Are Prior Year PFIC Gains Excluded from Current-Year Income

Prior Year PFIC Gains are Excluded from Current Income

Prior Year PFIC Gains are Excluded from Income in the Current Year

When it comes to international tax, one of the most complicated aspects of tax and reporting involves PFIC — which refers to Passive Foreign Investment Companies. These are the types of companies in which either the assets or the income is primarily ‘passive.’ Oftentimes, PFIC tax laws can sneak up on unsuspecting taxpayers and result in significant tax liabilities. In a now all too familiar situation, a US Taxpayer who owns foreign passive investments such as mutual funds or ETFs may become subject to the PFIC regime tax, and may end up owing twice or even triple (if not more) the tax rate of other similarly situated US assets. One of the most important aspects of PFIC is to determine what PFIC is taxable and how missed income may relate to the statute of limitations. In general, while current-year PFIC income is taxable, prior-year gains are generally excluded from current-year income for 6501(e) purposes. Let’s take a brief look at the Toso Tax Court case, which dealt with this issue directly:

PFIC 26 1291(a)(1)(B)

• • • (a) Treatment of distributions and stock dispositions

      • (1) Distributions If a United States person receives an excess distribution in respect of stock in a passive foreign investment company, then—

        • (A) the amount of the excess distribution shall be allocated ratably to each day in the taxpayer’s holding period for the stock,

        • (B )with respect to such excess distribution, the taxpayer’s gross income for the current year shall include (as ordinary income) only the amounts allocated under subparagraph (A) to—

          • the current year, or

          • (any period in the taxpayer’s holding period before the 1st day of the 1st taxable year of the company which begins after December 31, 1986, and for which it was a passive foreign investment company

Current vs Prior Year

Here is where it can get infinitely more complicated — especially when it comes to prior-year (undistributed) excess distribution calculations. When it comes to PFIC income, current-year income is allocated on the tax return and included as additional income (Schedule 1). Thus, when conducting the PFIC analysis, you allocate the current year’s income separate from the prior year’s excess distributions so that your current year’s income is taxed at your progressive tax rate. When it comes to prior-year excess distributions it is not treated the same as your current-year income. Instead, it is taxable at the highest tax rate, as well as interest for the prior years.

6501 Statute of Limitations

• • • (e) Substantial omission of items

      • Except as otherwise provided in subsection (c)—

        • (1) Income taxes In the case of any tax imposed by subtitle A—

          • General rule

            • If the taxpayer omits from gross income an amount properly includible therein and—

              • such amount is in excess of 25 percent of the amount of gross income stated in the return, or

                • such amount—

                  • (I)is attributable to one or more assets with respect to which information is required to be reported under section 6038D (or would be so required if such section were applied without regard to the dollar threshold specified in subsection (a) thereof and without regard to any exceptions provided pursuant to subsection (h)(1) thereof), and

                  • (ii) is in excess of $5,000,

      • the tax may be assessed, or a proceeding in court for collection of such tax may be begun without assessment, at any time within 6 years after the return was filed.

Prior Year Not Included in 6501(e)(1)(A)(i)

Since the prior year PFIC gains are not included for income purposes in the current year, it impacts 6501(e).  In determining whether the 3-Year Statute of Limitations applies or if the “in excess of 25% of the amount of gross income” prior-year PFIC gain include is generally not included in the income calculated – as laid out in the Toso case.

Current Year vs Prior Year Non-Compliance

Once a taxpayer missed the pension 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 that specializes exclusively in these types of offshore disclosure matters.

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