INSIGHTS AND RESOURCES
Proposed PFIC regulations revise reporting by US partnerships
TAX ALERT |
Authored by RSM US LLP
On Jan. 24, 2022, the IRS issued proposed regulations (REG-118250-20) that would eliminate the Form 8621 (Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund) reporting obligations for U.S. partnerships and allow partners in a U.S. partnership to make QEF, MTM and purging elections. The proposed regulations also address the section 1297(d) CFC/PFIC overlap rule. The regulations clarify that U.S. partners that own less than 10% in a CFC indirectly through a U.S. partnership cannot avoid the PFIC regime through an application of section 1297(d). The proposed changes reflect the shift toward treating U.S. partnerships as aggregates and were designed to align the PFIC rules to the revised treatment of U.S. partnerships under section 951A and subpart F. The proposed revisions also apply to S corporations.
Partnerships that did not report PFIC information to less than 10% U.S. shareholders (perhaps, relying on an application of the CFC/PFIC overlap rule) should review their foreign holdings and perform a PFIC analysis on an annual basis. U.S. and foreign partnerships must provide PFIC information to partners on a go forward basis as a result of the new K-2 and K-3 Schedules filing requirement. If it is determined that there are PFICs in the structure with U.S. partners owning less than 10% indirectly in the PFICs, taxpayers may want to consider making retroactive QEF elections, or purging elections followed by a QEF election. See below for a more detailed discussion of the current and proposed regulations.
Current PFIC reporting
Section 1298(f) imposes a reporting requirement on each U.S. person who is a shareholder of a passive foreign investment company (PFIC). For section 1298(f) reporting purpose, a U.S. partnership is treated as an entity and classified as a shareholder if it owns (directly or indirectly) stock in a PFIC.
A U.S. partner that owns shares in a PFIC indirectly through a U.S. partnership is also classified as a shareholder and has a duplicative Form 8621 filing obligation where the shareholder:
- receives an excess distribution within the meaning of section 1291(b);
- recognizes gain as an excess distribution, within the meaning of section 1291(a)(2), as a result of a disposition of the PFIC;
- has a qualified electing fund (QEF) inclusion under section 1293(a);
- has a mark-to-market (MTM) inclusion under section 1296(a); or
- is required to report the status of a section 1294 election.
However, a U.S. partner that owns shares in a PFIC through a U.S. partnership that has a Form 8621 filing obligation due to a QEF or MTM inclusion, is relieved from its filing obligation under Reg. section 1.1298-1(b)(2)(ii) if the U.S. partnership timely files Form 8621 and the U.S. partnership makes a QEF election with respect to the PFIC.
In contrast to a U.S. partnership, a foreign partnership is treated as an aggregate of its owners and is not classified as a shareholder for this purpose. The U.S. partners in a foreign partnership have the section 1298(f) reporting obligation with respect to PFIC stock owned by the partnership.
The current regulations essentially require the lowest-tier U.S. person in the chain of ownership (applying a bottom-up approach) to file Form 8621. An upper-tier U.S. person, such as a U.S. partner in a U.S. partnership, is often relieved of its Form 8621 filing obligation provided the U.S. partnership makes a QEF election and timely files Form 8621.
The current regulations also apply the entity approach to U.S. partnerships for purposes of making a QEF or MTM election. Generally, only the first U.S. person that is a direct or indirect shareholder of a PFIC may make a QEF or MTM election. Under Reg. section 1.1295-1(d)(2)(i)(A), if the first U.S. person in the chain of ownership is a U.S. partnership, the partnership has the authority to determine whether to make the QEF or MTM election (not the partners).
In contrast, an aggregate approach applies to foreign partnerships. If the first U.S. person in the chain of ownership is a partner in a foreign partnership, the U.S. partner has the authority to determine whether to make the QEF or MTM elections (not the partnership). See Regs. sections 1.1295-1(d)(2)(i)(B) and 1.1296-1(b)(2) and (e)(1).
Proposed revisions to PFIC reporting
Under the proposed regulations, U.S. partnerships are not considered shareholders for purposes of filing Form 8621 and making QEF, MTM or purging elections. Prop. Reg. section 1.1291-1(b)(7) would revise the definition of shareholder to expressly exclude U.S. partnerships, making the section 1291 treatment of U.S. partnerships consistent with foreign partnerships.
If these changes become effective, U.S. partners in a U.S. partnership will no longer be relieved of their Form 8621 filing obligation based on a filing by the U.S. partnership and will be required to file Form 8621 to report an indirect ownership in a PFIC. U.S. partnerships will still be required to compile information about the PFICs they own and provide it to investors on the new Schedule K-3, Partner’s Share of Income, Deductions, Credits, etc. – International of IRS Form 1065. However, a U.S. partnership will not be required to file Form 8621.
The revised definition of a shareholder will be incorporated into the MTM rules by Prop. Reg. section 1.1296-1(a)(4) and (e), the QEF election rules under Prop. Reg. section 1.1295-1(d)(2)(i)(A), and to PFIC purging elections in Prop. Reg. section 1.1291-1(b)(7).1 The proposed regulations provide that these elections will be made by the partners in a U.S. partnership (not the partnership). The proposed regulations will also require a U.S. partner to notify the partnership of the election within 30 days of filing the return in which the election is made. See Prop. Regs. sections 1.1295-1(d)(2)(i) and 1.1296-1(h)(1)(i)(B).
Any preexisting QEF, MTM or purging election made by a U.S. partnership that is in effect when the regulations become final will remain effective and will be treated as if it had been made by each U.S. partner. See Prop. Regs. sections 1.1295-1(d)(2)(i)(B) and (f)(3), and 1.1296-1(h)(1)(i)(A).
Recognizing that a U.S. partner which indirectly owns less than 10% of a CFC is no longer required to take into account a distributive share of a subpart F inclusion from a U.S. partnership, the proposed regulations confirm that a U.S. partner which indirectly owns less than 10% of a CFC (and, therefore, is not a U.S. shareholder within the meaning of section 951(b)) can no longer rely on the section 1297(d) overlap rule to avoid the application of the PFIC regime.
Section 1297(d)(1) provides that a corporation will not be treated as a PFIC with respect to a shareholder during the “qualified portion” of such shareholder’s holding period. The term “qualified portion” is defined in section 1297(d)(2) as the portion of the shareholder’s holding period during which the shareholder is a U.S. shareholder (as defined in section 951(b)) and the corporation is a CFC. The proposed regulations clarify that the term “qualified portion” does not include any portion of a U.S. partner’s holding period during which time the partner was not a U.S. shareholder within the meaning of section 951(b). See Prop. Regs. sections 1.1291-1(c)(5)(i).
Section 1297(d) was intended to eliminate the application of the PFIC regime for shareholders that are subject to current inclusions under the subpart F rules. Following the issuance of final regulations (T.D.9960) under the section 958 indirect ownership rules released at the same time as the proposed PFIC regulation, U.S. partnerships are treated as aggregates for purposes of section 951(a) and no longer have subpart F inclusions. The subpart F rules now only apply at the partner level and will only affect U.S. partners that own at least 10% the CFC (directly and indirectly). Similar rules were finalized June 21, 2019 (TD 9866) that provide parallel treatment of U.S. partnerships under the section 951A GILTI provisions.
Prior to T.D. 9960, a U.S. partnership that held 10% (directly or indirectly) in a CFC was treated as an inclusion shareholder and would take into account a subpart F amount at the partnership level. U.S. partners in the partnership were subject to tax on their distributive share of that subpart F regardless of whether the U.S. partner held indirectly 10% in the foreign corporation.
The proposed regulations include a transition rule that will apply to U.S. partners who, on the date the proposed regulations become final, own stock in a PFIC/CFC indirectly through a U.S. partnership, but who are not U.S. shareholders within the meaning of section 951(b) and, therefore, are not excluded from the PFIC provisions through an application of the section 1297(d) CFC/PFIC overlap rule. The transition rule would apply the section 1297(d) overlap rule to these shareholders for the portion of the shareholders’ holding period in which they were subject to a current inclusion under subpart F or GILTI as a result of owning an interest in a foreign corporation through a U.S. partnership (for example, as described in Notices 2019-46 and 2020-69). See Prop. Reg. section 1.1291-1(c)(5)(ii).
The proposed regulations will generally apply to tax years beginning on or after the date the final regulations are published in the Federal Register.
1Contrary to the current regulations, if a U.S. partner makes a QEF election with respect to PFIC stock held indirectly through a U.S. partnership, the election will apply to all shares in the PFIC owned by the U.S. partner (even if not held through the partnership).
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This article was written by Ayana Martinez, Lynn Ellenberg and originally appeared on 2022-02-10.
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