Feared PFIC Regs Get New Twist

By:
LISA S. GOLDMAN, CPA, and THOMAS V. RUTA, CPA
Published Date:
Apr 15, 2014

On Dec. 30, 2013, the IRS released Temporary Regulation 1.1298-1T under IRC Section 1298(f) dealing with the complicated and troublesome rules surrounding passive foreign investment companies (PFICs).

These new regulations require certain U.S. taxpayers who own shares in PFICs to report information about their investments on an enhanced Form 8621. The rules also have a complex history, and CPAs practicing in the international arena should pay close attention to the fine print.

The issue goes back to the Hiring Incentives to Restore Employment Act of 2010 (HIRE Act), which added IRC Section 1298(f). This provision requires all U.S. persons who are PFIC shareholders to report their ownership on Form 8621, even though there would be no other requirement to file the form.

Although Section 1298(f) is effective as of March 18, 2010, in Notices 2010-34 and 2011-55, the IRS suspended the filing requirement until regulations and a revised Form 8621 were issued. Notice 2011-55 would have applied the Section 1298(f) reporting requirements retroactively to tax years beginning after March 18, 2010. However, regulations issued on Dec. 30, 2013, eliminated the retroactive filing requirement and applies the new Section 1298(f) reporting requirements prospectively, beginning with tax years ending on or after Dec. 31, 2013. Thus, there is no retroactive reporting required for tax years 2011 and 2012.

Proposed regulations issued in 1992 required PFIC shareholders to file Form 8621 for any year in which the shareholder recognized a gain or made an election with respect to the PFIC. Under the new temporary regulations, Form 8621 is required to be filed annually for certain PFIC investments, even when the shareholder is not making any elections and has no PFIC income inclusions for that taxable year.

The new reporting requirement applies to indirect shareholders only when the shareholder owns the stock through foreign entities. To avoid duplicative reporting, if PFIC stock is held through a chain of domestic entities, the regulations only require the U.S. person who is at the lowest tier in the chain of ownership to file Form 8621. However, indirect shareholders must continue to file Form 8621 for the PFIC, if during the indirect shareholder’s tax year, that shareholder falls into any one of the following categories, in which he or she is—

  1. treated as receiving an excess distribution relating to the PFIC,
  2. treated as recognizing gain that is treated as an excess distribution as a result of a disposition of the PFIC,
  3. required to include income relating to a qualified electing fund (QEF) election,
  4. required to include income relating to a mark-to-market (MTM) election or
  5. required to report an election to extend time for payment of tax on undistributed earnings (as defined in Section 1294).

For example, assume that a U.S. individual directly owns an interest in a domestic partnership, which, in turn, owns an interest in a PFIC. In addition, the U.S. individual directly owns an interest in a foreign partnership, which, in turn, owns an interest in a PFIC. Neither the U.S. individual nor the domestic partnership has made a QEF election or an MTM election, with respect to the PFIC. As of the last day of 2013, the value of the domestic partnership’s interest in the PFIC is $200,000, and the value of the U.S. individual’s proportionate share of the foreign partnership’s interest in the PFIC is $100,000. During 2013, the U.S. individual did not receive an excess distribution or recognized gain treated as an excess distribution, with respect to the PFIC. For the 2013 tax year, the domestic partnership is required to file Form 8621, with respect to its ownership in the PFIC, and the U.S. individual is required to file Form 8621, with respect to his or her ownership of the PFIC through the foreign partnership.

Exceptions to reporting requirements

The new regulations include certain exceptions to these reporting requirements:

De minimis exception. The regulations provide a de minimis exception to the Form 8621 filing requirement for stock held directly or through a foreign partnership. This exception applies if all of the following conditions are met:

  1. No QEF or MTM election has been made in relation to the PFIC.
  2. The shareholder is not subject to tax under Section 1291, with respect to any excess distributions from the PFIC, or gains treated as excess distributions during the tax year.
  3. Either 1) the aggregate value of all PFIC stock owned by the shareholder at the end of the shareholder’s tax year does not exceed $25,000 ($50,000 for taxpayers filing a joint return) or 2) the PFIC stock is owned through a chain of PFICs, where the value of the shareholder’s proportionate share of the indirectly held PFIC is $5,000 or less.

Tax-exempt shareholders. A shareholder that is an organization exempt from tax under Section 501(c), 501(d) or Section 401(a); a state college or university described in Section 511(a)(2)(B); a retirement plan described in Section 403(b) or 457(b); an individual retirement plan or annuity described in Section 7701(a)(37); or a qualified tuition program described in Section 529 or 530 is not required to file Form 8621, unless the income derived from the PFIC stock would be taxable to the organization under the Unrelated Business Taxable Income (“UBTI”) rules under Subchapter F exempt organization rules.

Exception for foreign pension funds. The filing requirement under Section 1298(f) also does not apply to a U.S. person who is treated as the owner of any portion of a foreign grantor trust that is a foreign pension fund organized principally to provide pension or retirement benefits. However the exception is valid only if, pursuant to an income tax treaty, income earned by the pension fund is taxed as income to the U.S. person only when it is paid to the benefit of that person.

Exception for beneficiaries of foreign estates and foreign nongrantor trusts. U.S. persons who are considered owners of an interest in a PFIC because they are beneficiaries of a foreign estate or a foreign nongrantor trust and who have not made a QEF or MTM election, with respect to that PFIC, are not required to file Form 8621, unless the beneficiaries are treated as having received an excess distribution from the PFIC or are recognizing gain that is treated as an excess distribution, with respect to the PFIC.

Form updates and coordination

The IRS has issued a revised Form 8621 to reflect these new filing requirements. The December 2013 version of this form adds a new Part I, which requires detailed information about the PFIC investment, including a description of each class of shares owned, the dates when shares were acquired during the tax year, the number of shares held at the end of the tax year and the value of the shares held at the end of the taxable year.

The reporting of a PFIC on Form 8938 is not required, however, if the PFIC is reported on a Form 8621 that is filed in a timely fashion and the appropriate box is checked on Form 8938 reflecting the Form 8621 filings. A shareholder who fails to report a PFIC investment on either Form 8621 or Form 8938 when required is subject to a $10,000 penalty under IRC Section 6038D(d).

Lisa S. Goldman, CPA, is a partner at Raich Ende Malter & Co. LLP who specializes in international taxation and in providing services for both high-net-worth individuals and their businesses. Thomas V. Ruta, CPA, is the director of international tax and a partner at Raich Ende Malter & Co. LLP, specializing in international taxation and in providing family office services for high-net-worth individuals and their businesses.

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