Section 1291 Excess Distribution Calculations for PFIC Tax and Interest Reporting

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Section 1291 Excess Distribution Calculations for PFIC Tax and Interest Reporting TUESDAY, JUNE 19, 2018 Daniel Marques, CPA, MT, Principal Drucker & Scaccetti, Philadelphia dmarques@taxwarriors.com Patrick J. McCormick, J.D., LL.M., Principal Drucker & Scaccetti, Philadelphia pmccormick@taxwarriors.com

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Section 1291 Excess Distribution Calculations for PFIC Tax And Interest Reporting Patrick J. McCormick, JD, LLM Daniel J. Marques, CPA, MT

PATRICK J. MCCORMICK Patrick J. McCormick is a principal with Drucker and Scaccetti. He earned his J.D. from Vanderbilt University Law School in 2008, and his LL.M. from New York University School of Law in 2009. Mr. McCormick specializes in and regularly handles matters covering all areas of international taxation, frequently publishing articles and giving presentations on assorted areas of international tax law. 6

INTRODUCTION Rapid globalization has led to significant numbers of clients with international ties. Family members, business interests, assets, etc. Various reporting requirements exist for foreign holdings; Form 8621 is utilized by taxpayers with interests in passive foreign investment companies ( PFIC ). Reporting of these interests under default rules is timeconsuming, tremendously complicated, and costly. 7

THRESHOLD CONSIDERATIONS EXISTENCE OF A PFIC Generally, a foreign corporation is classified as a PFIC pursuant to Section 1297 if it meets either an income test or an asset test Before looking to the asset test or income test, must ascertain whether a foreign corporation exists Entails ascertaining both whether an entity is foreign and whether it is a corporation Sec. 7701(a)(5) a corporation is foreign if it is not domestic Sec. 7701(a)(4) a corporation is domestic if created or organized in the United States or under the law of the United States or any State Look to location of corporation rather than its investments i.e. a foreign corporation with US investments can still be a PFIC 8

THRESHOLD CONSIDERATIONS EXISTENCE OF A PFIC Corporation: by default, a foreign entity which provides limited liability to all members is an association taxable as a corporation; if at least one member does not have limited liability, the foreign entity is classified as either a partnership (if multiple members) or a disregarded entity (if only one member) Whether limited liability exists is fact-specific and involves local law, but it is likely that investment entities will by default be corporations Foreign entities which are not per se corporations can elect their classification for U.S. tax purposes ( eligible entities ) and change the default rules Whether an election is made will often be outside the control of the PFIC holder 9

THRESHOLD CONSIDERATIONS EXISTENCE OF A PFIC If a foreign corporation exists, it will be classified as a PFIC if it meets either an income test or an asset test Income test: 75% or more of a corporation s gross income from its tax year must be passive income Look to financial statements for income information if available Passive income: any income that is of a kind that would be foreign personal holding company income (FPHCI) Subpart F concept - primarily includes income sources such as dividends, interest, royalties, rents, and annuities (if passive) Also includes gains from property sales which generate those types of income, and gains from sales of property which produce no income 10

THRESHOLD CONSIDERATIONS EXISTENCE OF A PFIC Generally, a foreign corporation is classified as a PFIC pursuant to Section 1297 if it meets either an income test or an asset test Asset test: at least 50% of the average percentage of assets held by the foreign corporation during the tax year must be assets that produce passive income or that are held for the production of passive income Passive income uses the same standard as under the income test Foreign corporation may use adjusted basis for determination if (1) the corporation is not publicly traded for the tax year and (2) the corporation is (i) a controlled foreign corporation within the meaning of Section 957, or (ii) makes an election to use adjusted basis 11

THRESHOLD CONSIDERATIONS EXISTENCE OF A PFIC What is considered passive income? Though rents and royalties fall within the scope of FPHCI, an exception exists for active rents and royalties Active rents and royalties rents and royalties received in the active conduct of a trade or business Rents example: real property produces active rents for a lessor if the lessor (through its officers or staff of employees) regularly performs active and substantial management and operational functions Royalties example: property produces active royalties if the licensor (through its officers or staff of employees) has developed, created, or produced it 12

THRESHOLD CONSIDERATIONS EXISTENCE OF A PFIC Obligations generally arise where a United States person owns interests in a foreign corporation which primarily makes passive investments No threshold ownership requirement for application of PFIC rules unlike with other Code provisions (i.e. Subpart F) Companies focused on active operations usually thus are not PFICs Exceptions to PFIC reporting requirements can exist based on the availability/applicability of income tax treaties Always want to check treaties as a result Under Tax Cuts and Jobs Act, new Sec. 245A is inapplicable to distributions from PFICs, as are the deemed repatriation provisions TCJA does not significantly impact PFIC treatment 13

THRESHOLD CONSIDERATIONS EXISTENCE OF A PFIC Specific examples: what is considered a PFIC? Foreign mutual funds are normally classified as PFICs Funds are usually classified as corporations, and make investments which generate passive income Fund s assets are held for the production of passive income Holdings stocks create dividend income, and gains from them are also FPHCI Assets similar to foreign mutual funds are also normally PFICs 14

THRESHOLD CONSIDERATIONS EXISTENCE OF A PFIC Foreign pension plans/retirement plans Pensions typically treated as trusts for U.S. tax purposes, subject to lookthrough rules Many pensions are treated as trusts under foreign law Treatment can hinge on whether plan is classified as a grantor trust Most foreign plans are treated as nonqualified for U.S. tax purposes Foreign retirement plans are treated as foreign trusts Where the sum of employee contributions to the fund exceeds the sum of employer contributions, it can be treated as a foreign grantor trust (at least to the extent of employee contributions) Form 8621 is normally required when treated as a foreign grantor trust Exception can apply for annual reporting for participants in a foreign pension fund which is covered under an income tax treaty 15

THRESHOLD CONSIDERATIONS EXISTENCE OF A PFIC Specific determinations how do you start? Ascertain the type of interest at issue is it in a foreign entity likely classified as a corporation? If not, will not be subject to PFIC regime If an interest in a foreign corporation, looks to its activities Is it generating passive income? Financial statements can be helpful if available Need to evaluate the company s gross income Difficulties can arise with certain types of activities i.e. companies with real estate interests Macro-level where asset is not clearly a PFIC on its face (i.e. with a foreign mutual fund), often will need to do some digging 16

TAXATION OF A PFIC Three options for taxation Default rules under Sec. 1291 Qualified electing fund rules under Secs. 1293/1295 Mark-to-market rules under Sec. 1296 Under Sec. 1291, special tax rules apply to any excess distributions or dispositions related to the PFIC Portion of distributions that are not excess distributions are taxed under normal rules for distributions (Sec. 301) Dividend to the extent of E&P, the applied against basis, then capital gain 17

DEFAULT RULES SECTION 1291 Statutory language (excess distributions): (1) 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 (i) the current year, or (ii) any period in the taxpayer s holding period before the 1 st day of the 1 st taxable year of the company which begins after December 31, 1986, and for which it was a passive foreign investment company, and (C) the tax imposed by this chapter for the current year shall be increased by the deferred tax amount 18

DEFAULT RULES SECTION 1291 Where a taxpayer receives an excess distribution in respect to stock in a PFIC: the amount of the excess distribution shall be allocated ratably to each day in the taxpayer s holding period for the stock; the taxpayer s gross income for the current year shall include (as ordinary income) only the amounts allocable to the current year or any period before the first day of the first tax year of the company which begins after 1986 and for which it was a PFIC; and the tax imposed for the current year will be increased by the deferred tax amount. 19

DEFAULT RULES SECTION 1291 Excess distribution: the part of the distribution received in the current year that is greater than 125% of the average distributions received during the three preceding tax years or, if shorter, the portion of the shareholder s holding period before the current tax year The portion of a PFIC distribution not classified as an excess distribution is taxed under normal rules for corporate distributions 20

DEFAULT RULES SECTION 1291 Statutory language (dispositions): (2) If the taxpayer disposes of stock in a passive foreign investment company, then the rules of paragraph (1) shall apply to any gain recognized on such disposition in the same manner as if such gain were an excess distribution BUT: for purposes of determining gain itself, the normal rules apply: gain equals sales price minus basis Only the gain is subject to the excess distribution rules, rather than the entire amount realized 21

DEFAULT RULES SECTION 1291 Holders of PFICs are subject to tax on any excess distribution or disposition at the top marginal tax rates for individual taxpayers, plus interest amounts calculated based on their holding period All gains are classified as ordinary income Even those that would be classified as capital gains if they were shares in non- PFICs If gain is allocated to prior years, it is taxed at the maximum ordinary income tax rates for that year Tax on the portion of gain allocated to the prior year is subject to an interest charge as if gain was generated in that year 22

DEFAULT RULES SECTION 1291 Cannot carry forward any capital losses incurred in relation to PFICs Importantly, once stock is subject to Sec. 1291, it remains subject to Sec. 1291 even if it no longer meets the PFIC definition unless a purging election is made! Losses from the sale of a PFIC typically are recognized under normal loss rules 23

DANIEL J. MARQUES, CPA, MT Dan is a Principal with Drucker and Scaccetti. He earned his undergraduate degree in business administration from Drexel University with a concentration in accounting and finance. He earned his Master of Taxation from the Villanova Law School Graduate Tax Program where he was awarded the Bartley Medallion in recognition of outstanding achievement in his discipline. Dan focuses on tax planning and compliance for high-net-worth individuals, their families, and their enterprises including the taxation of pass-through entities and foreign disclosurerelated compliance. 24

FORM 8621 - BASICS Filing requirement U.S. person that is a direct or indirect shareholder of a PFIC must file if the U.S. person: Receives certain direct or indirect distributions from a PFIC, Recognizes gain on a direct or indirect disposition of PFIC stock, Is making an election in Part II of Form 8621, Is reporting information with respect to a qualified electing fund (QEF) or mark-tomarket (MTM) election, or Is required to file an annual report under IRC 1298(f) Separate Form 8621 required for each PFIC owned Exception for chain reporting removed by final regulations Form required for direct and indirect ownership in PFIC Definition of Indirect - Treas. Reg. 1.1291-1T(b)(8) Most common indirect ownership Schedule K-1 investment (hedge funds) 25

FORM 8621 FORM PREPARATION GUIDE Type of PFIC/Election All types for all years 1. General information 2. Part I Section 1291 Fund 1. Part V Annually Form 8621 Parts Requiring Completion QEF Election 1. Part II First year of election only (election A, B, D or E) 2. Part III, Lines 6a to 7c Annually 3. Part III, Lines 8a to 9c Only if elected to defer tax (election B) MTM Election 1. Part II First year of election only (election C, D or E) 2. Part IV Annually 26

FORM 8621 GENERAL INFORMATION 1. Identifying number Social security number or EIN of taxpayer filing the form 2. Checkbox If subject to Form 8938 filing requirement, check this box to avoid duplicative reporting of asset information on both forms. Allows taxpayer to simply list the number of Form(s) 8621 filed on Part IV of Form 8938. 3. Reference ID number Required if PFIC has no EIN but can also be used when EIN is present. Number is alphanumeric and determined by the taxpayer. Number must be used consistently for ALL future periods. Who Must Complete All taxpayers with a filing requirement 27

FORM 8621 PART I 1. General: Lines 1-4 make reference to shares but the information should be provided relative to the form of ownership (ex: partnership units) 2. Value: Can rely upon periodic account statements provided at least annually unless have knowledge indicating value in statement does not reflect a reasonable value 3. Income/Loss Information: Information will come from other sections of the form. Who Must Complete All taxpayers with a filing requirement except a shareholder that makes a marked-to-market election under IRC Section 475 (as opposed to IRC Section 1296 covered in this presentation) 28

SECTION 1291 FUND Default PFIC treatment unless elect QEF or MTM (discussed later) Worst case scenario from a tax compliance perspective Goal of Section 1291 Allocate distributions between current and prior years. Distributions applicable to current year are taxed as ordinary income. Distributions applicable to prior years are taxed at the highest income tax rate applicable to the prior year and an interest charge is imposed. 30

SECTION 1291 FUND (CONTINUED) 1. Line 15 Completed for all PFIC(s) considered Section 1291 funds irrespective of when acquired. a) First year of direct ownership: Complete Line 15a only unless there is also a disposition (complete Line 15f & 16) 2. Line 16 Completed for PFIC(s) considered Section 1291 funds with current year distributions that are attributable to shares acquired in prior years. a) First year of direct ownership: Not completed unless there is a disposition Who Must Complete Taxpayers with a Section 1291 fund 31

SECTION 1291 FUND (CONTINUED) Information Needed For Proper Compliance 1. Information relative to original acquisition date and amount paid separated by lot 2. Total distributions in current year on a per-share basis 3. Payment date(s) of current year distributions 4. Total distributions in each of prior 3 years (or lesser number of years if holding period is less) on a per-share basis 5. Information regarding Earnings and Profits of PFIC 32

SECTION 1291 FUND (CONTINUED) Information Needed For Proper Compliance (continued) Information Needed Information relative to original acquisition date and amount paid separated by lot Total distributions in current year on a per-share basis Payment date(s) of current year distributions Total distributions in each of prior 3 years (or lesser number of years if holding period is less) on a pershare basis Information regarding Earnings and Profits of PFIC Practical Location of Information The client or broker s records Distributions from account statements and per share amount manually determined Account statements Distributions from account statements and per share amount manually determined Investor relations website of company 33

SECTION 1291 FUND (CONTINUED) Calculations Covered In Following Examples 1. Single acquisition of PFIC stock with single current year distribution 2. Single acquisition of PFIC stock with multiple current year distributions 3. Multiple acquisitions of PFIC stock with single current year distribution 4. Multiple acquisitions of PFIC stock with multiple current year distributions Note: All examples are for distributions from a PFIC considered a Section 1291 fund. Gain/loss recognized on the disposition of a Section 1291 fund is automatically subject to the excess distribution allocation, deferred tax and interest. See steps 3 & 4 on the next slide & Example #1. 34

SECTION 1291 FUND (CONTINUED) Steps to Perform Required Calculations (Single Acquisition/Distribution) 1. Determine nonexcess distribution 2. Determine excess distribution 3. Allocate excess distribution across holding period on per-day basis ending on distribution date 4. Calculate deferred tax & interest on excess distributions allocated to prior years 35

SECTION 1291 FUND (CONTINUED) Example #1 - Single Acquisition/Distribution Taxpayer holds 6 shares of XYZ Corp, a Section 1291 fund. The Taxpayer acquired 6 shares on 12/31/2014. XYZ Corp made distributions of $10,000/share on 6/30/2015 and 6/30/2016. No portion of the distributions in 2015 and 2016 were considered excess distributions. On 6/30/2017, XYZ Corp distributed $30,000/share. Assume XYZ Corp has current year earnings and profits. Assume Taxpayer is in highest Federal tax bracket. Compute the tax consequences under Section 1291 for the 2017 tax year. 36

SECTION 1291 FUND (CONTINUED) Example #1 - Single Acquisition/Distribution (continued) Information Summary Acquisition Date 1/1/2015 # of Shares 6 Distribution 6 shs * $10,000 6/30/2015 = $60,000 Distribution 6 shs * $10,000 6/30/2016 = $60,000 Distribution 6/30/2017 6 shs * $30,000 = $180,000 Step #1 - Determine nonexcess distributions Distribution 6/30/2015 $ 60,000 Distribution 6/30/2016 $ 60,000 Total Prior Year Distributions (A) $ 120,000 - Form 8621, Part V, Line 15b # of Tax Years in Holding Period (B) 2 Average Distributions (C = A B) $ 60,000 - Form 8621, Part V, Line 15c Nonexcess distribution (C x 125%)*** $ 75,000 - Form 8621, Part V, Line 15d ***Assumption of current year earnings and profits means the nonexcess distribution should be treated as an ordinary dividend in the current year. Step #2 - Determine excess distributions Current year distribution (6/30/2017) $ 180,000 - Form 8621, Part V, Line 15a Nonexcess distribution determined in Step #1 $ (75,000) Excess Distribution $ 105,000 - Form 8621, Part V, Line 15e & Form 8621, Part I, Line 5(a) 38

SECTION 1291 FUND (CONTINUED) Example #1 - Single Acquisition/Distribution (continued) Step #3 - Allocate excess distribution across holding period Excess distribution calculated in Step #2 $ 105,000 Information Summary Acquisition Date 1/1/2015 # of Shares 6 Distribution 6 shs * $10,000 6/30/2015 = $60,000 Distribution 6 shs * $10,000 6/30/2016 = $60,000 Distribution 6/30/2017 6 shs * $30,000 = $180,000 2015 days in holding period (acquired 1/1/2015) 365 2016 days in holding period 366 2017 days in holding period (dividend date 6/30/2017) 181 Total days in holding period 912 Excess distribution on a per-day basis $ 115.13 2015 excess distribution $ 42,022 2016 excess distribution $ 42,138 2017 excess distribution*** $ 20,840 - Form 8621, Part V, Line 16b $ 105,000 ***Excess distribution allocated to current year is treated as ordinary income. 39

SECTION 1291 FUND (CONTINUED) Example #1 - Single Acquisition/Distribution (continued) Step #3 - Allocate excess distribution across holding period Excess distribution calculated in Step #2 $ 105,000 2015 days in holding period (acquired 1/1/2015) 365 2016 days in holding period 366 2017 days in holding period (dividend date 6/30/2017) 181 Total days in holding period 912 Excess distribution on a per-day basis $ 115.13 2015 excess distribution $ 42,022 2016 excess distribution $ 42,138 2017 excess distribution*** $ 20,840 $ 105,000 Step #4 - Calculate deferred tax & interest on excess distributions allocated to prior years 2015 excess distribution allocated in Step #3 $ 42,022 Highest Tax Rate 39.60% Deferred tax $ 16,641 Interest - 4/18/2016 to 4/17/2018 $ 1,391 2016 excess distribution allocated in Step #3 $ 42,138 Highest tax rate 39.60% Deferred tax $ 16,687 Interest - 4/17/2017 to 4/17/2018 $ 689 Total deferred tax $ 33,328 - Form 8621, Part V, Line 16c Total interest $ 2,080 - Form 8621, Part V, Line 16f ***Excess distribution allocated to current year is treated as ordinary income. 40

SECTION 1291 FUND (CONTINUED) Example #1 - Single Acquisition/Distribution (continued) Summary of Tax Consequences: Ordinary dividends from nonexcess distribution $ 75,000 Other income from current year excess distribution $ 20,840 Ordinary income recognized on tax return $ 95,840 2017 tax rate (ignores NIIT) 39.6% Tax due on ordinary income recognition $ 37,953 Deferred tax $ 33,328 Interest on deferred tax $ 2,080 Total tax and interest due with 2017 tax return $ 73,361 41

SECTION 1291 FUND (CONTINUED) Steps to Perform Required Calculations (Single Acquisition/Multiple Distributions) 1. Determine nonexcess distribution 2. Determine excess distribution 3. Allocate excess distribution pro-rata to current year distribution dates based upon current year distribution amounts 4. Allocate excess distribution across holding period on per-day basis ending on distribution date 5. Calculate deferred tax & interest on excess distributions allocated to prior years 42

SECTION 1291 FUND (CONTINUED) Example #2 - Single Acquisition/Multiple Distributions Same facts as Example #1 except 2017 distributions were as follows: 1/31/2017 = $7,500/share 7/31/2017 = $22,500/share Information Summary Acquisition Date 1/1/2015 # of Shares 6 Distribution 6 shs * $10,000 6/30/2015 = $60,000 Distribution 6 shs * $10,000 6/30/2016 = $60,000 Distribution 6 shs * $7,500 1/31/2017 = $45,000 Distribution 7/31/2017 6 shs * $22,500 = $135,000 43

SECTION 1291 FUND (CONTINUED) Example #2 - Single Acquisition/Multiple Distributions (continued) Information Summary Acquisition Date 1/1/2015 # of Shares 6 Distribution 6 shs * $10,000 6/30/2015 = $60,000 Distribution 6 shs * $10,000 6/30/2016 = $60,000 Distribution 6 shs * $7,500 1/31/2017 = $45,000 Distribution 7/31/2017 Steps #1 & #2 are identical to Example #1 except accounting for two current year distributions instead of one. 6 shs * $22,500 = $135,000 Step #1 - Determine nonexcess distributions Distribution 6/30/2015 $ 60,000 Distribution 6/30/2016 $ 60,000 Total Prior Year Distributions (A) $ 120,000 - Form 8621, Part V, Line 15b # of Tax Years in Holding Period (B) 2 Average Distributions (C = A B) $ 60,000 - Form 8621, Part V, Line 15c Nonexcess distribution (C x 125%)*** $ 75,000 - Form 8621, Part V, Line 15d ***Assumption of current year earnings and profits means the nonexcess distribution should be treated as an ordinary dividend in the current year. Step #2 - Determine excess distributions Current year distribution (1/31/2017) $ 45,000 Current year distribution (7/31/2017) $ 135,000 Total current year distributions $ 180,000 - Form 8621, Part V, Line 15a Nonexcess distribution determined in Step #1 $ (75,000) Excess Distribution $ 105,000 - Form 8621, Part V, Line 15e & Form 8621, Part I, Line 5(a) 44

SECTION 1291 FUND (CONTINUED) Example #2 - Single Acquisition/Multiple Distributions (continued) Step #3 - Allocate excess distribution pro-rata to current year distribution dates based upon current year distributions Total excess distribution $ 105,000 Pro-rata % Allocation Distribution 1/31/2017 $ 45,000 25.00% $ 26,250 Distribution 7/31/2017 $ 135,000 75.00% $ 78,750 Total current year distributions $ 180,000 100.00% $ 105,000 Step #3 is new while Step #4 is is the same as Example #1, Step #3 except the calculation is performed separately for each distribution Step #4 - Allocate excess distribution across holding period Distribution 1/31/2017 Distribution 7/31/2017 Total Excess distribution allocated in Step #3 $ 26,250 $ 78,750 $ 105,000 2015 days in holding period 365 365 2016 days in holding period 366 366 2017 days in holding period 31 212 Total days in holding period 762 943 Excess distribution on a per-day basis $ 34.45 $ 83.51 2015 excess distribution $ 12,574 $ 30,481 $ 43,055 2016 excess distribution $ 12,609 $ 30,565 $ 43,174 2017 excess distribution*** $ 1,067 $ 17,704 $ 18,771 - Form 8621, Part V, Line 16b $ 26,250 $ 78,750 $ 105,000 ***Excess distribution allocated to current year is treated as ordinary income. 45

SECTION 1291 FUND (CONTINUED) Example #2 - Single Acquisition/Multiple Distributions (continued) Step #5 is the same as Example #1, Step #4 Step #5 - Calculate deferred tax & interest on excess distributions allocated to prior years Total 2015 excess distribution computed in Step #4 $ 43,055 Highest Tax Rate 39.60% Deferred tax $ 17,050 Interest - 4/18/2016 to 4/17/2018 $ 1,425 2016 excess distribution computed in Step #4 $ 43,174 Highest tax rate 39.60% Deferred tax $ 17,097 Interest - 4/17/2017 to 4/17/2018 $ 706 Total deferred tax $ 34,147 - Form 8621, Part V, Line 16c Total interest $ 2,131 - Form 8621, Part V, Line 16f 46

SECTION 1291 FUND (CONTINUED) Example #2 - Single Acquisition/Multiple Distributions (continued) Summary of Tax Consequences: Total Ordinary dividends from nonexcess distribution $ 75,000 Other income from current year excess distribution $ 18,771 Ordinary income recognized on tax return $ 93,771 2017 tax rate (ignores NIIT) 39.60% Tax due on ordinary income recognition $ 37,133 Deferred tax $ 34,147 Interest on deferred tax $ 2,131 Total tax and interest due with 2017 tax return $ 73,411 47

SECTION 1291 FUND (CONTINUED) Steps to Perform Required Calculations (Multiple Acquisition/Single Distribution) 1. Segregate information by lot based upon date acquired (Blocks) 2. Determine nonexcess distribution for each Block 3. Determine excess distribution for each Block 4. Allocate excess distribution across holding period on per-day basis ending on distribution date 5. Calculate deferred tax & interest on excess distributions allocated to prior years 48

SECTION 1291 FUND (CONTINUED) Example #3 - Multiple Acquisitions/Single Distribution Same facts as Example #1 except original acquisition of shares are: 1/1/2015 = 2 shares 1/1/2016 = 4 shares Step #1 - Segregate information by lot based upon date acquired Block #1 Block #2 Acquisition Date 1/1/2015 1/1/2016 # of Shares 2 4 Distribution 6/30/2015 2 shs * $10,000 = $20,000 N/A Distribution 6/30/2016 2 shs * $10,000 = $20,000 4 shs * $10,000 = $40,000 Distribution 6/30/2017 2 shs * $30,000 = $60,000 4 shs * $30,000 = $120,000 49

SECTION 1291 FUND (CONTINUED) Example #3 - Multiple Acquisitions/Single Distribution (continued) Step #2 - Determine nonexcess distributions Block #1 Block #2 Total Distribution 6/30/2015 $ 20,000 Distribution 6/30/2016 $ 20,000 $ 40,000 Total Prior Year Distributions (A) $ 40,000 $ 40,000 $ 80,000 - Form 8621, Part V, Line 15b # of Tax Years in Holding Period (B) 2 1 Average Distributions (C = A B) $ 20,000 $ 40,000 $ 60,000 - Form 8621, Part V, Line 15c Nonexcess distribution (C x 125%)*** $ 25,000 $ 50,000 $ 75,000 - Form 8621, Part V, Line 15d ***Assumption of current year earnings and profits means the nonexcess distribution for each block of shares should be treated as an ordinary dividend in the current year. Step #3 - Determine excess distributions Block #1 Block #2 Current year distribution (6/30/2017) $ 60,000 $ 120,000 - Form 8621, Part V, Line 15a Nonexcess distribution determined in Step #2 $ (25,000) $ (50,000) Excess Distribution $ 35,000 $ 70,000 - Form 8621, Part V, Line 15e & Form 8621, Part I, Line 5(a) 50

SECTION 1291 FUND (CONTINUED) Example #3 - Multiple Acquisitions/Single Distribution (continued) Step #4 - Allocate excess distribution across holding period Block #1 Block #2 Total Excess distribution calculated in Step #3 $ 35,000 $ 70,000 $ 105,000 2015 days in holding period 365 2016 days in holding period 366 366 2017 days in holding period 181 181 Total days in holding period 912 547 Excess distribution on a per-day basis $ 38.38 $ 127.97 2015 excess distribution $ 14,009 $ 14,009 2016 excess distribution $ 14,047 $ 46,837 $ 60,884 2017 excess distribution*** $ 6,944 $ 23,163 $ 30,107 - Form 8621, Part V, Line 16b $ 35,000 $ 70,000 $ 105,000 ***Excess distribution allocated to current year is treated as ordinary income. 51

SECTION 1291 FUND (CONTINUED) Example #3 - Multiple Acquisitions/Single Distribution (continued) Step #5 - Calculate deferred tax & interest on excess distributions allocated to prior years Total 2015 excess distribution computed in Step #4 $ 14,009 Highest Tax Rate 39.60% Deferred tax $ 5,548 Interest - 4/18/2016 to 4/17/2018 $ 464 2016 excess distribution computed in Step #4 $ 60,884 Highest tax rate 39.60% Deferred tax $ 24,110 Interest - 4/17/2017 to 4/17/2018 $ 996 Summary of Tax Consequences: Total Ordinary dividends from nonexcess distribution $ 75,000 Other income from current year excess distribution $ 30,107 Ordinary income recognized on tax return $ 105,107 2017 tax rate (ignores NIIT) 39.60% Tax due on ordinary income recognition $ 41,622 Deferred tax $ 29,658 Interest on deferred tax $ 1,460 Total tax and interest due with 2017 tax return $ 72,740 Total deferred tax $ 29,658 - Form 8621, Part V, Line 16c Total interest $ 1,460 - Form 8621, Part V, Line 16f 52

SECTION 1291 FUND (CONTINUED) Steps to Perform Required Calculations (Multiple Acquisition/Distribution) 1. Segregate information by lot based upon date acquired (Blocks) 2. Determine nonexcess distribution for each Block 3. Determine excess distribution for each Block 4. Total excess distributions from each individual Block and allocate total pro-rata to current year distribution dates based upon current year distribution amounts 5. Allocate excess distribution across holding period on per-day basis ending on distribution date 6. Calculate deferred tax & interest on excess distributions allocated to prior years 53

SECTION 1291 FUND (CONTINUED) Example #4 - Multiple Acquisitions & Distributions Same facts as Example #1 except original acquisition of shares and current year distributions are: Original Acquisitions: 1/1/2015 = 2 shares 1/1/2016 = 4 shares Current Year Distributions: 1/31/2017 = $7,500/share 7/31/2017 = $22,500/share Step #1 - Segregate information by lot based upon date acquired Block #1 Block #2 Acquisition Date 1/1/2015 1/1/2016 # of Shares 2 4 Distribution 6/30/2015 2 shs * $10,000 = $20,000 N/A Distribution 6/30/2016 2 shs * $10,000 = $20,000 4 shs * $10,000 = $40,000 Distribution 1/31/2017 2 shs * $7,500 = $15,000 4 shs * $7,500 = $30,000 Distribution 7/31/2017 2 shs * $22,500 = $45,000 4 shs * $22,500 = $90,000 54

SECTION 1291 FUND (CONTINUED) Example #4 - Multiple Acquisitions & Distributions (continued) Step #2 - Determine nonexcess distributions Block #1 Block #2 Total Distribution 6/30/2015 $ 20,000 Distribution 6/30/2016 $ 20,000 $ 40,000 Total Prior Year Distributions (A) $ 40,000 $ 40,000 $ 80,000 - Form 8621, Part V, Line 15b # of Tax Years in Holding Period (B) 2 1 Average Distributions (C = A B) $ 20,000 $ 40,000 $ 60,000 - Form 8621, Part V, Line 15c Nonexcess distribution (C x 125%)*** $ 25,000 $ 50,000 $ 75,000 - Form 8621, Part V, Line 15d ***Assumption of current year earnings and profits means the nonexcess distribution for each block of shares should be treated as an ordinary dividend in the current year. Step #3 - Determine excess distributions Block #1 Block #2 Total Current year distribution (1/31/2017) $ 15,000 $ 30,000 $ 45,000 Current year distribution (7/31/2017) $ 45,000 $ 90,000 $ 135,000 Total current year distributions $ 60,000 $ 120,000 $ 180,000 - Form 8621, Part V, Line 15a Nonexcess distribution determined in Step #2 $ (25,000) $ (50,000) $ (75,000) Excess Distribution $ 35,000 $ 70,000 $ 105,000 - Form 8621, Part V, Line 15e & Form 8621, Part I, Line 5(a) 55

SECTION 1291 FUND (CONTINUED) Example #4 - Multiple Acquisitions & Distributions (continued) Step #4 - Allocate excess distribution pro-rata to current year distribution dates Distribution Pro-Rata Determination: Distributions Pro-rata % Distribution 1/31/2017 $ 45,000 25.00% Distribution 7/31/2017 $ 135,000 75.00% Total current year distributions $ 180,000 100.00% Excess Dist Dist 1/31/17 Dist 7/31/17 Block #1 - Excess distribution allocation (%'s above) $ 35,000 $ 8,750 $ 26,250 Block #2 - Excess distribution allocation (%'s above) $ 70,000 $ 17,500 $ 52,500 Total excess distribution $ 105,000 $ 26,250 $ 78,750 56

SECTION 1291 FUND (CONTINUED) Example #4 - Multiple Acquisitions & Distributions (continued) Step #5 - Allocate excess distribution across holding period Block #1-1/1/2015 Block #2-1/1/2016 Total Distribution 1/31/2017 Distribution 7/31/2017 Distribution 1/31/2017 Distribution 7/31/2017 Excess distribution calculated in Step #4 $ 8,750 $ 26,250 $ 17,500 $ 52,500 $ 105,000 2015 days in holding period 365 365 2016 days in holding period 366 366 366 366 2017 days in holding period 31 212 31 212 Total days in holding period 762 943 397 578 Excess distribution on a per-day basis $ 11.48 $ 27.84 $ 44.08 $ 90.83 2015 excess distribution $ 4,190 $ 10,162 $ 14,352 2016 excess distribution $ 4,202 $ 10,189 $ 16,133 $ 33,244 $ 63,768 2017 excess distribution*** $ 358 $ 5,899 $ 1,367 $ 19,256 $ 26,880 - Form 8621, Part V, Line 16b $ 8,750 $ 26,250 $ 17,500 $ 52,500 $ 105,000 ***Excess distribution allocated to current year is treated as ordinary income. 57

SECTION 1291 FUND (CONTINUED) Example #4 - Multiple Acquisitions & Distributions (continued) Step #6 - Calculate deferred tax & interest on excess distributions allocated to prior years Total 2015 excess distribution computed in Step #5 $ 14,352 Highest Tax Rate 39.60% Deferred tax $ 5,683 Interest - 4/18/2016 to 4/17/2018 $ 475 2016 excess distribution computed in Step #5 $ 63,768 Highest tax rate 39.60% Deferred tax $ 25,252 Interest - 4/17/2017 to 4/17/2018 $ 1,043 Total deferred tax $ 30,935 - Form 8621, Part V, Line 16c Total interest $ 1,518 - Form 8621, Part V, Line 16f 58

SECTION 1291 FUND (CONTINUED) Example #4 - Multiple Acquisitions & Distributions (continued) Summary of Tax Consequences: Total Ordinary dividends from nonexcess distribution $ 75,000 Other income from current year excess distribution $ 26,880 Ordinary income recognized on tax return $ 101,880 2017 tax rate (ignores NIIT) 39.60% Tax due on ordinary income recognition $ 40,344 Deferred tax $ 30,935 Interest on deferred tax $ 1,518 Total tax and interest due with 2017 tax return $ 72,797 59

SECTION 1291 FUND (CONTINUED) Practical Considerations Example #1 Example #2 Example #3 Example #4 Ordinary dividends from nonexcess distribution $ 75,000 $ 75,000 $ 75,000 $ 75,000 Other income from current year excess distribution $ 20,840 $ 18,771 $ 30,107 $ 26,880 Ordinary income recognized on tax return $ 95,840 $ 93,771 $ 105,107 $ 101,880 2017 tax rate (ignores NIIT) 39.6% 39.6% 39.6% 39.6% Tax due on ordinary income recognition $ 37,953 $ 37,133 $ 41,622 $ 40,344 Deferred tax $ 33,328 $ 34,147 $ 29,658 $ 30,935 Tax before interest $ 71,281 $ 71,280 $ 71,280 $ 71,279 Interest on deferred tax $ 2,080 $ 2,131 $ 1,460 $ 1,518 Total tax and interest due with 2017 tax return $ 73,361 $ 73,411 $ 72,740 $ 72,797 60

SECTION 1291 FUND (CONTINUED) Practical Considerations (continued) 1. If you own/acquire a PFIC, make an election in the year of acquisition! 2. Do not directly invest in a pass-through entity (most commonly a hedge fund) that invests in PFIC(s). Instead, invest in the pass-through entity via an IRA. The IRA is not subject to the insanity of Section 1291. 61

SECTION 1291 FUND (CONTINUED) Practical Considerations (continued) 3. If filing requirement is arising out of investment in passthrough entity, read all footnotes carefully. Have to file Form 8621 but must be careful not to double-count income. 62

SECTION 1291 FUND (CONTINUED) Practical Considerations (continued) 3. If filing requirement is arising out of investment in passthrough entity, read all footnotes carefully. Partnership made QEF election and no further Form 8621 is required. 63

QEF ELECTION SECTIONS 1295 AND 1293 PFICs are treated as a qualifying electing fund with respect to a taxpayer if: An election by the taxpayer applies to the company for the taxable year, and The company complies with requirements for determining the ordinary earning and net capital gain of the company and otherwise carries out the purposes of the QEF provisions. Taxpayer who owns stock in a QEF includes in gross income: as ordinary income, their pro rata share of the ordinary earnings of the fund for the year, and as long-term capital gain, their pro rata share of the net capital gain of the fund for the year. 66

QEF ELECTION SECTION 1293 Taxpayer may make a QEF election with respect to any PFIC for any taxable year; once made, election shall apply to all subsequent years unless revoked (requiring consent of the Secretary) In order for election to be made, the PFIC must comply with reporting requirements imposed by the United States PFIC Annual Information Statement is needed from the PFIC PFIC Annual Information Statement statement of the PFIC that contains specified information delineated in the Regulations; permits the shareholder to determine his/her pro rata share of income Includes shareholder-specific information i.e. shareholder s pro rata share of the ordinary earnings and net capital gain of the PFIC for the taxable year If required information not included, election cannot be made statement is prerequisite for election 67

QEF ELECTION SECTION 1293 QEF Election made on Form 8621 If an election is made which does not meet QEF election requirements (i.e. no PFIC Annual Information Statement), the PFIC is taxed under the default rules If election is determined to be invalid on Service review, the Service may either terminate or invalidate the election Invalidation treated as if QEF election never made, so all years for which election was attempted are taxed under default method Termination only prospective years taxed under default method 68

ELECTIONS TAX COMPLIANCE Who Must Complete Completed in first year of any applicable election 69

ELECTIONS TAX COMPLIANCE (CONTINUED) QEF Election Election A Election Requirements 1. Election must be made by first U.S. person in chain of ownership 2. Election must be made for each individual PFIC (irrevocable) 3. To elect, PFIC must provide Annual Information Statement or Annual Intermediary Statement see Treas. Reg. Section 1.1295-1(g) a) This requirement is typically what causes a PFIC to be ineligible for the QEF election b) Check investor relations website of PFIC to determine if statement issued annually 70

ELECTIONS TAX COMPLIANCE (CONTINUED) QEF Election Election A (continued) Example of PFIC Annual Information Statement 71

ELECTIONS TAX COMPLIANCE (CONTINUED) QEF Election Election A (continued) When to make election? 1. PFIC satisfies annual statement requirement First year of ownership 2. PFIC does not satisfy annual statement requirement but does so in a later year First year PFIC satisfies the requirement a) Suggest retroactive election (described below) for non-qef years to remove the Section 1291 taint moving forward 3. Retroactive election available if performed in conjunction with deemed sale election (Election D) or deemed dividend election (Election E) 72

ELECTIONS TAX COMPLIANCE (CONTINUED) QEF Election Election A (continued) How to make election? 1. Form 8621, Part II Check box A 2. Form 8621, Part III Complete lines 6a to 7c What is required for continuing compliance? 1. File Form 8621 annually completing Part I, II and III (lines 6a to 7c) 2. Maintain all Form(s) 8621 filed for all years and associated supporting documentation (PFIC annual information statement) indefinitely. 73

ELECTIONS TAX COMPLIANCE (CONTINUED) QEF Election Election A (continued) 1. Lines 6a-7c Completed for all years PFIC is a QEF 2. Lines 8a-9c Completed in year PFIC elects to defer tax on QEF earnings (Election B) 3. Sum of Line 6c and 7c is also entered on Form 8621, Part I, Line 5(b) Who Must Complete Taxpayers making a QEF election 74

ELECTIONS TAX COMPLIANCE (CONTINUED) QEF Election Election A (continued) Tax Consequences 1. Pro-rata share of ordinary earnings Ordinary Income 2. Pro-rata share of net capital gains Long-term capital gain 3. Distributions: a) Distribution < Previously Taxed Amounts Non-taxable b) Distribution > Previously Taxed Amounts IRC Section 301 rules 4. Sale of shares Capital gain or loss if capital asset 75

ELECTIONS TAX COMPLIANCE (CONTINUED) QEF Election Election A (continued) Other considerations? 1. Basis of PFIC shares: a) Increased by earnings included in income b) Decreased by distributions of previously taxed amounts 2. QEF election is automatically terminated if marked-to-market (MTM) election is made under any provision of the Internal Revenue Code 76

MARK-TO-MARKET ELECTION SECTION 1296 For marketable stock in a PFIC owned by a U.S. person, a mark-tomarket election may be made If the fair market value of the stock as of the close of the taxable year exceeds its adjusted basis, the taxpayer includes in gross income an amount equal to the amount of the excess; If the adjusted basis of the stock exceeds the fair market value of the stock as of the close of the taxable year, a deduction is allowed equal to the lesser of The amount of the excess, or The unreversed inclusions with respect to the stock. 77

MARK-TO-MARKET ELECTION SECTION 1296 Election only available for marketable stock generally defined as PFIC stock regularly traded on a securities exchange Mark-to-market gains are treated as ordinary income; losses can be recognized, but only to the extent of prior gains Essentially are treated as selling the stock at the end of each year Unreversed inclusions get increased annually by amount of gain reported, and decreased by the amount of losses (but never below zero) Election made on Form 8621 78

ELECTIONS TAX COMPLIANCE (CONTINUED) MTM Election Election C Election Requirements 1. Can only be made for marketable stock (see prior slide, IRC Section 1296(e) and Treas. Reg. 1.1296-2) 2. In first year of election, must treat any appreciation as the disposition of a Section 1291 fund (Excess Distribution See slide 29) a) Tip If the election is made in the first year of ownership, the excess distribution is always zero and thus no complicated calculation required When to make election? 1. Made in the year the Taxpayer wishes to apply it. 2. Retroactive election Available only via what is commonly known as Section 9100 relief (Treas. Regs. 301-9100-1 through -3) 79

ELECTIONS TAX COMPLIANCE (CONTINUED) MTM Election Election C (continued) How to make the election? 1. Form 8621, Part II Check box C 2. Election made in 1 st Year of Ownership Form 8621, Part IV 3. Election made in other than first year of ownership Form 8621, Part V What is required for continuing compliance? File Form 8621 annually completing Part I, II and IV 80

ELECTIONS TAX COMPLIANCE (CONTINUED) MTM Election Election C (continued) 1. Lines 10a-12 Completed for all years PFIC is MTM a) Unreversed inclusion means gains recognized in prior years net of losses recognized in prior years. Losses are limited to gains previously recognized. 2. Lines 13-14c Completed in years where PFIC stock for which a MTM election applies is sold 3. Sum of lines 10c and 12 should also be included on Form 8621, Part I, Line 5(c) Who Must Complete Taxpayers making a MTM election 81

ELECTIONS TAX COMPLIANCE (CONTINUED) MTM Election Election C (continued Tax Consequences 1. Increase in value Ordinary Income 2. Decrease in value: a) Loss to the extent of current and prior income inclusions Ordinary b) Loss in excess of current and prior income inclusions Disallowed 3. Distributions IRC Section 301 rules 4. Sale of shares: a) Gain Ordinary income b) Loss: i. To extent of current and prior income inclusions Ordinary ii. In excess of current and prior income inclusions Capital 82

ELECTIONS TAX COMPLIANCE (CONTINUED) MTM Election Election C (continued) Other considerations? 1. Basis of PFIC shares: a) Direct owner Generally increased/decreased by gains/losses recognized b) Indirect owner Special rules apply under Treas. Reg. Section 1.1296-1(d)(2) 83

COMPARISON OF TAX OPTIONS Normally, when available, election for QEF treatment will give the best result However, need to obtain a PFIC Annual Information Statement, which can be problematic for certain PFICs (i.e. foreign mutual funds) Foreign entity may not want to comply with requirements for specific shareholders Mark-to-market election provides an alternate approach which is normally preferable to default rules, but also may not be available (if not publicly traded stock) End result can sometimes be that there is no other option aside from the default rules If this is the case, need to question whether holding the PFIC makes sense 84

PURGING ELECTION FOR PFICS Ideally want to elect QEF treatment in the year of acquisition of the PFIC However, existence of a PFIC is only discerned after holding it for years i.e. taxpayer reported the PFIC on their United States tax return similarly to how domestic income would be reported, or believed they had no current reporting requirement (because no dividends/sales) When an election is required in a year after acquisition of the PFIC interest, any gain which has accrued in the PFIC must be purged Typically cannot make a late election applicable to prior years 85

PURGING ELECTION FOR PFICS Purging election either a deemed sale election or a deemed dividend election Deemed sale election PFIC is treated as sold under the default rules provided by Sec. 1291 (taxed as an excess distribution) as of the beginning of the tax year Can be made by a U.S. person that elects to treat a PFIC as a QEF for a foreign corporation s tax year following its first tax year as a PFIC included in the shareholder s holding period Deemed dividend election treated as received a dividend (taxed under Sec. 1291 as an excess distribution) equal to the pro rata share of post-1986 earnings and profits of the PFIC as of the beginning of the tax year Can be made by a U.S. person that elects to treats a PFIC which is also a controlled foreign corporation as a QEF for the foreign corporation s tax year following its first tax year as a PFIC included in the shareholder s holding period 86