In January 2022, the IRS issued proposed regs regarding the treatment of domestic partnerships and S corporations that own stock of passive foreign investment companies (PFICs) and their domestic partners and shareholders. The proposed regs also provide guidance on a number of other matters, including the:
- Determination of the controlling domestic shareholders of foreign corporations,
- Determination of the owner of a controlled foreign corporation (CFC) or qualified electing fund (QEF) that makes an election under Internal Revenue Code Section 1411,
- Treatment of S corporations with accumulated earnings and profits under subpart F of the U.S. Code, and
- Determination and inclusion of related person insurance income under Sec. 953(c).
If all that sounds rather complex, the American Institute of Certified Public Accountants (AICPA) agrees. The organization recently went on record saying that the proposed PFIC regs would needlessly complicate filings for some investors.
The proposed regs would apply the so-called aggregate approach under the CFC regime to PFIC rules. This means domestic partnerships and S corporations would no longer be treated as direct U.S. shareholders for the purposes of PFIC compliance requirements and applicable elections. The U.S. Department of the Treasury, per the preamble to the regs, seeks to have the aggregate approach consistent for CFCs and PFICs.
In a June 28 letter to Lily Batchelder, assistant Treasury secretary for tax policy, and IRS Commissioner Charles Rettig and Principal Deputy Chief Counsel William Paul, the AICPA’s Jan Lewis, chair of AICPA’s Tax Executive Committee, recommended that the IRS retain the “entity approach.” Should the final regs adopt the aggregate approach, Lewis wrote, a provision should be included so that domestic partnerships and S corporations could be “delegated by the unit holders or shareholders the authority to continue to make all required PFIC filings and elections with the income tax returns filed by the partnership or S corporation.”
Lewis argued that most PFIC shareholders are “small investors” with indirect interests held through domestic partnerships, and the compliance burden would be shifted mainly to those “who have no knowledge of the PFIC rules.” These taxpayers, according to her letter, would have “dramatically” more complicated income tax filings — consequently leading to higher return preparation costs.
A Flood of Forms
Sec. 1298(f) provides that, if those required to file a Form 8621 “Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund (QEF)” fail to do so, the window for tax assessment is extended pursuant to Sec. 6501(c)(8). Further, if a QEF election related to a PFIC isn’t made, gains from the sale of related stock can’t be taxed as long-term capital gains. Affected taxpayers “may not have invested in certain partnerships had they known that they would be personally responsible to comply with the PFIC filing requirements,” per the letter.
According to Lewis, the IRS would also shoulder a greater administrative burden if the regs are adopted as written. She said the agency’s challenges from responding to COVID-19 would be worsened by a possible “flood” in Forms 8621 to process.
The AICPA recommends allowing entities the option to make PFIC filings and elections, including for QEFs and market-to-market elections. An annual consent form could be sent to individual holders confirming that the entity has such authority, the organization suggested. It also suggested that holders of foreign partnerships should have “the same ability” to delegate PFIC filings.
“The proposed regulations ‘move the goalposts’ for existing investors from the standpoint of complex international tax reporting,” Lewis wrote. “Accordingly, if the final regulations adopt the aggregate approach, consideration should be given to ‘grandfathering’ the entity approach for partnerships formed prior to the date that the final regulations come into effect.”
We Can Help
If you believe the proposed PFIC regs could affect your tax situation, contact us and ask for updates on whether the regs will be finalized as is or subject to changes.
The information provided in this communication is of a general nature and should not be considered professional advice. You should not act upon the information provided without obtaining specific professional advice. The information above is subject to change.