December 28, 2017 - Haoshen Zhong

Tax Cuts on PFICs: Not Much Changed

Effect of the tax cut on PFICs

These are some notes I took about how the tax cut affects passive foreign investment companies (PFICs)–or does not affect PFICs.

The short answer is that not much changed, particularly if you are an individual. PFICs stay more or less as bad as they were before. The dramatic changes to tax law that just passed do not affect PFIC owners much.

Code references are to the amended provisions

The Code citations used in this post refer to provisions as amended by the tax cut–unless, of course, the citation notes that it refers to the provisions without amendment.

No territorial system for PFIC income

One of the touted features of the tax cut is that corporations are now taxed on a territorial basis, meaning profits earned abroad are not taxed. It is not quite like that, but it is beyond the scope of this post to go into depth about corporate taxation in general.

The way the territorial system works is that if a US corporation owns 10% or more of a “specified 10-percent owned foreign corporation”, then it gets to deduct dividends received from the foreign corporation that can be attributed to foreign profits. IRC §245A(a).

This territorial system only works for corporations, not individuals. US citizens living abroad who own shares of foreign corporations do not get this benefit.

PFICs are specifically excluded from the definition of a specified 10-percent owned foreign corporation. IRC §245A(b)(2). This territorial system does not work for PFIC income.

No deemed repatriation of PFIC income

One of the features of the tax cut is that there is a deemed repatriation of accumulated profits of foreign corporations.

The deemed repatriation applies to 10% shareholders of “deferred foreign income corporations”. IRC §965(a). A deferred foreign income corporation is a “specified foreign corporation” that has accumulated foreign income since 1986. IRC §965(d)(1). And a PFIC is excluded from specified foreign corporations. IRC §965(e)(3).

There is no deemed repatriation of profits from PFICs.

Indirect tax credit limited to QEFs

The tax cut eliminated the indirect tax credit for income taxes that foreign corporations pay. §14301(a). This eliminated the indirect tax credit that US corporations used to get if they own 10% or more of a PFIC, and the PFIC paid foreign taxes. IRC §1291(g)(2).

But if you are a US corporation that owns 10% or more of a qualified electing fund (QEF), then you get an indirect tax credit for the foreign taxes that the QEF paid. IRC §1293(f).

Insurance exception tightened

At the moment, if a company is in the business of insurance, and it would be taxed as an insurance company in the US, then its insurance income is nonpassive for determining whether it is a PFIC. IRC §1297(b)(2)(B), before amendment.

The tax cut adds another requirement: insurance liabilities need to be more than 25% of its total assets, determined using financial statements (presumably GAAP). IRC §1297(f)(1)(B). The IRS can loosen the 25% requirement slightly for insurance companies whose insurance liabilities dip below the requirement because of runoffs. IRC §1297(f)(2).