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August 11, 2010 - Phil Hodgen

Voluntary Disclosure Participants with Mutual Funds Get a Break, Sorta

If you are in the Voluntary Disclosure Program and your offshore account had mutual funds in it, you had an extra layer of fun waiting for you in the Pain Factory:

  • That mutual fund was a “Passive Foreign Investment Company.”
  • You have to report income/loss from the mutual fund on Form 8621.
  • Getting the data to do so was either impossible or damn near impossible.
  • The tax results were either uncertain or horrific or both.

The obvious solution

The obvious solution to these problems was a little thing called a “mark-to-market” election.  Basically it allowed you to trump all of the hard tax calculations, and calculate your gain/loss on foreign mutual funds by looking at the value of the mutual fund at the beginning of the year and the end of the year.  If the value went up, you had ordinary income.  If the value went down, you had ordinary loss.  Simple.

The obvious solution didn’t work

Unfortunately, in order to make the “mark-to-market” election you had to do so on a timely-filed income tax return.  Duh.  If you’re in the Voluntary Disclosure Program you self-evidently didn’t make a “mark-to-market” election on a timely-filed income tax return.

The obvious solution now works, by executive fiat

The IRS has authority to waive the requirement that you must make the “mark-to-market” election on a timely filed income tax return.  This is under Regs. Section 301.9100-3, for those of you who are singing along with the choir. Usually this requires a specific application for a letter ruling, months of delay, etc. etc.

Thanks to Chuck Rettig and a few others, the IRS brass appears to have consumed a few sanity pills which will ease the procedures for participants in the Voluntary Disclosure Program.  Effectively you can use the “mark-to-market” election procedures for 2003-2008, even if you didn’t make the timely election.

Revenue Agents around the country who have Voluntary Disclosure Programs will shortly be advised of the following:

Taxpayers who have been accepted within the VDP will be provided an opportunity to elect into a procedure for the resolution of all PFIC issues for tax years through December 31, 2008. For those who elect to have this PFIC procedure apply, the proposal will apply to all of the taxpayer’s PFIC assets and will generally provide as follows:

  1. A first mark-to-market (MTM) determination of the net asset value (NAV) for all PFIC assets as of 12/31/2003.
  2. The basis in PFIC assets for the first MTM exercise is to be determined with the Revenue Agents based on historical asset cost. If the taxpayer can not locate the actual historical cost data, they should attempt to work out the NAV with the Revenue Agents based on whatever information is available.
  3. There will be a standard tax rate of 20% on all MTM gains and distributions post-12/31/2002, instead of the statutory PFIC (ordinary income) rates.
  4. Losses will be limited to prior year PFIC inclusions. Any tax benefit arising from PFIC losses will be determined at the same 20% rate that applied to the PFIC gains and distributions.
  5. A 7% annual interest charge will be applied to the PFIC liability from the date of asset acquisition through 12/31/03. The 7% was basically determined by a weighted average of the underpayment rate using a 3-year holding period (and is not-negotiable under the proposal). This computation is only required in the first year of a conversion to the MTM treatment (generally 2003, under this methodology) and would be calculated starting with the due date of the return for the year of acquisition and ending on the due date of the return for the first MTM year. The 7% interest charge is in lieu of the interest required within the deferred tax computation of Section 1296(c)(1)(B) and eliminates the look-back interest computation resulting from allocating the gain to all periods over which the PFIC investment was held. Subsequent period income adjustments to the year end NAV would be subjected to the 20% rate, gain or loss [see (3) and (4) above]. There would continue to be an underpayment interest charge from the due date of that first year (4/15/2004 for 2003) to the actual date paid.
  6. Electing taxpayers will be required to remain with the MTM mechanism for PFIC securities held post-12/31/2008 but the PFIC rate will revert to the statutory (ordinary income) rate for gains and losses arising after 12/31/2008.
  7. The 20% accuracy-related penalty under the VDP will apply to PFIC tax liabilities arising during 2003-2008.
  8. The foregoing alternative, elective PFIC procedure is available to all VDP applicants, whether or not they had a PFIC excess distribution between 2003 and 2008.
  9. Taxpayers who do not elect into the foregoing alternative PFIC procedure will have their PFIC tax liabilities determined under the normal rules applicable under Sections 1291-1298, requiring a look-back tax computation for the entire holding period of their PFIC assets.
Voluntary Disclosure