In an Information Letter, the IRS has advised a taxpayer, who sold his interest in a passive foreign investment company (PFIC), on the steps to take to verify that he’d properly reported his PFIC transaction and, presumably, determine whether he’s due a refund.

PFIC rules were enacted in 1986 to address concerns regarding U.S. investors in foreign corporations and their ability to defer income and recharacterize ordinary income as income from capital gains.

A PFIC is any foreign corporation if:

  • At least 75% of its gross income for its tax year is passive, or
  • At least 50% of the assets it held during the year produce passive income or are held to produce passive income.

The passive assets test is generally applied based on the fair market value (FMV) of the corporation’s assets, but assets are valued based on their adjusted basis where the corporation isn’t publicly traded and either is a controlled foreign corporation or elects to use the adjusted basis instead of FMV.

How a PFIC’s U.S. shareholder is taxed depends on whether the shareholder has made a qualifying electing fund (QEF) election or a mark-to-market election, or hasn’t made any election.

Taxpayer inquiry

A taxpayer, who sold his interest in a PFIC, contacted the IRS and inquired as to whether he could recover the amount he’d paid to the IRS because of this PFIC transaction.

The IRS advised the taxpayer that he should take the following steps to verify that he’d properly reported his PFIC transaction:

  1. Determine the portion, if any, of the gain that was attributable to years in which the investment wasn’t considered a PFIC. Based on available information, the IRS stated that this amount would be the portion of the gain attributable to the period from the date of purchase until the taxpayer became a U.S. resident for U.S. tax purposes.
  2. If the investment was held in a retirement account, the taxpayer should consult the applicable U.S. income tax treaty to determine if there are income tax treaty provisions that apply to the investment. U.S. income tax treaties can be found at
  3. If either of the above first two steps results in a change in the way the taxpayer reported the transaction on his tax return, he should complete and file an amended return (Form 1040X, “Amended U.S. Individual Income Tax Return”) to claim a refund.

In addition, the IRS advised the taxpayer that, regarding a question he had on the PFIC Annual Information Statement, PFICs weren’t required to issue this statement annually.

Making a QEF election

A shareholder makes a QEF election by attaching an IRS form to its federal income tax return filed by the election due date for the shareholder’s election year. Your tax advisor will handle all the details.

Contact a B&V tax advisor, at 713-667-9147 or, for more information or if you have any questions.

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