an overall expatriation strategy.