Good news for passive foreign investment company shareholders

The Internal Revenue Service and the Treasury Department recently issued temporary (TD 9650) and proposed (REG-140974-11) regulations (2013 temporary regulations) providing passive foreign investment company (PFIC) guidance for tax years ending on and after Dec. 31, 2013 and, thus, applicable to 2013 calendar year taxpayers. The areas covered include determination of ownership of a PFIC, annual filing requirements, and exceptions to the filing requirements.

PFIC definition and Form 8621 requirements

A PFIC primarily is used as a passive investment vehicle. Characterization of a foreign corporation as a PFIC is determined by the satisfaction of either an income or asset test. The income test requires that 75 percent or more of a foreign corporation’s gross income consist of passive income. The asset test requires at least 50 percent of the foreign corporation’s average assets (based on either value or, in certain circumstances, adjusted tax basis) held during the tax year produce passive income. Typically, passive income is defined to include dividends, interest, rents, royalties, annuities, certain personal service contracts, income from notional principal contracts, and certain gains from sale of property. Rents and royalties that originate from an active trade or business are excluded from the definition of passive income.

In general, US persons owning stock—even one share—of a PFIC may be subject to tax at top marginal rates, plus an interest charge, on certain distributions and dispositions of PFIC stock. Even an indirect owner of PFIC stock may be subject to the regime. Both the gain from a disposition and a targeted distribution (referred to as an excess distribution) are taxed often at the highest marginal rate, without regard to the tax attributes of the PFIC stockholder (for example, ignoring its net operating losses). An interest charge is also imposed based on the shareholder’s holding period for the PFIC stock. A taxpayer may avoid the regime by purging the PFIC taint by a deemed sale election, a deemed dividend election, or by means of two alternative elections: (1) the qualified electing fund (QEF) or (2) the mark-to-market election. If a QEF election is made, a taxpayer usually includes in income each year its pro rata share of the PFIC’s ordinary earnings and its pro rata share of the PFIC’s net capital gain. Taxpayers holding marketable PFIC stock may make the mark-to-market election to include annually in gross income the excess of the fair market value over the PFIC stock’s adjusted basis (or, in certain circumstances, take a deduction if adjusted basis is greater than fair market value).

PFIC direct or indirect shareholders receiving an excess distribution from a PFIC, disposing of its shares, or making an election to purge its stock (i.e., QEF election or mark-to-market election) are required to file Form 8621. PFIC reporting could duplicate reporting required under section 6038D (specified foreign financial asset reporting on Form 8938). As a result, section 6038D limits the duplicate reporting. Additionally, section 6501(c)(8) cross-references the section 1298(f) filing requirement, which means the statute of limitations does not begin until Form 8621 is filed. Failure to meet these filing requirements can result in significant penalties.

The Hiring Incentives to Restore Employment Act of 2010 (HIRE Act) imposed an annual reporting requirement for shareholders of PFICs. In July 2011, the IRS issued Notice 2011-55 announcing its intention to issue regulations implementing the annual PFIC reporting rules and to revise Form 8621. At the same time, the IRS suspended the annual reporting requirement until the release of the revised form for PFIC holders who were not obligated to file under the then-current instructions according to section 1298(f). The IRS made it clear at the time that filing a Form 8621 would be required for the suspended years once the new Form 8621 was issued.

Exceptions and welcome relief

The 2013 temporary regulations clarify the definition of PFIC shareholders and their reporting requirements for tax years ending Dec. 31, 2013, and thereafter. The regulations define who is a direct or indirect PFIC shareholder, including those who have ownerships through C corporations, partnerships, S corporations, estates, non-grantor trusts, and grantor trusts. They also define pedigreed qualifying electing funds and section 1291 funds.

The IRS announced in the regulations that taxpayers exempt from filing under IRS Notice 2011-55 will not need to file Form 8621 for any of the suspended years (2011 and 2012), even though Notice 2011-55 indicated they would be required to file.

The 2013 temporary regulations also list persons exempt from filing, such as certain tax-exempt entities, and establish a new de minimis threshold amount. If the threshold is not met on the last day of the shareholder’s tax year, no filing is required, unless the investors either received an excess distribution or made a QEF or a mark-to-market election. No reporting is required if, on the last day, the aggregate value of all PFIC stock owned directly or indirectly by the shareholder is $25,000 or less ($50,000 if married filing jointly and both spouses own the stock) or if the shareholder indirectly owns $5,000 or less of a section 1291 fund stock. In determining value of these funds, the shareholder may rely on periodic account statements unless they have actual knowledge or accessible information that such statements do not reflect a reasonable estimate of the PFIC’s value. The 2013 temporary regulations have detailed rules in how to calculate ownership interest held through other entities. However, it may be unclear whether US persons that beneficially own PFIC stock through certain entities are treated as shareholders of any PFIC.

Some duplicative filing is eliminated. Filing is not required when a US investor owns PFIC stock through another US person who timely files a Form 8621 and when the US investor is required to include an amount in income under the QEF or mark-to-market rules with respect to the PFIC stock held through the other US person.

The regulations state if a US person is required to file Form 8621 under section 1298(f), a separate Form 8621 should be filed for each PFIC owned, except if the US person files a joint return with his/her spouse, a single Form 8621 may be filed with respect to the same PFIC if owned by each spouse.


The 2013 temporary regulations are good news for individuals investing in a US hedge fund or a US private equity fund where the US entity owns interests in foreign funds that are PFICs. Fewer than expected individual investors in a hedge fund or private equity fund are required to file Form 8621 if the US fund itself has filed Form 8621 and the individuals have QEF or mark-to-market elections in place.

For further information on Form 8621 requirements, or to learn how Baker Tilly asset management industry specialists can help, contact our team.

Next up

FASB tentatively decides to add natural expense reporting requirement for all nonprofits including higher education Institutions