Michele Hyndman Hodge
Michele Hyndman Hodge

New annual reporting requirements for PFIC shareholders

Here’s what taxpayers need to know to comply with the new rules.

February 27, 2014
by Michele Hyndman Hodge, Esq.

The annual filing requirements for shareholders of a passive foreign investment company (PFIC) are in effect for the current tax season. The annual filing requirement is imposed on U.S. persons who are PFIC shareholders who do not currently file Form 8621, Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund. Thus, almost all PFIC shareholders (with some exceptions discussed below) are required to complete and file Form 8621 with the IRS. This filing requirement applies to tax years ending on or after Dec. 31, 2013, which means it affects the current tax reporting and filing season.

By way of background, there are two ways that a foreign corporation can be classified as a PFIC. First, a foreign corporation is considered a PFIC if 75% or more of its gross income for the tax year consists of passive income, meaning foreign personal holding company income, which generally includes dividends, interest, rents, royalties, annuities, and net gains from certain property, commodities, and foreign currency transactions. Second, a foreign corporation is also considered a PFIC if 50% or more of the average annual value of its total assets consists of passive income-producing assets. For example, cash, working capital, and noninventory investments in stock are generally considered to be passive income-producing assets.

Taxation of PFIC shareholders

PFIC shareholders can be taxed under one of three tax schemes: (1) the tax-and-interest scheme; (2) the current taxation scheme; or (3) the mark-to-market scheme. The tax-and-interest scheme is the worst one for a PFIC shareholder because it subjects the shareholder not only to a special tax, but also to an interest charge when the shareholder receives either (1) gains from the sale of PFIC stock or (2) a payment from the PFIC that is an excess distribution.

The current taxation and mark-to-market schemes, on the other hand, are much better tax scenarios for PFIC shareholders. The current taxation scheme taxes a PFIC shareholder on its share of PFIC income in the tax year that the PFIC income was earned. For a PFIC shareholder to be subject to tax under this scheme, the shareholder must make a qualified electing fund (QEF) election with the IRS.

The mark-to-market tax scheme can be used by PFIC shareholders whose stock is marketable on a reputable stock exchange. Similar to the current tax scheme, the mark-to-market tax scheme taxes a PFIC shareholder on the PFIC income or loss annually.

Who is a PFIC shareholder?

For purposes of the annual filing requirement, a PFIC shareholder is any U.S. person that owns stock of a PFIC directly or indirectly. For example, a PFIC shareholder can be any of the following: (1) a U.S. citizen; (2) a U.S. resident; (3) a domestic corporation; (4) a domestic partnership; (5) a domestic S corporation; or (6) a domestic grantor trust. A PFIC shareholder can also be a U.S. person that owns PFIC stock through another U.S. person.

For example, if a U.S. person (e.g., USP1) owns an interest in another U.S. person (e.g., USP2), USP1 can be considered a PFIC shareholder to the extent of its proportionate interest in USP2. USP2 can be a corporation, partnership, S corporation, estate, or trust that owns PFIC stock. In addition, a U.S. person that owns an interest in a foreign partnership, estate, or trust that owns PFIC stock can be considered a PFIC shareholder to the extent of its proportionate interest in the foreign partnership, estate, or trust.

A U.S. beneficiary of a domestic or foreign trust may also be considered a PFIC shareholder to the extent of its proportionate share of the trust and may be subject to the PFIC annual filing requirement in the future. However, currently, a U.S. beneficiary of a domestic or foreign trust is not subject to the annual filing requirement.

The annual filing requirement

Once a U.S. person is identified as a PFIC shareholder, that shareholder is required to file Form 8621 beginning in the tax year that ends on or after Dec. 31, 2013. Then, the PFIC shareholder must attach Form 8621 to its federal income tax return (or information return) each tax year, unless one of the exceptions discussed below applies. A PFIC shareholder must file Form 8621 for each PFIC the shareholder owns. Joint return filers may file one Form 8621 for a PFIC that they own jointly or individually.

Exceptions to the annual filing requirement

If a PFIC shareholder falls under one of the following exceptions, that PFIC shareholder is exempt from the annual filing requirement.

$25,000 and $5,000 stock value exceptions: This exception applies only to PFIC shareholders who are subject to tax under the tax and interest charge scheme.

If a PFIC shareholder does not receive a payment from the PFIC or does not receive gains from the sale of the PFIC stock, and either:

  1. The combined value of all PFIC stock at the end of the PFIC shareholder’s tax year does not exceed $25,000 ($50,000 for joint filers); or
  2. The PFIC shareholder owns the PFIC (e.g., PFIC1) through another PFIC (e.g., PFIC2) and the value of the PFIC shareholder’s proportionate interest in PFIC2 through PFIC1 does not exceed $5,000, then the PFIC shareholder is not required to file Form 8621 in that tax year.

Exception for foreign pension funds: In general, a U.S. person that owns a foreign pension fund that primarily provides pension or retirement benefits is not required to file Form 8621.

Partial exception for domestic liquidating trusts: A U.S. person that owns a domestic liquidating trust is not required to file Form 8621 for any PFICs the trust owns, but the trust itself must file Form 8621.

Exception for tax-exempt organizations: A PFIC shareholder that is a tax-exempt organization is not required to file Form 8621 unless the PFIC income is unrelated business income.

What’s coming up this tax season?

Beginning in the 2014 tax season, all PFIC shareholders are required to file Form 8621 with their federal tax return (or information return), unless one of the exceptions listed above applies. To implement this new annual filing requirement, revised Form 8621 is practically the same as the old Form 8621, except that Part I, “Summary of Annual Information,” is no longer reserved for future use. As the 2014 tax season commences, unanticipated problems may be encountered as tax practitioners assist their clients on the revised Form 8621 and reviewing their clients’ PFIC holdings in general.

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Michele Hyndman Hodge, Esq., is a senior manager in the International Business Tax Group at The Wolf Group PC in Fairfax, Va. She is responsible for advising clients on structuring business entities, minimizing global tax exposure, efficient repatriation of earnings, transfer pricing, and the tax implications of cross-border business transactions.