Press Room: Tax Release

February 13, 2014

IRS Releases New PFIC Regulations Affecting 2013 Filers

On December 30, 2013, the Treasury Department and IRS issued temporary and proposed regulations under Internal Revenue Code Secs. 1291 and 6038 (temporary passive foreign investment company (PFIC) regs), which clarify and amend certain rules for determining ownership in a PFIC and outline requirements for shareholders to file Form 8621, Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund. The temporary PFIC regs implement the PFIC reporting requirements called for by Sec. 1298(f), which was enacted under the 2010 Hiring Incentives to Restore Employment Act (HIRE Act) as part of the overall effort to toughen disclosure rules for U.S. taxpayers holding foreign financial assets. The temporary PFIC regs are generally effective for tax years ending on or after December 31, 2013, and thus apply to calendar-year taxpayers for the upcoming filing season. It is important to note that the temporary PFIC regs incorporate many provisions from the previously proposed regulations dating back to 1992 and from subsequent related guidance. As a result, taxpayers who were following the proposed regs should have the same reporting requirements for Form 8621 as in the past. Although IRS Notices temporarily suspended the requirement for a PFIC shareholder to file Form 8621 until final regulations were issued, and stated that any final regulations issued would apply retroactively requiring back filings through the year of issuance, the temporary PFIC regs do not require filing of Form 8621 for tax years during which the filing requirement was suspended.

Discussion

The temporary PFIC regs provide rules for determining ownership of a PFIC by incorporating and refining certain rules from the previously proposed regulations and other guidance. They define a shareholder as a U.S. person that directly or indirectly owns an interest in a PFIC. Indirect ownership of a PFIC through domestic and foreign corporations, partnerships, S corporations, estates, and trusts – both grantor and non-grantor – is covered by these provisions. 

The temporary PFIC regs also refine, and to some extent liberalize, the requirements for filing Form 8621. According to the rules, taxpayers need to report on a separate Form 8621 their direct or indirect ownership of any PFIC (subject to certain exceptions) and any related income inclusions.  Generally, a U.S. person that is a direct or indirect shareholder of a PFIC must file Form 8621 for each tax year under any of the following five circumstances, 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 Qualified Electing Fund (QEF) or mark-to-market (MTM) election;
  4. Is making an election reportable in Part II of Form 8621; or
  5. Is required to file an annual report pursuant to Sec. 1298(f).

The temporary PFIC regs provide an exception from filing for PFIC shareholders, other than those that have income inclusions from QEF or MTM elections, when the value of all their PFIC stock at the end of the taxable year is less than $50,000 ($25,000 for single filers and married filing separate), or they own a PFIC (upper tier PFIC) which owns another PFIC (lower-tier PFIC), and the value of the proportionate share that the upper tier PFIC owns in the lower tier PFIC does not exceed $5,000. The exception also applies for shareholders who are not subject to tax under Sec. 1291 with respect to any excess distributions or gains derived with respect to the PFIC that are treated as excess distributions. Exempt organizations not subject to tax on PFIC income are also not subject to the filing requirements of the regulations.

The temporary PFIC regs provide some general rules for non-grantor and grantor trusts. Additional guidance regarding PFIC ownership by foreign or domestic estates and non-grantor trusts is forthcoming. Currently, there is no guidance on how to apply the Sec. 1291 excess-distribution rules when an estate or non-grantor trust, or beneficiary thereof, receives or is treated as receiving an excess distribution. The preamble to the temporary PFIC regs advises taxpayers in this situation to report the excess distribution in a reasonable manner. It expands on this notion by implying that it would be unreasonable to take the position that neither the beneficiaries nor the estate or trust are subject to the tax and interest charge rules under Sec. 1291.

PFIC reporting could result in duplicative reporting, for example, under the specified foreign financial asset reporting on Form 8938, Statement of Specified Foreign Financial Assets. Relief from duplicative reporting is provided under Sec. 6038D; however, a taxpayer that fails to report on either Form 8621 or 8938 could be assessed penalties. Additionally, failure to file a Form 8621 potentially keeps the taxpayer’s statute of limitations for the tax year open indefinitely and it would only begin to run the date the information is filed. The temporary PFIC regs also implement the constructive ownership exception to Form 5471 as well as finalize in regulations certain long-standing changes to Form 5471 and Sec. 953(c) reporting. In the past, for example, a statement had to be included on a taxpayer’s return indicating they were avoiding duplicative submission of Form 5471. This statement is no longer required. Such a statement is required, however, when similarly foregoing a duplicative filing with Form 8938.

Conclusion

Treasury and IRS seemed to take a very reasonable and taxpayer-friendly approach in the newly released temporary PFIC regs, particularly in the area of potential duplicative filings, and Form 8621 will be revised by the IRS to reflect these changes. The de-minimis exception will likely have very limited applicability and the attribution rules, particularly those pertaining to partnerships, can create more expansive indirect ownership resulting in a wider group that will have to file Form 8621. Accordingly, the temporary PFIC regs should be analyzed now in light of each taxpayer’s unique situation to avoid potentially adverse results this upcoming filing season. Failing to meet the requirements provided in the regulations potentially has more significant consequences (i.e., penalties and tolling of the statute of limitations) than in the past, thus increasing the importance of properly identifying investments in PFICs.