The IRS recently issued Notice 2014-51, which exempts taxpayers that elect mark to market treatment under a non-section 1296 regime from the passive foreign investment company (“PFIC”) reporting requirements.

Congress enacted the PFIC rules under the Tax Reform Act of 1986 to even the playing field between investors in domestic mutual funds and investors in foreign assets. The former had to pay tax currently on their pro rata share of mutual fund income while holders of foreign investments could generally delay tax until they received distributions. The PFIC rules leveled the playing field by imposing great costs on PFICs (and their shareholders) that defer distributions.

Congress defines a PFIC under either an income or assets test. The income test is satisfied if 75% or more of the foreign corporation’s gross income consists of passive income. The assets test is satisfied if at least 50% of the foreign corporation’s average assets held during a taxable year produce passive income. The PFIC rules apply to most foreign mutual funds, pension funds and money market accounts.

Congress provides three different ways for PFIC shareholders to pay tax on their PFIC shares. Under the section 1291 fund election, shareholders must pay tax on excess distributions for prior years at the highest marginal rate for each year that an excess distribution occurred as well as interest on any underpayment. Under the QEF election method, PFIC shareholders are taxed like holders of domestic mutual funds, with ordinary income and capital gains passing through to shareholders. However, PFICs electing this method must comply with IRS reporting requirements, which is a burden that many foreign companies want to avoid. Under the section 1296 mark to market election method, shareholders report as ordinary income the excess of the fair market value of their PFIC shares on the last day of the tax year over the adjusted basis of such shares on the first day of the tax year.

In addition to paying tax currently, PFIC shareholders must also satisfy annual reporting requirements. Specifically, in Section 521 of the Hiring Incentives to Restore Employment Act of 2010, Congress added IRC § 1298(f), which requires PFIC shareholders to file a Form 8621 annual information return.

In the same act, Congress amended IRC § 6501(c)(8) to extend the statute of limitations for taxpayers failing to file Form 8621 as well as other foreign information returns. Additionally, Congress further amended section 6501(c)(8) to toll the statute of limitations for a taxpayer’s entire tax return for failure to file Form 8621 and other reports. However, for most taxpayers, PFIC reporting requirements did not actually commence until tax year 2013. Nonetheless, the extension of the statute of limitations needs to be considered if the IRS contacts you. We have found that a client may think they have the usual three year statute when, in fact, that statute is extended by reason of failure to file accurate foreign reporting forms.

The IRS issued temporary regulations in December 2013 that exempted taxpayers electing IRC § 1296 mark to market treatment from the PFIC reporting requirements. Many practitioners welcomed this change. PFIC shareholders electing IRC § 1296 mark to market treatment report all of their PFIC gain or loss annually and therefore do not supply the IRS with additional information through Form 8621, yet such shareholders were potentially subject to an extended statute of limitations for assessment on their entire tax return for failure to file Form 8621.

However, the IRS only exempted taxpayers that mark to market under section 1296 in the December 2013 regulations. Securities dealers elect mark to market treatment under section 475(f) and annually report all of their gain and loss on PFIC shares just as taxpayers electing section 1296 treatment. Additionally, securities dealers are generally exempt from most PFIC income inclusion rules. Yet, securities dealers had to file a Form 8621 or risk keeping their statute of limitation for assessment open for their entire tax return for no apparent tax policy objective. On May 22, the Securities Industry and Financial Markets Association (SIFMA) submitted comments to the IRS requesting that the Service exclude taxpayers electing IRC § 475(f) mark to market treatment from PFIC reporting requirements.

In response to the comments, the IRS recently issued Notice 2014-51, in which it exempted taxpayers electing non-section 1296 mark to market treatment from PFIC reporting. Taxpayers may rely on the Notice for tax years ending on or after December 31, 2013. Although dealers constitute a relatively small group of taxpayers, they hold a large amount of PFIC stock and therefore the Notice significantly reduces the amount of PFIC stock required to be reported under section 1298(f).