Income test—75% or more of a corporation’s gross income in a particular year is passive income.
Asset test—the average value of “passive assets” held by a corporation during a particular year is 50% or more of its total assets. US persons who are shareholders of a PFIC are subject to the PFIC rules regardless of the size of their interest in the PFIC. The rules for PFICs are designed to eliminate the benefits of a tax deferral where a PFIC earns income, but does not distribute it on a current year basis. However, the PFIC rules can apply even if the foreign entity does distribute all of its income on an annual basis.
Taxation of US Shareholders 4.3.1 Excess Distribution Distribution Regime (section 1291) 4.3.1.1 Overview The excess distribution regime is the default regime that applies when a US shareholder in a PFIC has not elected under either the mark to market or QEF regimes. The purpose of this system is to approximate the tax that would have been imposed if the PFIC had distributed all income earned each year on a current year basis. The excess distribution rules are designed, in general, to prevent the accumulation of passive income in a foreign entity in a manner that defers US tax. This is generally considered the most punitive of all of the possible PFIC tax regimes and should be avoided if possible. 4.3.1.2 Inclusion of PFIC Income A tax liability under the excess distribution rules arises only when an actual distribution is made by the PFIC, or when the US investor disposes of his or her investment in the PFIC. The annual distribution from a PFIC will be broken into two parts: 1. amount taxed in the current year as ordinary income, and 2. the “excess distribution” amount (which includes an interest charge). Calculation of Excess Distribution Amount: The excess distribution amount arises when there is either an actual distribution from the PFIC or when a gain is realized on the disposition of the PFIC stock. All of the gain on a sale is treated as an excess distribution. A loss on a sale is generally not recognized. The rules are applied on a PFIC by PFIC basis (i.e., distributions received by a US investor from more than one PFIC in a year are not aggregated). Also, the calculations are done on a share by share basis. Therefore, adjustments must be made for blocks of shares purchased on different dates. A distribution is an excess distribution only to the extent the total of actual distributions during a year to a shareholder exceeds 125% of the average of actual distributions received in the three preceding years (or if a shorter holding period, the portion of the shareholder’s holding period before the current year) (i.e., excess distributions are really defined by reference to prior year distributions). The total amount of the excess distribution is allocated on a pro rata basis to all days in the investor's holding period. This can potentially result in an allocation to three periods— 1. "pre-PFIC period," (days in the investor's holding period prior to the time the foreign entity was a PFIC); 2. "current-year period," (days in the year in which the excess distribution occurs); and 3. "prior-year PFIC period," (days in the prior years during which the foreign entity was a PFIC). Amounts allocated to the pre-PFIC period and the current-year period are totaled and included in the US investor's income as ordinary income. The amount allocated to the prior-year PFIC period is subject to the highest marginal rate of tax for the year to which allocated, and each of the resulting tax amounts attracts an interest charge as if it were an underpayment of taxes for the year in question. Importantly, amounts allocated to the prior-year PFIC period are never included in the investor's regular income. Instead, the tax and interest determined under these rules (the "deferred tax amount"), is added to the investor's tax liability, without regard to other tax characteristics of the investor. Therefore, the deferred tax amount is a payable tax liability, even where the investor otherwise has a current year loss or loss carryovers. The portion of the excess distribution allocated to the current year does not include an interest charge. The calculation above is done in Part IV of IRS Form 8621 “Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund” available at http://www.irs.gov/pub/irs-pdf/f8621.pdf. Instructions on completion of the form are available at http://www.irs.gov/pub/irs-pdf/i8621.pdf . Example 1 John, a US person, purchases 100 units of ABC mutual fund on January 1, 2004. ABC is a PFIC for all relevant years. John does not make a QEF or mark to market election with regard to his units in ABC. ABC makes no distributions in 2004. On December 31, 2005, ABC distributes $100 to John. The entire $100 is an excess distribution because John’s base period average is zero. This is because there were no previous distributions from the PFIC to John. The distribution is allocated to all days of John's holding period, up to and including the date of distribution. Consequently, $50 is allocated to 2004, and $50 is allocated to 2005. The $50 allocated to 2005 is included in John's income as "other income” and taxed at regular marginal rates. The $50 allocated to 2004 is taxed at the highest individual tax rate for 2004 and attracts an interest charge for the period. Example 2 The facts are the same as in Example 1, except that ABC distributes $100 to John on January 1, 2005 instead of December 31, 2005. The distribution is allocated to the days in the period from January 1, 2004 through January 1, 2005. As a result, virtually all of the distribution is allocated to 2004, ABC’s prior year. Instead of $50 being allocated to 2004, almost $100 is allocated to 2004. Tax is imposed at the highest rate for 2004, and that tax draws an interest charge. The base on which the interest is determined is doubled, and the resulting interest charge is doubled, as compared to Example 1. Example 3 (purchases on different dates) A US individual owns 12 shares of FC, a PFIC, acquired as follows: --2 shares on December 31, 2002 (Group 1) --4 shares on December 31, 2003 (Group 2) --6 shares on December 31, 2004 (Group 3) On June 30, 2003 and 2004, FC distributed $10 to each outstanding share. No portion of either distribution was an excess distribution. On June 30, 2005, FC distributed $30 to each outstanding share. For 2005, the excess distribution would be calculated for each group of shares. Group 1—The excess distribution is $35 ($60 received less 125% of ((20+20)/2) (2 years of holding prior to distribution). Group 2—The excess distribution is $70 ($120 received less 125% of 40) (1 year of holding prior to distribution.) Group 3—No excess distribution because the first year of the holding period is 2005, the year of distribution. Avoiding the Excess Distribution Regime: Once a foreign corporation qualifies as a PFIC at any time during the US investor’s holding period, any subsequent distribution by the PFIC to, or disposition of the PFIC stock by the investor, will be subject to the excess distribution rules, regardless of whether the foreign corporation is a PFIC in the year of the distribution or disposition, unless the US investor elected QEF status on a timely basis. This can be avoided in one of three ways: 1. QEF Election in First Year of PFIC Status (and in subsequent years if certain procedures are followed) (section 4.3.3) 2. Marking PFIC stock to market and treating accrued gain as an excess distribution (section 4.3.2) 3. Recognizing Post-1986 Earnings and Profits of Controlled Foreign Corporations Other: · Once a foreign corporation qualifies as a PFIC, all subsequent distributions or dispositions will be considered to be made by a PFIC regardless of whether the foreign corporation is a PFIC in the particular year (unlike when a QEF election is made). Miscellaneous Items: Deemed distributions or dispositions of indirectly held PFIC stock may also be subject to the excess distribution rules. Return of capital distribution could be classified as an excess distribution. Non-recognition provisions that generally apply to certain transfers of stock do not apply to transfers involving PFIC stock (cost basis adjustments will normally apply). Amounts treated as excess distributions have their own special foreign tax credit rules. No part of a distribution received or deemed received during the first tax year of the shareholder’s holding period will be treated as an excess distribution. It’s possible that amounts may not be taxable to a shareholder of a PFIC that is a tax exempt organization (e.g. U.S. charity)
Go see a tax advisor
Good luck!!
No part of a distribution received or deemed received during the first tax year of the shareholder’s holding period will be treated as an excess distribution.
If I dump it this year, it's ordinary income. I was planning on holding it as a long-term investment, but screw that.