A taxpayer with shares in a passive foreign investment company (a “PFIC”) may qualify to make either a qualified electing fund (“QEF”) election or an election to apply mark-to-market treatment with respect to marketable stock. All things equal, taxpayers will typically prefer QEF treatment. The code, however, requires that the taxpayer meet certain criteria before they can make a valid QEF election. If a taxpayer makes a mark-to-market election, the Code generally provides that the MTM election remains in place until the foreign company ceases to be a PFIC or the IRS consents to the revocation of the MTM election in light of a “substantial change in circumstances.”
Sometimes, the information necessary to make a QEF election is not available at the time that the taxpayer files their tax return. Indeed, investments in PFICs can present notorious challenges in terms of obtaining the necessary documentation to support a QEF election.
Generally, if the fund provides a PFIC Annual Information Statement described in Treas. Reg. § 1.1295-1(g)(1), the Shareholder may qualify to make a QEF election with respect to the foreign company. If the fund does not provide such a PFIC Statement, QEF status may not be available. A fund may nonetheless qualify for a mark-to-market election. But what if, in a later year, the fund provides the PFIC Statement or otherwise would qualify for QEF status? Can a taxpayer then revoke a mark-to-market election and elect QEF status?
It depends. Such relief may require a private letter ruling.
PFIC Reporting Obligations
A U.S. person who is a direct or indirect shareholder of a PFIC is generally required to file Form 8621 if the shareholder:
- Receives certain direct or indirect distributions from a PFIC,
- Recognizes gain on a direct or indirect disposition of PFIC stock,
- Is reporting information with respect to a Qualified Electing Fund (QEF) or section 1296 mark-to-market election,
- Is making a reportable election, or
- Is required to file an annual report.
What is a PFIC?
A PFIC is defined as any foreign corporation if:
- 75 percent or more of the gross income of the corporation for the taxable year is passive income; or
- the average percentage of assets (as determined in accordance with section 1297(e)) held by the corporation during the taxable year which produce passive income or which are held for the production of passive income is at least 50 percent.
Mark-to-Market Elections
A United States person who owns (or is treated as owning) marketable stock in a PFIC may elect mark-to-market treatment with respect to the PFIC.
The MTM election applies to the taxable year for which it is made and all subsequent taxable years unless the stock ceases to be marketable stock or the IRS consents to the revocation of the election.
What is marketable stock?
Marketable stock is defined as PFIC stock that is regularly traded on:
- An SEC-registered national securities exchange;
- the national market system established under section 11A of the Securities Exchange Act of 1934; or
- a foreign securities exchange that is regulated or supervised by a governmental authority of the country in which the market is located and has certain characteristics described in Regulations.
Marketable stock also includes stock in certain PFICs that are described in Regulations section 1.1296-2(d).
Note that there are special rules for regulated investment companies (RICs) that own PFIC stock that are beyond the scope of this Insight post.
When a PFIC provides an annual PFIC Statement described in Treas. Reg. § 1.1295-1(g)(1), many shareholders prefer to elect to treat the PFIC as a qualified electing fund (QEF) in the year of acquisition. But when a PFIC does not provide Statements to its shareholders and the PFIC qualifies for a mark-to-market (MTM) election, the taxpayer-shareholder may make such an election. But what if the fund later begins to provide PFIC Statements? A shareholder who would like to change course and invoke a QEF election is prohibited from doing so while its MTM elections are in effect. And a MTM election can be revoked only with the consent of the Commissioner “upon a finding of a substantial change in circumstances” within the meaning of Treas. Reg. § 1.1296-1(h)(3).
Under Treasury Regulations, a United States person’s section MTM election will be terminated if (i) the PFIC stock ceases to be marketable; (ii) the United States person elects, or is required, to mark to market the PFIC stock under another provision of chapter 1 of the Code; or (iii) the Commissioner, in the Commissioner’s discretion, consents to the United States person’s request to revoke its MTM election upon a finding of a substantial change in circumstances, which may include a foreign corporation ceasing to be a PFIC. Treasury regulations provide that where a MTM election is revoked with the consent of the Commissioner, section 1296 will cease to apply beginning with the first taxable year of the United States person after the revocation is granted, unless otherwise provided by the IRS.
A shareholder may be able to seek a private letter ruling from the IRS to revoke its MTM election on the basis that a foreign company’s change in policy regarding issuing Statements was a “substantial change in circumstances.” Taxpayer-shareholders seeking relief in the form of a PLR should seek legal counsel from a qualified tax attorney.
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