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!

First Quarter 2024 IRS Interest Rates on Overpayment & Underpayment of Tax

/in , /by

On November 17, 2023, the IRS announced that the First Quarter 2024 IRS interest rates on overpayment and underpayment of tax will not change from the Fourth Quarter of 2023.

This means that, the First Quarter 2024 IRS interest rates will be as follows:

  • eight (8) percent for overpayments (seven (7) percent in the case of a corporation);
  • eight (8) percent for underpayments;
  • ten (10) percent for large corporate underpayments; and
  • five and a half (5.5) of a percent for the portion of a corporate overpayment exceeding $10,000.

Internal Revenue Code (“IRC”) §6621 establishes the IRS interest rates on overpayments and underpayments of tax. Under §6621(a)(1), the overpayment rate is the sum of the federal short-term rate plus 3 percentage points for individuals and 2 percentage points in cases of a corporation. There is an exception to this rule: with respect to a corporate overpayment of tax exceeding $10,000 for a taxable period of time, the rate is the sum of the federal short-term rate plus one-half of a percentage point.

Under §6621(a)(2), the underpayment rate is the sum of the federal short-term rate plus 3 percentage points. Again, there is an exception for a large corporate underpayment: in such cases, §6621(c) requires the underpayment rate to be the sum of the relevant federal short-term rate plus 5 percentage points. The readers should see §6621(c) and §301.6621-3 of the Regulations on Procedure and Administration for the definition of a large corporate underpayment and for the rules for determining the applicable date.

Pursuant to the IRC §6621(b)(1), the First Quarter 2024 IRS interest rates were computed based on federal short-term rates for October 2023 to take effect on November 1, 2023, based on daily compounding.

It is important to note that the First Quarter 2024 IRS interest rates are relevant for a great variety of purposes. Let’s highlight three of its most important uses. First, these rates will determine the interest a taxpayer will get on any IRS refunds.

Second ,the rates will also be used to establish the interest to be added to any additional US tax liability on amended or audited tax returns. This also applies to the tax returns that were amended pursuant to Streamlined Domestic Offshore Procedures and Streamlined Foreign Offshore Procedures.

Finally, the First Quarter 2024 IRS interest rates will be used to calculate PFIC interest on any relevant §1291 PFIC tax. This PFIC interest will be reported on the relevant Form 8621 and ultimately Form 1040.

We at Sherayzen Law Office constantly deal with the IRS interest rates on overpayments and underpayments of tax. This is why we closely follow any changes in these IRS interest rates, including the First Quarter 2024 IRS interest rates.