Tax Alert: IRS Issues New Passive Foreign Investment Company Regulations and Revises Form 8621 PFIC Information Return Instructions

February 16, 2014

On December 30, 2013, the IRS issued Treasury Decision 9650, which includes new temporary regulations under Treas. Reg. Sections 1.1291-1T and 1.1298-1T regarding Passive Foreign Investment Company (“PFIC”) reporting. The new regulations provide guidance on determining ownership of a PFIC and on the annual reporting requirements for shareholders of PFICs. The regulations are effective for tax years ending on or after December 31, 2013. The new PFIC reporting requirements apply to 2013 U.S. federal tax returns for taxpayers with a calendar tax year end. In January 2014, the IRS issued revised and updated instructions to the Form 8621 which is the Information Return by a Shareholder of a PFIC or Qualified Electing Fund.

A foreign corporation is a PFIC if 75% or more of its gross income for the tax year is passive income or 50% or more of the average assets held during the tax year produce passive income or are held for the production of passive income. The U.S. federal taxation of PFIC shareholders is based on rules for excess distributions, qualified electing funds (“QEFs”) and the mark-to-market election. A special tax and interest charge apply to a U.S. shareholder of a PFIC who receives excess distributions or recognizes gain from the disposition of PFIC stock. An excess distribution is the part of the PFIC distribution received in the current tax year that is greater than 125% of the average distributions received during the preceding three tax years. A U.S. shareholder of a PFIC who elects QEF treatment is required to include in income each year the proportionate share of earnings and profits of the PFIC. The mark-to-market election allows the U.S. shareholder of a PFIC to include in income each year the excess of the fair market value over the shareholder’s adjusted basis of the PFIC stock. The controlled foreign corporation (“CFC”) rules under Subpart F generally control with respect to a U.S. shareholder to the extent that a foreign corporation is both a CFC and a PFIC.

The new PFIC rules provide that a U.S. shareholder of a PFIC is any person that owns stock of a PFIC directly or indirectly. An indirect shareholder is a U.S. person that owns stock of a PFIC indirectly under certain attribution rules. Stock ownership of a PFIC is attributed to a U.S. person through interests held in C corporations, S corporations, partnerships, estates and trusts.

The regulations and the Form 8621 instructions generally require a U.S. person that is a direct or indirect shareholder of a PFIC to file the Form 8621 each year. A U.S. person is within the scope of the Form 8621 filing requirement if the U.S. person:

  1. Receives certain direct or indirect distributions from a PFIC;
  2. Recognizes gain on a direct or indirect disposition of PFIC stock;
  3. Is reporting information with respect to a QEF or mark-to-market election;
  4. Is making an election reportable in Part II of Form 8621; or
  5. Is required to file an annual report pursuant to I.R.C. Section 1298(f).

I.R.C. Section 1298(f) provides the basic reporting requirement that all shareholders of a PFIC must file the Form 8621 each year. There are certain exceptions to this reporting requirement. A U.S. shareholder of a PFIC is not required to file the Form 8621 under the following circumstances:

  1. The U.S. shareholder of the PFIC is not subject to tax on excess distributions and gains on the disposition of PFIC stock during the year; and
  2. Either: (a) the aggregate value of PFIC stock owned by the U.S. shareholder at the end of the tax year is not greater than $25,000 ($50,000 for taxpayers who are married filing jointly); or (b) the U.S. shareholder owns the PFIC stock through another PFIC and the value of the shareholder’s share of the upper-tier PFIC’s interest in the lower-tier PFIC is not greater than $5,000.

There are also exceptions to the Form 8621 filing requirement provided for certain tax-exempt organizations, state colleges and universities, retirement plans and qualified tuition programs. Those categories of U.S. persons are not required to file Form 8621 unless income from the PFIC would be taxable to the organization as unrelated business taxable income.

The failure to file the Form 8621 currently does not result in a specific penalty. However, if the Form 8621 is required to be filed, the statute of limitations does not begin to run on the entire U.S. federal tax return until the Form 8621 is filed. An individual shareholder of a PFIC could be subject to a $10,000 penalty for the failure to report a PFIC investment on a Form 8938 or otherwise reference a Form 8621 filing on the Form 8938 Report of Specified Foreign Financial Assets.

The new regulations also provide a change with respect to a Form 5471 filing requirement based on the constructive ownership exception. A Form 5471 is generally filed by a U.S. person to report ownership of a foreign corporation. Certain U.S. shareholders who owned stock of a foreign corporation constructively through attribution were previously required to file a statement with their respective U.S. federal tax return to claim that the Form 5471 was not being filed based on the constructive ownership exception. The requirement to file a separate statement to claim the Form 5471 constructive ownership exception is removed under the new regulations.

Another set of regulations issued in 2013 provides that the new 3.8% Net Investment Income Tax applies to a U.S. shareholder’s income from a PFIC.

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