Is PFIC Reform for Missed/Late Elections on the Horizon?

PFIC Reform & Relief on the Horizon for Missed Elections?

New PFIC Reform for Missed Elections?

The idea of hope springs eternal is not lost on the U.S. government, which is why they publish an annual Green Book of revenue proposals. For taxpayers who are interested to learn more about the process, the Taxpayer Advocate website is a good starting point. There are various different proposals within the green book on issues involving domestic and international tax law, but there are two key issues may significantly impact general international tax, penalties, and reporting for individuals with foreign accounts, assets, and investments. One in particular involves the Passive Foreign Investment Company or PFIC. Many U.S. persons across the globe who are considered U.S. persons for tax purposes get stuck in the PFIC matrix because they own foreign investment funds such as a foreign mutual funds or ETFs. And unless the taxpayer makes a timely election during the first year of owning a PFIC, making a retroactive election is very complicated because it requires approval. But, according to the proposal issued by the United States government, there is a chance that it may become easier for taxpayers to make a retroactive election. Let’s look at the excerpts from the Treasury Department released its fiscal year (FY) 2025 Green Book of revenue proposals.

Current Law

• • • The passive foreign investment company (PFIC) rules are intended to prevent taxpayers from deferring the taxation of income from passive investments and from transforming the character of income from those investments from ordinary income into capital gain by holding the investments through a foreign investment company. Absent a qualified electing fund (QEF) or another permitted election, excess distributions received from a PFIC are subject to additional tax in an amount determined by reference to the taxpayer’s holding period during which the company has been a PFIC, the highest marginal tax rates applicable during that period, and the rate of interest that applies to underpayments of tax. Gain recognized on disposition of PFIC stock is treated as an excess distribution.

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    • If an investor in a PFIC makes a QEF election, the taxpayer is not subject to the tax on excess distributions after the effective date of the election. Instead, the taxpayer generally is required to take into account the taxpayer’s pro rata share of the ordinary income and long-term capital gain of the PFIC on an annual basis and pay tax on this income. Section 1295(b)(2) of the Internal Revenue Code (Code) generally allows the owner of a PFIC to make a QEF election for any taxable year at any time on or before the due date for filing the return of the tax. Section 1295(b)(2) permits an election to be made after that date if the taxpayer reasonably believed that the company was not a PFIC, to the extent provided by regulations. Under regulations, a taxpayer also is permitted to make a retroactive QEF election if the Commissioner of the Internal Revenue Service (IRS) consents to the election under a special consent procedure.

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    • To qualify for the special consent procedure, three conditions must be met: the taxpayer must have relied on a qualified tax professional, granting consent must not prejudice the interests of the U.S. Government, and the request for the special consent must be made before the issue is raised on audit.

Reasons for Change

• • • A taxpayer who makes a QEF election does not obtain the timing and character benefits that the PFIC rules are intended to prevent. QEF elections reduce tax costs to investors and increase tax compliance. The availability of a QEF election also incentivizes taxpayers to voluntarily report investments in a PFIC. Under current law, individuals who inadvertently did not make a QEF election with respect to a PFIC investment may not be eligible for relief under the special consent procedure. For example, a student with low or no income may inherit stock and discover only years later that the stock is that of a PFIC when the individual hires a qualified tax professional.

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    • In other cases, an individual may have hired a qualified tax professional who fails to advise the taxpayer of the availability of a QEF election but refuses to provide an affidavit acknowledging that failure. Additionally, there are large individual and administrative costs under current law for the existing special consent procedure. The existing procedure requires a taxpayer to file a ruling 51 General Explanations of the Administration’s Fiscal Year 2025 Revenue Proposals request with the IRS and pay a user fee that is currently several thousand dollars. The IRS receives many requests for consent, which result in the use of IRS time and resources to determine whether consent should be granted and, if so, to issue the private letter ruling.

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    • In many cases, allowing the taxpayer to make a retroactive QEF election would be consistent with the proper administration of the law and would promote tax compliance, but the IRS must deny the request because the taxpayer does not qualify for relief under the special consent procedure. To encourage more taxpayers to make QEF elections, improve taxpayer disclosure, and relieve the costs and burdens that current law imposes on both taxpayers and the IRS, retroactive QEF elections should be permitted for a broader range of circumstances through changes to the statute that expand regulatory authority. For example, the IRS should have authority to allow a retroactive QEF election after the first year of ownership of a PFIC in appropriate cases that promote these goals even if the taxpayer cannot demonstrate a reasonable belief that the company was not a PFIC and cannot satisfy the special consent requirements.

Proposal

• • • The proposal would modify section 1295(b)(2) of the Code to permit a QEF election by the taxpayer at such time and in such manner as the Secretary shall prescribe by regulations. Taxpayers would be eligible to make a retroactive QEF election without requesting consent only in cases that do not prejudice the U.S. Government. For example, if the taxpayer owned the PFIC in taxable years that are closed to assessment, the taxpayer would need to obtain consent and to pay an appropriate amount to compensate the government for the taxes not paid in the closed years on amounts that would have been includable in the taxpayer’s income if the taxpayer had made a timely QEF election.

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    • While it is less common for partnerships and other non-individual taxpayers to inadvertently fail to make a QEF election, the Secretary would have authority to allow such taxpayers to make retroactive QEF elections in appropriate circumstances. The proposal would be effective on the date of enactment. It is intended that regulations or other guidance would permit taxpayers to amend previously filed returns for open years.

Late Filing Penalties May be Reduced or Avoided

For Taxpayers who did not timely file their FBAR and other international information-related reporting forms, the IRS has developed many different offshore amnesty programs to assist taxpayers with safely getting into compliance. These programs may reduce or even eliminate international reporting penalties.

Current Year vs Prior Year Non-Compliance

Once a taxpayer missed the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, taxpayers should consider speaking with a Board-Certified Tax Law Specialist who specializes exclusively in these types of offshore disclosure matters.

Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)

In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful Taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties. 

Need Help Finding an Experienced Offshore Tax Attorney?

When it comes to hiring an experienced international tax attorney to represent you for unreported foreign and offshore account reporting, it can become overwhelming for taxpayers trying to trek through all the false information and nonsense they will find in their online research. There are only a handful of attorneys worldwide who are Board-Certified Tax Specialists and who specialize exclusively in offshore disclosure and international tax amnesty reporting. 

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure. 

Contact our firm today for assistance.