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

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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!

Brazilian Mutual Funds: US Tax Obligations | International Tax Lawyer & Attorney

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It is a common, almost default practice in Brazil to invest in Brazilian mutual funds. While this practice is perfectly innocent for majority of Brazilians, it may present a huge compliance issue for Brazilians who are also US taxpayers. The problem is that this type of an investment draws at least two important US tax reporting requirements – FBAR and Form 8621. In this article, I will provide a broad overview of each of these requirements concerning Brazilian mutual funds.

Brazilian Mutual Funds: FBAR Reporting

FinCEN Form 114, the Report of Foreign Bank and Financial Accounts, commonly known as “FBAR”, is undoubtedly the most important requirement that applies to US taxpayers with Brazilian mutual funds. As long they meet the filing threshold, US taxpayers are required to disclose all of their Brazilian mutual funds on FBAR.

The threshold is very easy to meet for two reasons. First, it is very low, just $10,000. Second, this threshold is determined by taking the calendar-year highest balances of all of the taxpayer’s foreign accounts and adding them all up. Sometimes, this results in significant over-reporting of a person’s actual balances, which easily satisfies the FBAR reporting threshold.

What makes FBAR compliance so important is its draconian penalty system. FBAR noncompliance may result in severe noncompliance penalties, even criminal penalties. The 2024 Civil FBAR Penalties and the IRS FBAR Tax Lawyer & Attorney willful penalties are huge and are imposed on a per-account basis. Even if the taxpayer did not know about the existence of FBAR, the IRS may still impose large non-willful FBAR penalties.

Brazilian Mutual Funds: Form 8621 PFIC Reporting

The biggest practical problem with Brazilian mutual funds, however, lies in the fact that all of these funds are classified as Passive Foreign Investment Companies or PFICs under US international tax law. This is bad news for US taxpayers, because being an owner of a PFIC means a substantial tax compliance burden, especially under the default IRC Section 1291 rules.

There are four PFIC problems that make PFIC tax compliance so burdensome to US owners of foreign mutual funds. First, the PFIC tax and PFIC interest can be substantial. Moreover, since PFIC tax and PFIC interest are calculated independent of a taxpayer’s actual tax bracket, a taxpayer with Brazilian mutual funds may see a significant rise in his US tax liability. It may occur even in a situation where a taxpayer may not otherwise owe any tax to the IRS. This fact may also be significant in the context of an offshore voluntary disclosure.

Second, PFIC calculations may be very complex and expensive. The professional fees for PFIC calculations may easily outstrip all other professional fees related to other aspects of your US tax compliance.

Third, the actual disclosure of PFIC income occurs on Form 8621 before it is entered into your personal or business tax return. This information return must be filed with your US tax return. Unfortunately, since the vast majority of tax software programs (consumer and professional) do not support Form 8621 compliance, it is very likely that you will not be able to e-file your US tax return; rather, you may have to mail it.

Finally, Form 8621 is a very obscure requirement known mostly to a handful of US tax professionals who specialize in US international tax compliance (such as Sherayzen Law Office). This means that your local tax accountants are unlikely to be able to do PFIC calculations. Rather, in order to stay in full US tax compliance, you will have to secure help from someone among a very small number of PFIC specialists, like Mr. Eugene Sherayzen of Sherayzen Law Office, that exist in the United States.

Contact Sherayzen Law Office for Professional Help With US Tax Reporting of Your Brazilian Mutual Funds

If you are a US owner of Brazilian mutual funds, contact Sherayzen Law Office for professional assistance. We have helped hundreds of US taxpayers resolve their US tax compliance issues concerning foreign mutual funds, including Brazilian mutual funds, and we can help you!

Contact Us Today to Schedule Your Confidential Consultation!