Hello from Debra Rudd.
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This week’s topic comes from reader K:
What if the company or fund does not provide a QEF investor statement, are there other ways for one to confirm that the company or fund complies with IRS requirements for QEFs? What happens if there was an incorrect election made on Form 8621 and it turns out it does not qualify for a QEF treatment? How would we correct?
This is a common question. If the fund doesn’t provide you with the statement you need to make the QEF election, but you somehow get the same information that would be provided on the statement, shouldn’t you still be able to make the QEF election? After all, you would be reporting the income correctly according to the QEF rules.
The IRS says no.
A Qualified Electing Fund is a PFIC for which a valid QEF election has been made. Under the QEF rules, your PFIC is taxed much like a partnership, meaning that income retains its character (capital gains are taxed as capital gains, for instance) and is passed through to the shareholder for current inclusion in income.
You will pay less tax under the QEF rules than you will pay under the punitive Mark to Market (MTM) rules of IRC § 1296 or the extremely punitive excess distribution rules of IRC § 1291. You will want to make the QEF election (if you can) because it has the best outcome for a PFIC.
For your QEF election to be valid, the PFIC must comply with “such requirements as the Secretary may prescribe” for the purposes of determining the amount and character of income attributed to the shareholder. IRC § 1295(a)(2).
What, exactly, are those requirements?
The answer is found in the Regulations, at Regs. § 1.1295-1(g):
For each year of the PFIC ending in a taxable year of a shareholder to which the shareholder’s section 1295 election applies, the PFIC must provide the shareholder with a PFIC Annual Information Statement. The PFIC Annual Information Statement is a statement of the PFIC, signed by the PFIC or an authorized representative of the PFIC, that contains the following information and representations[.]
The Regulations provide a detailed list of the information that must be present on the PFIC Annual Information Statement.
There are four main pieces of information that a PFIC Annual Information Statement must have.
First, the PFIC Annual Information Statement must tell you the start and end dates of the time period to which the statement applies. Regs. § 1.1295-1(g)(1)(i).
Second, the PFIC Annual Information Statement must contain any one of the following three things:
Third, it must tell you the amount of cash and fair market value of other property distributed to you (or deemed distributed) during the period to which the statement applies. Regs. § 1.1295-1(g)(1)(iii).
Lastly, it must contain either a statement that the PFIC will allow the shareholder to inspect its books, or alternative documentation requirements approved by the IRS through a Private Letter Ruling and Closing Agreement. Regs. §§ 1.1295-1(g)(1)(iv), (g)(2).
Recall that, as mentioned above, the PFIC Annual Information Statement must be issued by the PFIC and signed by an authorized representative.
If the statement does not contain the required information as described above, or if it is not signed by a representative of the PFIC, you cannot make the election.
The Regulations are clear: you must receive a PFIC Annual Information Statement to make a QEF election:
A shareholder that makes a section 1295 election with respect to a PFIC held directly or indirectly, for each taxable year to which the section 1295 election applies, must . . . receive and reflect in Form 8621 the PFIC Annual Information Statement described in paragraph (g)(1) of this section, the Annual Intermediary Statement described in paragraph (g)(3) of this section, or the applicable combined statement described in paragraph (g)(4) of this section, for the taxable year of the PFIC ending with or within the taxable year for which Form 8621 is being filed. If the PFIC Annual Information Statement contains a statement described in paragraph (g)(1)(ii)(C) of this section, the shareholder must attach a statement to its Form 8621 that the shareholder rather than the PFIC provided the calculations of the PFIC’s ordinary earnings and net capital gain. Regs. § 1.1295-1(f)(2)(C).
If you do not receive the statement, you cannot make the election. The statement may, rather than telling you your ordinary income and capital gains, simply tell the IRS that you looked at the company’s books to determine the ordinary income and capital gains attributable to you, but you must receive the statement that contains all the required information, it must be signed by a representative of the PFIC, and you must attach it to Form 8621 to make the QEF election.
If an incorrect election is made, the PFIC reverts to the excess distribution rules of IRC § 1291.
You can fix an incorrect QEF election by filing an amended return with a Form 8621 attached, showing that no elections are made and the applicable calculations in Part V of the form. Because there are no penalties for filing Form 8621 late or filing it incorrectly, it is just a matter of fixing the paperwork and paying the additional tax.
If the IRS determines through an examination that your QEF election is incorrect (because you or the PFIC failed to satisfy the initial or annual IRC § 1295 requirements, including the PFIC Annual Information Statement requirements), they may either terminate or invalidate the election. Regs. § 1.1295-1(i)(1).
Terminating the election means that you may not have to revert back to the IRC § 1291 treatment for all years in which you made the QEF election, but going forward from the date of termination your PFIC will no longer be taxed using the QEF rules. The effective date of the termination is at the IRS’s discretion. Regs. § 1.1295-1(i)(1)(iii).
Invalidating the election means that you will be treated as if the QEF election had never been made, so all years for which the election was made will revert back to the IRC § 1291 treatment. Regs. § 1.1295-1(i)(1)(iii).
As always, thank you for reading, remember that this is not tax advice to you, and please feel free to send me any questions you may have.