Posts

Start-Up Year PFIC Exception | International Tax Lawyer & Attorney

/in , /by

Passive Foreign Investment Company (PFIC) classification of a foreign corporation may have highly undesirable consequences for its US shareholders.  In addition to high PFIC tax, these taxpayers face expensive and burdensome tax reporting requirements.  This is why US taxpayers and their tax advisers generally try to avoid PFIC designation.  This article explores a possible way to do so by utilizing the Start-Up Year PFIC Exception.

Start-Up Year PFIC Exception: PFIC Background Information

PFIC law is a powerful anti-deferral tax regime. PFIC rules are meant to discourage US investment in PFIC companies by eliminating real or perceived benefits of such an investment.

Any company that meets either the income test or the asset test set forth in 26 USC §1297(a) would generally be considered a PFIC for US tax purposes.  This means that it would subject to taxation based on: (a) default IRC §1291 Fund regime; (b) Qualified Election fund (QEF) regime; or (c) Mark-to-Market (MTM) regime.  All of these methods are punitive in one form or another.

PFICs are reported on Forms 8621. Reporting under IRC §1291 method may prevent a taxpayer from e-filing his US tax returns.

In some cases, even if a corporation meets a PFIC test, it may still avoid PFIC treatment if it meets one of the exceptions.  Start-UP Year PFIC exception is one of them.

Start-Up Year PFIC Exception: Purpose

The legislative history explains that the purpose behind this exception is to avoid PFIC designation for a business that will engage in active business operations but has mostly passive income in its first year.  Staff of the Jt. Comm. on Taxation, General Explanation of the Tax Reform Act of 1986, at 1026 (JCS-10-87) (May 4, 1987) (1986 Bluebook).

Start-Up Year PFIC Exception: Main Test

26 USC §1298(b)(2) sets forth the Start-Up Year Exception. It states that, if a corporation would otherwise be a PFIC in its start-up year, it would not be treated as a PFIC in that year if it means the following test:

  1. No predecessor corporation was a PFIC;
  2. It is established to the IRS’s satisfaction that the corporation will not be a PFIC in either of the two years following the start-up year; and
  3. The corporation is not, in fact, a PFIC for either succeeding year.

Despite its apparent simplicity, this test contains important complications.

Start-Up Year PFIC Exception: What is “Start-Up Year”

The first complication arises from the definition of “Start-Up Year”. 26 USC §1298(b) defines this term as the first taxable year in which a corporation earns gross income. In other words, “start-up year” may not actually mean the first year of the corporation’s existence, because a corporation may exist without any income.

What if the corporation has gross income but incurs a net loss? In my opinion, this would qualify as a “start-up year”.

What if the corporation has no gross income whatsoever and just incurs a loss? In my opinion, there is sufficient basis for the argument, based on the strict interpretation of statutory language, that this is still not “start-up year”.

Start-Up Year PFIC Exception: Danger of Prior Interaction With the Asset Test

Another related complication is the fact that this PFIC exception would not apply where a foreign corporation would satisfy the PFIC asset test in a prior year.

For example, let’s suppose that, for the first two years of its existence, a foreign corporation earns no income whatsoever. Since no income is earned, the Start-UP Year PFIC exception would not apply here yet.  If, in one of those years, the corporation satisfies the PFIC asset test, then this corporation would become a PFIC.  This means that, even if the Start-Up Year PFIC exception satisfied in year three, it would not be applicable, because the corporation is already a PFIC under the “once a PFIC, always a PFIC” rule. For example, see 2002 WL 1315676.

Start-Up Year PFIC Exception Only Applies For One Year

The other complication concerning this exception is the fact that it is limited to one year only. This could even mean a short year of one day. In other words, a corporation can only use it once to escape PFIC designation.

Start-Up Year PFIC Exception: Parent Holding Company

The interaction of the exception with the subsidiary look-through rule (which I will explore more in a future article) is very interesting. While it appears that the IRS has not issued any direct guidance on this issue, my analysis shows that the Start-Up Year PFIC exception can be extended to the parent holding company of a start-up corporation under the subsidiary look-through rule.

This conclusion, however, depends very much on the actual fact pattern.  For example, if a foreign holding company is established at the same time as the start-up corporation and the holding company only has its subsidiary’s stock as its asset, then it is very likely that the Start-Up Year PFIC exception would be extended to the holding company.

Contact Sherayzen Law Office for Professional Help With US International Tax

Start-Up Year PFIC Exception is one of the innumerable intricacies of the highly complex US international tax law.  This is why you need to contact Sherayzen Law Office for professional help with US international tax compliance.

Sherayzen Law Office is a leader in US international tax compliance and planning, including PFIC compliance.  We have a profound knowledge of and extensive experience with US international tax law.  We can help you!

Contact Us Today to Schedule Your Confidential Consultation!

2022 2Q IRS Interest Rates | US International Tax Lawyers

/in , /by

On February 23, 2022, the Internal Revenue Service (“IRS”) announced that the 2022 Second Quarter IRS underpayment and overpayment interest rates (“2022 2Q IRS Interest Rates”) will increase from the first quarter of 2022. This means that, the 2022 2Q IRS interest rates will be as follows:

  • four (4) percent for overpayments (three (3) percent in the case of a corporation);
  • one and one-half (1.5) percent for the portion of a corporate overpayment exceeding $10,000;
  • four (4) percent for underpayments; and
  • six (6) percent for large corporate underpayments.

The second quarter will start on April 1, 2022.

Under the Internal Revenue Code, these interest rates are determined on a quarterly basis. The IRS used the federal short-term rate for February of 2022 to determine the 2022 2Q IRS interest rates. The IRS interest is compounded on a daily basis.

The 2022 2Q IRS interest rates are important for many reasons for US domestic and international tax purposes. For example, the IRS will use these rates to determine how much interest a taxpayer needs to pay on an additional tax liability that arose as a result of an amendment of his US tax return through Streamlined Domestic Offshore Procedures and Streamlined Foreign Offshore Procedures. The IRS will also utilize 2022 2Q IRS interest rates with respect to the calculation of PFIC interest on Section 1291 tax.

As an international tax law firm, Sherayzen Law Office keeps track of the IRS underpayment and overpayment interest rates on a regular basis. Since our specialty is offshore voluntary disclosures, we often amend our client’s tax returns as part of an offshore voluntary disclosure process and calculate the interest owed on any additional US tax liability. In other words these interest rates are relevant to Streamlined Domestic Offshore Procedures, Streamlined Foreign Offshore Procedures, IRS Voluntary Disclosure Practice, Delinquent International Information Return Submission Procedures and Reasonable Cause Disclosures. We also need to take interest payments into account with respect to additional tax liability that arises out of an IRS audit.

Moreover, we regularly have to do PFIC calculations for our clients under the default IRC Section 1291 methodology. This calculation requires the usage of the IRS underpayment interest rates in order to determine the amount of PFIC interest on the IRC Section 1291 tax.

Finally, it is important to point out that the IRS will use the 2022 2Q IRS interest rates to determine the amount of interest that needs to be paid to a taxpayer who is due a tax refund as a result of an IRS audit or amendment of the taxpayer’s US tax return. This situation may also often arise in the context of offshore voluntary disclosures.

Thus, the IRS underpayment and overpayment interest rates have an impact on a lot of basic items in US tax law. Hence, it is important to keep track of changes in these rates on a quarterly basis.

IRS Interest Rates for the Second Quarter of 2019 | PFIC Tax Lawyer & Attorney

/in , /by

On February 25, 2019, the IRS announced that the IRS underpayment and overpayment interest rates will remain the same for the second quarter of 2019 as they were in the first quarter of 2019. The second quarter of 2019 begins on April 1, 2019 and ends on June 30, 2019.

This is an important announcement because these rates will have impact on various calculations and affect many US taxpayers. In particular, the second quarter of 2019 IRS interest rates will apply to the calculation of interest owed on any underpayment of tax as calculated on the amended tax returns. This includes the payments that US taxpayers must make pursuant to the Streamlined Domestic Offshore Procedures and Streamlined Foreign Offshore Procedures.

Moreover, the increase in the interest rates for the second quarter of 2019 directly affects the calculation of PFIC interest due on any PFIC tax. It is important to remember that PFIC interest cannot be offset by foreign tax credit.

According to the aforementioned IRS announcement, the second quarter of 2019 IRS interest rates will be as follows: 

six (6) percent for overpayments (five (5) percent in the case of a corporation);
three and one-half (3.5) percent for the portion of a corporate overpayment exceeding $10,000;
six (6) percent for underpayments; and
eight (8) percent for large corporate underpayments.

Under the Internal Revenue Code, the rate of interest for the second quarter of 2019 is determined on a quarterly basis. The current year’s overpayment and underpayment interest rates are computed from the federal short-term rate determined during January 2019 to take effect February 1, 2019, based on daily compounding.

Generally, in the case of a corporation, the underpayment rate is the federal short-term rate plus 3 percentage points and the overpayment rate is the federal short-term rate plus 2 percentage points. The rate for large corporate underpayments is the federal short-term rate plus 5 percentage points. The rate on the portion of a corporate overpayment of tax exceeding $10,000 for a taxable period is the federal short-term rate plus one-half (0.5) of a percentage point.

New PFIC Foreign Trust Rules by June of 2018 | PFIC Lawyer & Attorney

/0 Comments/in , /by

On November 9, 2017, the IRS gave a clear signal that it is working on new PFIC Foreign Trust rules and hopes to have these new regulations published by June of 2018. The IRS also indicated that other areas of PFIC rules will be affected and it expects the Subpart F regulations to come out before the new PFIC regulations.

The area of intersection of PFIC rules and Foreign Trust rules is an area of law that has remained murky since the late 1980s. Let’s explore in more detail what exactly the problem is and why the new PFIC Foreign Trust regulations are so important.

PFIC Foreign Trust Rules & Regulations

PFIC Foreign Trust Rules

PFIC Foreign Trust Rules: What is a PFIC?

In general, a foreign corporation that is not a “controlled foreign corporation” (CFC) as defined in IRC section 957, nor a “foreign personal holding company” (FPHC) as defined in IRC section 552, will be determined to be a Passive Foreign Investment Company or (PFIC) if it has at least one US shareholder and meets either one of the two tests found in IRC section 1297: (a) income test: at least 75% or more of the corporation’s gross income is passive income; or (b) asset test: at least 50% of the average percentage of its assets are investments that produce or are held for the production of passive income.

PFIC is a unique US classification that has no equivalents anywhere in the world. The PFIC designation was created by Congress in 1986 (as part of the Tax Reform Act of 1986). In essence, this is an anti-deferral regime meant to deter US taxpayers from deferring or avoiding payment of US taxes by transferring money or investing in passive offshore entities. This is why the PFIC rules are so severe, imposing the highest marginal tax on the income considered as “excess distribution” and converting the rest of the income from capital gains into ordinary income.

PFIC Foreign Trust Rules: Foreign Trust Rules on Distribution of Accumulated Income

The IRS also has a special set of rules concerning foreign trust’s distribution of accumulated income from prior years. In order to analyze these rules, we need to understand two concepts: distributable net income (“DNI”) and undistributed net income (“UNI”). With respect to foreign trusts, in general (and there are exceptions), DNI includes all of the ordinary income and capital gains earned by a foreign trust in current taxable year. If a foreign trust does not distribute its entire DNI in the taxable year when DNI is earned, then, the undistributed portion of DNI (after taxes) becomes UNI.

Hence, whenever we discuss a distribution of a foreign trust’s accumulated income, this means a distribution of UNI in excess of DNI (on FIFO basis). So, what happens if a foreign trust distributes UNI to a US beneficiary?

In general, such distributions of UNI are taxed according to the infamous “throwback rule”. The throwback rule is complex and I can only state here a very simplified description of it. In general, under the throwback rule, distributed UNI will be taxed at the beneficiary’s highest marginal tax rate for the year in which UNI was earned. In other words, the throwback rule divides up UNI back into DNI portions for each relevant taxable year (but not exactly; this is an assumed DNI, not an actual one), adds these portions to the already-reported income on the beneficiary’s US tax returns and, then, imposes the tax on this income.

The throwback rule, however, does more than just add the income to the tax returns – it adds the income always as ordinary income, even if the original undistributed DNI consisted of long-term capital gains. Moreover, the throwback rule imposes an interest charge on the additional “throwback” taxes; the interest accumulates in a way somewhat similar to PFIC rules.

There is a way to mitigate the highly unfavorable consequences of the throwback rule called the “default method” (the name does not make much sense because you can use it only in specific circumstances). In general, you can use the default method in situations where the foreign trust does not provide its US beneficiaries with the information sufficient to identify the character of the distributed income. It is beyond the scope of this article to describe this method in detail, but, there are potentially highly unfavorable consequences to using the default method as well.

PFIC Foreign Trust Rules: the Inconsistency Between PFIC Rules and Foreign Trust Rules With Respect to Accumulated Income

Now that we have a general familiarity with PFIC rules and the foreign trust UNI distribution rules, we can now understand the area of confusion between PFIC rules and Foreign Trust rules that the IRS wishes to finally clear up by June of 2018. The confusion arises when both anti-deferral regimes are combined into PFIC Foreign Trust rules.

Let’s clarify this issue further. The basic problem occurs whenever a foreign trust distributes UNI that originates from accumulated PFIC income. For example, in a situation where a foreign trust received PFIC dividends and did not distribute them as part of its DNI distribution, such dividends would be added to the trust’s UNI. In this situation, if the trust distributes its PFIC UNI and we just follow the standard UNI rules, the PFIC rules would never be taken into account. The IRS, however, never said that the throwback rule or the default method should trump PFIC rules; it is also unclear about what should be reported on Form 8621 (for indirect ownership of PFICs).

On the other hand, if a taxpayer calculates his tax liability under the PFIC rules, then, he cannot comply with his Form 3520 requirements. The IRS also never stated that PFIC rules should triumph over either the throwback rule or the default method for UNI distributions. In other words, there is no clear guidance on what to do in this situation.

There is simply no compatibility between the foreign trust’s UNI distribution rules and the PFIC rules: one of them has to triumph or a completely new set of regulations has to be issued by the IRS to address the PFIC Foreign Trust rules. As an international tax attorney, I hope that the IRS keeps its word and resolves this highly important dilemma of the US international tax law.

Contact Sherayzen Law Office for Help With PFIC Foreign Trust Rules and Other International Tax Issues

If you are struggling with the PFIC Foreign Trust rules or you have any other issues concerning your compliance with your US international tax obligations, contact Sherayzen Law Office for professional help.

Sherayzen Law Office has helped hundreds of US taxpayers around the globe with their US tax compliance issues, including those concerning the PFIC rules and foreign trust rules. We can help You!

Contact Us Today to Schedule Your Confidential Consultation!