If your client’s offshore voluntary disclosure involves PFIC (Passive Foreign Investment Company) income, you should be aware that the 2012 OVDP (Offshore Voluntary Disclosure Program) offers an alternative PFIC calculation method. In this article, I intend to outline broad contours of the alternative method and put it in a broader context of voluntary disclosure.
From the outset, I want to emphasize that the calculation of PFIC increase in tax is an extremely complex matter and should be conducted only by international tax professionals; therefore, this article is likely to be more of interest to international tax attorneys and accountants rather than the taxpayers themselves.
When Alternative OVDP PFIC Method Is Usually Elected
Whether to elect an alternative OVDP Method of PFIC calculation is a matter that should be decided by your international tax attorney in charge of your voluntary disclosure case. However, there are four common situations when taxpayers usually (but not always) choose the OVDP method.
First, for obvious reasons, if a PFIC election was already timely made (QEF or Market-to-Market (MTM)) in the past, the OVDP method is usually avoided.
Second, where a lack of historical information on the cost basis and holding period of many PFIC investments makes it difficult for taxpayers to prepare statutory PFIC computations and for the IRS to verify them. This is a very common reason for choosing OVDP method, especially in situations where PFICs were inherited by U.S. taxpayers.
Third, where the OVDP method is more financially beneficial than the statutory § 1291 method. Unfortunately, it is usually not easy to identify whether the OVDP or the statutory method is going to be advantageous; preliminary PFIC calculations will need to be conducted on both methods before a recommendation can be made to a client.
Finally, the fourth type of situations when people choose OVDP over § 1291 method are those where the default statutory PFIC method is so difficult and time-consuming to calculate that the clients simply opt for the OVDP method because it will save them more money in legal and accounting fees than whatever advantage a default statutory method would bring.
I once spoke with an attorney who always recommended OVDP method over § 1291, because the default method is too difficult to calculate. I believe this is an exaggeration and I would caution tax professionals from making such unfounded judgments. I have had situations where the default method was superior over the MTM method, OVDP or otherwise, based on the way the transactions were structured or the violent shifts in the value of PFICs. Therefore, one should always study the special circumstances of a client before laying out the options to the client and making the final recommendation.
OVDP Alternative MTM Method
Once your client selects the OVDP Alternative Method, it is important that you follow the rules of the method. In essence, the OVDP Method utilizes the mark-to-market methodology authorized in Internal Revenue Code § 1296 but without the requirement for complete reconstruction of historical data (which, in situations where are several legitimate places to start, may offer room for planning).
There are other differences between the traditional MTM and OVDP MTM methods. For example, a rate of 7% of the tax computed for PFIC investments marked to market in the first year of the OVDP application will be added to the tax for that year, in lieu of the PFIC interest charges. Also, a tax rate of 20% will be applied to the MTM gain(s), MTM net gain(s) and gains from all PFIC dispositions during the voluntary disclosure period under the OVDP, in lieu of the rate contained in IRC § 1291(a)(1)(B) for the amount allocable to the current year and IRC §1291(c)(2) for the deferred tax amount(s) allocable to any other taxable year.
With respect to limiting losses, the OVDP MTM method does follow the unreversed inclusions rule with very detailed instructions on the post-voluntary disclosure treatment of losses. I will not get into details in this article, but tax professionals should diligently study these instructions.
Once the OVDP Alternative method is selected, it will apply to all of your client’s PFIC investments. The initial MTM computation of gain or loss under this methodology will be for the first year of the OVDP application, but could be made after that year depending on when the first PFIC investment was made.
Election Of the OVDP MTM Method Will Have Tax Consequences On the Post-Disclosure Period
It is important to emphasize that the OVDP MTM method will have tax consequences on your client’s post-OVDP tax situation. For example, any unreversed inclusions at the end of the voluntary disclosure period will be reduced to zero and the MTM method will be applied to all subsequent years in accordance with IRC § 1296 as if the taxpayer had acquired the PFIC stock on the last day of the last year of the voluntary disclosure period at its MTM value and made an IRC § 1296 election for the first year beginning after the voluntary disclosure period.
Other important tax consequences must also be explained to your clients.
Contact Sherayzen Law Office for Help With PFICs In a Voluntary Disclosure Context
This article offers only a very broad outline of the OVDP MTM method and it should not be relied upon in your PFIC calculations. My only intent in this article was to alert the tax professionals to the existence and general contours of the OVDP Alternative PFIC Method. Whether to use it and how to use it requires deep understanding of the various PFIC calculation methods in conjunction with planning for various voluntary disclosure options.
If you or your clients are facing PFIC issues in a voluntary disclosure context, contact Sherayzen Law Office for help. Our experienced international tax firm will thoroughly analyze your client’s situation, propose various voluntary disclosure options, explain how these options affect your PFIC calculation method, and complete all of the required calculations and tax forms.