By Bethany Bouw
The IRS allows certain entities to use a pass-through taxation via Form K-1. Essentially, this moves the income tax liability from those earning the income to those who benefit from it. Many individuals receive Form K-1, due to their investments in flow-through entities like partnerships and S-Corporations. Those K-1 forms will include additional supplementary information behind the K-1 itself. This supplementary information is often where information on passive foreign investment companies (PFICs) is located. PFICs are a serious matter and require great consideration with reporting and elections.
The IRS defines a PFIC as: A foreign corporation that meets either the income or asset test described below.
- Income test- 75% or more of the corporation’s gross income for its taxable year is passive income (as defined in section 1297(b)).
- Asset test- At least 50% of the average percentage of assets (determined under section 1297(e)) held by the foreign corporation during the taxable year are assets that produce passive income or that are held for the production of passive income.
There are specific things related to PFICs to look for on the K-1 which will help in preparing your tax return.
Five Things to Consider:
- Does the K-1 mention that it is a US entity? The first US shareholder of the PFIC is eligible to make a PFIC election to be a Qualified Electing Fund or QEF. This means that if the K-1 entity isn’t a US shareholder in the PFIC, it is ineligible to make the election. The taxpayer should consider the elections available to them and the associated ramifications to determine if they should make an election for the PFIC in question. If the K-1 entity is a US shareholder in the PFIC, the taxpayer should read the information carefully to determine if an election has been made.
- Does the K-1 mention that the entity has made a QEF election for the PFICs? The supplementary information should note if an election has been made for the PFIC. If it has, the taxpayer should read through the information to make sure they have reported the QEF income in the preceding information.
- Is there a date after which an election is in place? The K-1 will sometimes note that there is a date after which the PFICs were elected to be QEFs. If your ownership began after that date, your PFICs are QEFs and you will pick up the income that they have shown in the preceding pages of the K-1. If your ownership began before the date specified, you will need to delve further into the supplementary information to determine the appropriate information to report.
- Has the K-1 provided a table with information based on elections? Often if the K-1 entity isn’t a US shareholder in the PFIC, they will provide a table or list of information for the taxpayer. Such a table or list will provide the information to be reported on the Form 8621 based on elections they have made regarding the PFIC fund.
- Other considerations. We strongly advise you to contact your tax advisor regarding PFICs whether in a K-1 entity you own or funds you own directly. They are a serious tax matter and require care in addressing. It is very important to know about them in the first year of ownership as it is significantly more difficult in subsequent years and can give rise to excess tax and interest on the distributions and gains. If elections aren’t made in the first year, the PFICs may be subject to the default treatment.
Ryan & Wetmore has assisted clients with their PFICs (QEF, mark-to-market, and default treatment) over the years. We would be happy to assist you with questions or concerns regarding your PFIC ownership.
Bethany Bouw CPA, is a manager at Ryan & Wetmore and has been with the firm for over eight years. She has experience with offshore voluntary compliance and assisting taxpayers with foreign asset and entity reporting requirements. Contact her at firstname.lastname@example.org.
Traci Getz CPA, is a partner with Ryan & Wetmore, P.C. Traci has over fifteen years of experience providing accounting, tax, and consulting services to small and medium-sized business owners. She works with clients to understand their accounting and tax issues while specializing in international tax, healthcare, and construction. Please contact Traci at Tgetz@ryanandwetmore.com
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