New PFIC QEF election regulations encourage purging PFIC taint of a CFC/PFIC for 1997 tax year.

• Author: Chan, David
• Position: Passive foreign investment company, qualified electing fund, controlled foreign corporation

A calendar-year U.S. corporation owning stock of a foreign corporation that is both a controlled foreign corporation and a passive foreign investment company (CFC/PFIC) should consider taking action to make a timely election with its original 1997 income tax return to "purge" any "PFIC taint" from that CFC/PFIC under Sec. 1298(b)(1). By paying the U.S. tax resulting under the deemed sale election of Temp. Regs. Sec. 1.1297-3T(a) or the deemed dividend election of Temp. Regs. Sec. 1.1297-3T(c), and complying with the other requirements of Temp. Regs. Sec. 1.1297-3T(b) by the filing date for the original income tax return for 1997 (including any extensions of time to file), the U.S. corporation can reduce the amount of interest otherwise owing on untaxed PFIC earnings and can avoid the "once-a-PFIC-always-a-PFIC" rule of Sec. 1298(b)(1).

Under the once-a-PFIC-always-a-PFIC rule, once the stock of a foreign corporation held by a U.S. person is tainted with PFIC status, unless an appropriate qualified electing fund (QEF) election is made, such stock never loses that taint in the hands of the U.S. person, even if the foreign corporation ceases to have sufficient passive assets or income to be a PFIC within the meaning of Sec. 1297(a). A tainted foreign corporation that no longer meets the PFIC definition is referred to as a former PFIC"; a foreign corporation that has avoided the once-a-PFIC-always-a-PFIC taint by making a QEF election is known as a "pedigreed QEF."

A former PFIC can remove its taint if it makes a "purging" election under Sec. 1298(b)(1) to trigger income recognition as of the last day of the last tax year for which the company was a PFIC without regard to the once-a-PFIC-always-a-PFIC rule. The Taxpayer Relief Act of 1997 (TRA '97) gave new impetus for a U.S. person to make the election if he currently owns and has owned since before 1998, 10% or more of the voting stock of a foreign corporation that (1) is (and has been prior to 1998) both a CFC and a PFIC and (2) is not a pedigreed QEF, because the US. person did not make a QEF election for the first year in which the foreign corporation became a PFIC. The potential benefit of making the purging election stems from new Sec. 1297(e), which modifies the applicability of the PFIC rules to CFCs.

New PFIC QEF election regulations were published on Jan. 2, 1998 (TD 8750). The wording of the new regulations under Sec. 1298(b)(1) raises concerns about whether a taxpayer is allowed to...