Posted by: Robert Horwitz | September 12, 2018

One Benefit from a PFIC Investment: The Six-Year Statute of Limitation for Exclusion of More than 25% of Gross Income May Not Apply by ROBERT S. HORWITZ

Long ago, some practitioners may have thought “PFIC” was a type of electric plaque removal devise.  OVDI changed all that.  Now we know it stands for “Passive Foreign Investment Company” and that special rules exist for determining taxable income from owning PFIC stock.  See §§ 1291 et seq.

Toso v Commissioner, 151 T.C. No. 4 (Sept. 4, 2018), here, addresses the six-year statute of limitations for assessing deficiencies due to a substantial understatement of gross income where gain from the sale of PFIC stock is involved and whether net PFIC losses can be offset against PFIC gains.  The taxpayers had an account at UBS in 2006, 2007, and 2008.  Their original timely filed returns did not report items relating to the UBS account.  They subsequently filed amended returns reporting items related to the UBS account.  On January 15, 2015, the IRS issued a statutory notice of deficiency for 2006, 2007 and 2008.  It determined that gain reported on the amended returns was from the sale of PFIC stock.  The taxpayers argued that the notices of deficiency were barred by IRC §6501(a)’s three-year statute of limitations on assessment.  The IRS contended that the six-year statute under IRC §6501(e)(1)(A)(i), for substantial understatements of gross income, applied.  The issues before the court were whether gains from the sale of PFIC stock are counted as gross income for purposes of the six-year statute of limitations and, if so, whether PFIC losses could be offset against PFIC gains.  The answers were no and no.

The Tax Court began with the definition of “gross income.”  Gross income for purposes of the statute of limitations is generally synonymous with gross income for purposes of IRC §61(a), which includes gains from dealings with property.  Gains from PFIC stock are taxed under special rules: normally §1291 applies unless the taxpayer elects to treat PFIC stock as a qualified electing fund under §§1292-1295 or to mark to market under §1296.  If no election is made, as was the case with the taxpayers, §1291 applies.

Sec. 1291 provides that gain from sale of PFIC stock is allocated ratably on a daily basis over the entire holding period of the stock.  Only PFIC gain attributable to the year of sale is included as ordinary income in gross income.  It is taxed as ordinary income.  The gain allocated to prior years is not included in current year PFIC income.  Instead, there is a “deferred tax amount” calculated by a) allocating non-current year PFIC gain ratably by day over the entire holding period, b) multiplying the amount of gain allocated to each prior year by the highest ordinary income rate in effect for that year, c) computing interest on the tax and d) summing up all the tax and interest.  This deferred tax amount is added to the taxpayer’s tax for the current year.  As a result, only the gain allocated to the current year is included in the current year’s gross income and included in determining whether there was a substantial understatement of gross income under §6501(e)(1)(A)(i).  Gain allocated to prior years is not included in gross income for any purpose.

The Tax Court rejected the IRS’s argument that all non-current year PFIC gain is gross income and that §1291 is nothing more than a method of calculating tax and interest.  According to the Court, such a reading treats §1291 out of existence.  Since it is part of the Code and is a specific provision, it overrides the general provision, §61.

According to the Court, this should have ended the issue, but it felt obliged to address the IRS’s policy argument.  The PFIC provisions were enacted in 1986.  Prior to that time, a taxpayer who invested in a foreign investment company that had no US source income, did not do business in the US, and retained earnings rather than paying dividends could defer tax until the foreign investment company stock was sold.  By contrast a domestic registered investment company (“RIC”) had to distribute 90% of its ordinary income each year to its shareholders.  If it did not, it was taxable as a C corporation.  Even if it distributed the requisite 90%, it would still pay a tax on retained ordinary income.  The PFIC provisions were enacted so that taxpayers who invested in PFICs would be treated similarly to taxpayers who invested in RICs.

From this, the IRS argued that since holders of PFIC stock are to be treated similarly to holders of RIC stock, all gain from the sale of PFIC stock should be treated as gross income for statute of limitations purposes.  This argument did not meet with approval.  That the PFIC provisions were meant to treat owners PFIC similarly to owners of RIC stock, they were not treated identically.  Among other things, gain from sale of PFIC stock under §1291 is taxed at ordinary income rates while gain from the sale of RIC stock is taxed at capital gain rates.  Similarity is not identicality.  The Court concluded that PFIC gain allocated to prior years under §1291 is not “gross income” for purposes of §6501(e)(1)(A)(i).

The Court next determined whether there was a substantial understatement of gross income for any of the three years before it.  2006 was the only year in which the amount of unreported gross income was more than 25% of what was reported on the original return.  The notices of deficiency for 2007 and 2008 were thus time barred.

Finally, the Court addressed the taxpayer’s argument that it should be allowed to net PFIC losses against PFIC gains.  Since §1291 only applies to PFIC gains, it found no basis for allowing the losses to be offset against the gains.

So one benefit of PFIC is if you didn’t report all of your gross income for one or more years, not all gains from the sale of PFIC stock will be treated as gross income.  That is if a court of appeal does not reverse the Tax Court.

ROBERT S. HORWITZ – For more information please contact Robert S. Horwitz – or 310.281.3200   Mr. Horwitz is a principal at Hochman, Salkin, Rettig, Toscher & Perez, P.C., a former Assistant United States Attorney of the Tax Division of the Office of the U.S. Attorney (C.D. Cal) and represents clients throughout the United States and elsewhere involving federal and state, administrative civil tax disputes and tax litigation as well as defending criminal tax investigations and prosecutions. Additional information is available at

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