Should You Make a Late QEF Purging Election with Deemed Sale?

Is a Deemed Sale/Late QEF Late Purging PFIC Election Worth It?

Is a Deemed Sale/Late QEF Late Purging PFIC Election Worth It?

Unfortunately, there is a lot of misinformation and misguidance online regarding making a late QEF election involving PFIC tax and reporting. When a taxpayer owns a PFIC (Passive Foreign Investment Company), such as a foreign mutual fund or ETF, the default tax position is that they will have to pay excess distribution tax on certain dividend distributions and redemptions/sales of the fund. The excess distribution tax far exceeds what the taxpayer would otherwise have had to pay if it were a domestic version of the foreign mutual fund, because under the excess distribution tax rules, a taxpayer is not entitled to long-term capital gain treatment. To minimize the tax burden, some taxpayers will want to make a QEF election if they qualify, but the question is what happens if the taxpayer does not make the QEF election in the first year of owning the PFIC. The Internet would have you believe you should just go back and file a late election count, but unfortunately, the Internet does not provide you with the costs and risks of making these types of elections, as well as the requirements to qualify for a QEF Election.

What is a QEF Election for PFIC?

The QEF Election for PFIC is an election that the taxpayer typically makes in the first year of owning the PFIC. By making the election, the taxpayer will ultimately receive preferential tax treatment when they redeem or otherwise sell the PFIC. If the taxpayer receives dividends throughout the ownership of the PFIC, then the taxpayer still does not receive qualified dividend treatment, but overall, in most scenarios, the QEF election will net a much better tax result than maintaining the default access distribution tax regime.

Not all PFIC Qualify for QEF Treatment and Risks to Your Investments

One important component of making the QEF election is that the taxpayer owns the type of investment that qualifies to make a QEF election. More specifically, the foreign financial institution that houses the investment must make available sufficient information that the IRS requires to make a QEF election. PFIC.

One key fact that is missing from your Internet research is that most foreign financial institutions do not want to deal with US investors. Thus, if you approach the investment fund seeking whether they offer to provide you with that type of detailed statement information, they may respond by removing you from the investment because they don’t want to deal with all the requirements and headaches of having US investors in their foreign fund.

QEF Election Not Made in First Year

When the QEF election is not made in the first year, then the taxpayer has to make a late QEF election. The problem is that the IRS does not make it simple for the taxpayer to make a late QEF election. Rather, before making the QEF election, the taxpayer must make a purging election unless they can prove reasonable cause in making a late election to avoid having to make the purging election.

Establishing Reasonable Cause for a Late QEF is Tough

When a taxpayer makes a reasonable cause submission for something such as a late FBAR, depending on the facts and circumstances, they may be in a strong position to avoid penalties. But, using reasonable cause to make a late QEF election is markedly different, and the taxpayer has very specific parameters in order to be eligible to make a reasonable cause submission for a late QEF election.

Oftentimes, the taxpayer will simply not meet the eligibility requirements for submitting a late QF election.

Purging Election or Selling and Repurchasing

The IRS provides the taxpayer an opportunity to make a late QEF election without having to prove reasonable cause, but it requires the taxpayer to make a purging election first. With a purging election, the taxpayer cleanses the taint by operating as if they sold the fund — and pays the excess distribution calculation tax. Then, going forward, the taxpayer can make the QEF election. This comes with its own set of risks, such as in a situation in which the taxpayer makes the purging election and pays a huge amount of tax, only for the value of the asset to go down so that they are going to eventually sell it for a loss anyway. Thus, in addition to any tax consequences, investors should evaluate their portfolio to determine whether paying a large tax now is worth it, especially if it is a highly speculative asset.

Offshore Disclosure Risks

Finally, for taxpayers considering offshore disclosure, such as the streamlined procedures, typically the goal is to get the submission made without causing any red flags. Very typically, taxpayers would not make late elections as part of the streamlined or other type of offshore disclosure procedures to minimize the audit/examination risks of making the disclosure.

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.