Why is this Topic Important to Wealth Managers? Discusses alternative tax and interest calculations available to certain taxpayers with regards to Passive Foreign Investment Company income as part of the Voluntary Disclosure Programs. 

A significant number of Offshore Voluntary Disclosure Practice cases (remember the Swiss Bank Accounts) involve Passive Foreign Investment Company (PFIC) investments.  A lack of historical information on the cost basis and holding period of many PFIC investments, the Service notes, may make it difficult for taxpayers to prepare statutory PFIC computations and for the Internal Revenue Service to verify them.  As a result, resolution of many Disclosure Practice cases are said to be unduly delayed.  Therefore, for purposes of this initiative, the Internal Revenue Service is offering taxpayers an alternative to the statutory PFIC computation that will resolve PFIC issues on a basis that is consistent with the Mark to Market (MTM) methodology authorized in Internal Revenue Code section 1296 but will not require complete reconstruction of historical data. [1]

The terms of the alternative resolution offered by the Internal Revenue Service are as follows:

• If elected, the alternative resolution will apply to all PFIC investments in cases that have been accepted into the Disclosure Practice and that qualify for the special civil penalty framework announced by the IRS on March 23, 2009.  [2]
• The initial MTM computation of gain or loss under this methodology will be for the first year of the Disclosure Practice application but could be made after 2003 depending on when the first PFIC investment was made.  Generally, under the terms of the March 23, 2009 framework, the first year of the Disclosure Practice application will be for the calendar year ending December 31, 2003.   This will require a determination of the basis for every PFIC investment, which should be agreed between the taxpayer and the Service based on the best available evidence.  
• A tax rate of 20% will be applied to the MTM gain(s), MTM net gain(s) and gains from all PFIC dispositions during the Disclosure Practice period. [3]
• A rate of 7% of the tax computed for PFIC investments marked to market in the first year of the Disclosure Practice application will be added to the tax for that year. [4]
• MTM losses will be limited to unreversed inclusions (generally, previously reported MTM gains less allowed MTM losses) on an investment-by-investment basis in the same manner as section 1296. During the Disclosure Practice period, these MTM losses will be treated as ordinary losses [5]and the tax benefit is limited to the tax rate of 20%.  This limitation is accomplished by multiplying the MTM loss by 20% and applying the result as a credit against the tax liability for the year. 
• Regular and Alternative Minimum Tax are both to be computed without the PFIC dispositions or MTM gains and losses.  The tax from the PFIC transactions (20% plus the 7% for 2003, if applicable) is added to (or subtracted from) the applicable total tax, either regular or AMT, whichever is higher.  The tax and interest (i.e., the 7% for the first year of the Disclosure Practice) computed under the Disclosure Practice alternative MTM will then be added to the applicable total tax. 
• Generally, underpayment interest and penalties on the deficiency are computed in accordance with the Internal Revenue Code and the terms of the Disclosure Practice.
• For any PFIC investment retained beyond 12/31/2008, the taxpayer must continue using the MTM method, but will apply the normal statutory rules of section 1296 as well as the provisions of sections 1291-1298, as applicable.

However, if the taxpayer does not elect to use the alternative PFIC computation, then the PFIC provisions of Sections1291-1298 apply.  The IRS recommends for those considering the alternative calculation to seek professional tax advice with regards to these Disclosure Practices.    

Next week’s blogticles will discuss new hot topics in 2011.  

We invite your opinions and comments by posting them below, or by calling the Panel of Experts.

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[1] Internal Revenue Service.  Offshore Voluntary Disclosure Initiative: Passive Foreign Income Company Investment Computations.  September 2010.   http://www.irs.gov/taxpros/.  Last Accessed 1/27/2011.

[2] See generally, Statement from IRS Commissioner Doug Shulman on Offshore Income.  http://www.irs.gov/newsroom/article/0,,id=206014,00.html, Last Accessed 1/27/2011; IRM 9.5.11.9, Revised IRS Voluntary Disclosure Practice. http://www.irs.gov/newsroom/article/0,,id=104361,00.html.  Last Accessed 1/27/11. 

[3] This arrangement is in lieu of the rate contained in section 1291(a)(1)(B) for the amount allocable to the current year and section 1291(c)(2) for the deferred tax amount(s) allocable to any other taxable year.

[4] This arrangement is in lieu of the interest charge mechanism described in sections 1291(c) and 1296(j).

[5] Under IRC 1296(c)(1)(B).

Tags: Banking in Switzerland, Doug Shulman, Douglas Shulman, Internal Revenue Service, Passive Foreign Investment Company, Tax, UBS, United States

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