A Brief on the New Final Regulations For Shareholders of PFICs

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Jason B. Freeman

Jason B. Freeman

Managing Member


Mr. Freeman is the founding member of Freeman Law, PLLC. He is a dual-credentialed attorney-CPA, author, law professor, and trial attorney.

Mr. Freeman has been named by Chambers & Partners as among the leading tax and litigation attorneys in the United States and to U.S. News and World Report’s Best Lawyers in America list. He is a former recipient of the American Bar Association’s “On the Rise – Top 40 Young Lawyers” in America award. Mr. Freeman was named the “Leading Tax Controversy Litigation Attorney of the Year” for the State of Texas for 2019 and 2020 by AI.

Mr. Freeman has been recognized multiple times by D Magazine, a D Magazine Partner service, as one of the Best Lawyers in Dallas, and as a Super Lawyer by Super Lawyers, a Thomson Reuters service. He has previously been recognized by Super Lawyers as a Top 100 Up-And-Coming Attorney in Texas.

Mr. Freeman currently serves as the chairman of the Texas Society of CPAs (TXCPA). He is a former chairman of the Dallas Society of CPAs (TXCPA-Dallas). Mr. Freeman also served multiple terms as the President of the North Texas chapter of the American Academy of Attorney-CPAs. He has been previously recognized as the Young CPA of the Year in the State of Texas (an award given to only one CPA in the state of Texas under 40).

The IRS recently issued final regulations that will affect United States persons that own interests in PFICs, and certain United States shareholders of foreign corporations.  The new regulations provide guidance on determining ownership of a passive foreign investment company (PFIC) and on certain annual reporting requirements for shareholders of PFICs to file Form 8621, ‘‘Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund.’’ In addition, the final regulations provide guidance on an exception to the requirement for certain shareholders of foreign corporations to file Form 5471, ‘‘Information Return of U.S. Persons with Respect to Certain Foreign Corporations.’’ A brief summary of the new provisions follows:

The Definition of Shareholder and Indirect Shareholder in § 1.1291–1(b)(7) and (8)

The final regulations modify the definition of shareholder in § 1.1291–1 as announced in Notice 2014–28. Under new § 1.1291–1(e)(2), a United States person is not treated as a shareholder of a PFIC to the extent the person owns PFIC stock through a tax-exempt organization or account described in § 1.1298–1(c)(1).  For example, the preamble specifically recognizes that applying the PFIC rules to a United States person that owns stock of a PFIC through an individual retirement account (IRA) described in section 408(a) would be inconsistent with the principle of deferred taxation provided by IRAs.

Indirect Shareholder as a Result of Attribution Through a Domestic Corporation

The final regulations include a non-duplication rule. Specifically, the final regulations provide under § 1.1291–1(b)(8)(ii)(C)(1) that, solely for purposes of determining whether a person owns 50 percent or more in value of the stock of a foreign corporation that is not a PFIC under § 1.1291–1(b)(8)(ii)(A), a person who directly or indirectly owns 50 percent or more in value of the stock of a domestic corporation is considered to own a proportionate amount (by value) of any stock owned directly or indirectly by the domestic corporation. However, the non-duplication rule in § 1.1291– 1(b)(8)(ii)(C)(2) states that a United States person will not be treated, as a result of applying § 1.1291–1(b)(8)(ii)(C)(1), as owning (other than for purposes of determining whether a person satisfies the ownership threshold of § 1.1291–1(b)(8)(ii)(A)) stock of a PFIC that is directly owned or considered owned indirectly under § 1.1291–1(b)(8) by another United States person (determined without regard to § 1.1291–1(b)(8)(ii)(C)(1)).

The final regulations clarify, under § 1.1291–1(b)(8)(ii)(C)(3), that the ownership rule of § 1.1291– 1(b)(8)(ii)(C)(1) does not apply to stock owned directly or indirectly by an S corporation; rather, the indirect ownership rule under § 1.1291– 1(b)(8)(iii)(B) applies in those instances. Second, the final regulations clarify that the attribution rule in § 1.1291– 1(b)(8)(ii)(C) applies to all PFICs and not only section 1291 funds, in order to ensure that United States persons who are treated as indirect shareholders of PFICs are permitted to make qualified electing fund elections under section 1295.

Exceptions to Section 1298(f) Reporting

Exception for PFIC Stock That Is Marked To Market Under a Non-Section 1296 MTM Provision Announced in Notice 2014–51

The final regulations, in accordance with Notice 2014–51, add § 1.1298– 1(c)(3), which provides that United States persons that own PFIC stock that is marked to market under a non-section 1296 MTM provision are not subject to section 1298(f) reporting unless they are subject to section 1291 under the coordination rule in § 1.1291–1(c)(4)(ii). Generally, under § 1.1291–1(c)(4)(ii), when a United States person’s PFIC stock is marked to market under a non- section 1296 MTM provision in a taxable year after the year in which the United States person acquired the stock, the United States person is subject to section 1291 for the first taxable year in which the United States person marks to market the PFIC stock. Thus, the United States person is subject to section 1291 with respect to any unrealized gain in the stock as of the last day of the first taxable year in which the stock is marked to market, as if the person disposed of the stock on that day. See § 1.1291–1(c)(4)(ii) and § 1.1296–1(i)(2) and (3).

Exception for Certain Domestic Partnerships

The final regulations provide a final rule in § 1.1298–1(c)(6) that exempts a domestic partnership from section 1298(f) reporting with respect to an interest in a PFIC for a taxable year when none of its direct or indirect partners are required to file Form 8621 with respect to the PFIC interest under section 1298(f) and the governing regulations because the partners are not subject to the PFIC rules.

Exception for PFIC Stock Held Through Certain Foreign Pension Funds That Are Covered by a U.S. Income Tax Treaty

The final regulations revise the treaty-based exception for PFIC stock held by a United States person through certain foreign pension funds under § 1.1298–1T(b)(3)(ii) to eliminate the requirement that the foreign pension fund be treated as a foreign trust under section 7701(a)(31)(B). The final rule, which is renumbered § 1.1298–1(c)(4), clarifies that a foreign pension fund (or equivalent) covered by this exception may be any type of arrangement, including but not limited to, one of the arrangements listed in § 1.1298–1(c)(4). The final rule also applies in the case of an income tax treaty that provides the relevant benefit by election (or other procedure), such as under paragraph 7 of Article 18 of the U.S.-Canada income tax treaty, to the extent that the election is in effect (or other procedure properly satisfied).

Exception for Dual Resident Taxpayers

The final regulations provide an exception from the section 1298(f) reporting rules for dual resident taxpayers who are treated as residents of a treaty country, and, accordingly, not subject to tax under the PFIC provisions.  The final regulations add § 1.1298–1(c)(5), which sets forth an exception from section 1298(f) reporting for a dual resident taxpayer for a taxable year, or the portion of a taxable year, during which the dual resident taxpayer determines any U.S. income tax liability as a nonresident alien under § 301.7701(b)–7, and complies with the filing requirements of § 301.7701(b)–7(b) and (c) and, if applicable, § 1.6012– 1(b)(2)(ii)(b) (applicable when the dual resident taxpayer is treated as a resident of the treaty country on the last day of the taxable year), or § 1.6012– 1(b)(2)(ii)(a) (applicable when the dual resident taxpayer is treated as a resident of the United States on the last day of the taxable year).

Exception for Certain PFIC Stock Held for a Period of 30 Days or Less

The final regulations provide an exception for section 1298(f) reporting for certain shareholders with respect to PFICs that were owned for a short period of time during which no PFIC taxation was imposed on the shareholders. Specifically, under § 1.1298–1(c)(7), a shareholder is not required to file a Form 8621 under section 1298(f) with respect to stock of a section 1291 fund that it acquired either during its taxable year or the immediately preceding year, when the shareholder (i) does not own any stock of the section 1291 fund for more than 30 days during the period beginning 29 days before the first day of the shareholder’s taxable year and ending 29 days after the close of the shareholder’s taxable year and (ii) did not receive an excess distribution (including gain treated as an excess distribution) with respect to the section 1291 fund.

Exception for Certain Bona Fide Residents of U.S. Territories

The final regulations add § 1.1298– 1(c)(8) to provide an exception from reporting under section 1298(f) for a taxable year in which the individual is a bona fide resident of Guam, the Northern Mariana Islands, or the United States Virgin Islands and is not required to file a U.S. income tax return.

However, no exception from reporting is provided with respect to bona fide residents of Puerto Rico and American Samoa. Bona fide residents of Puerto Rico and American Samoa who are not required to file U.S. income tax returns in a given year may still be subject to tax under the PFIC provisions if they are shareholders of a PFIC and receive excess distributions (or recognize gain treated as excess distributions) in a later year.

 The $25,000 and $5,000 Exceptions

The final regulations essentially left alone the rule under § 1.1298–1T(c)(2)(i), which provides that a shareholder generally is not required to file Form 8621 with respect to a section 1291 fund when the shareholder is not treated as receiving an excess distribution (or recognizing gain treated as an excess distribution) with respect to the section 1291 fund stock, and, as of the last day of the shareholder’s taxable year, either the value of all PFIC stock considered owned by the shareholder is $25,000 (or $50,000 for shareholders that file a joint return) or less, or, if the stock of the section 1291 fund is owned indirectly, the value of the indirectly owned stock is $5,000 or less. Stock in a PFIC that is indirectly owned through another PFIC or United States person that is a shareholder of the PFIC is not taken into account in determining if the $25,000 (or $50,000 for joint returns) threshold is met.

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