Topic 10:Individual Issues: PFIC, 911, GILTI for Non-MNCs

Question 1

§911:What are the 2 main categories of income that can be excluded under §911 for US citizens or residents living abroad

Answer 1

1.Foreign earned income.
2.Housing cost amount

Question 2

Define the term “qualified individual” as it relates to §911:

Answer 2

An individual whose tax home is in a foreign country & who meets 1 of the criteria:
(1) Is a US citizen & establishes to the satisfaction of the Secretary that they are a bona fide resident of a foreign country for an uninterrupted period that includes an entire taxable year

(2) Is a US citizen or resident & has been present in a foreign country(ies) for atleast 330 full days during any period of 12 consecutive months

Question 3

How does §911 define “earned income”?

Answer 3

Earned income =
1. Wages, salaries, or professional fees
2. Other amounts recieved as comp for personal services actually rendered

Question 4

What does §911 NOT include under “earned income”

Answer 4

IT does NOT include
(1) The portion of compensation derived by the TP for personal services rendered to as Corp that represents a distribution of E+P rather than a reasonable allowance as compensation for the personal services actually rendered
(2) Amts received as a pension or annuity
(3) Amts paid by the U.S or an agency thereof to an E’ee of the U.S or an Agency thereof
(4) Amts included in GI by reason of §402(b) relating to taxability of beneficiary of nonexempt trust) or §403(c) (relating to taxability of beneficiary under a non qualified annuity)
(5) Amts received after the close of the taxable year following the taxable year in which the services to which the amts are attributable are performed

Question 5

What is the limitation on the amount of foreign earned income that can be excluded under §911?

Answer 5

Each year, there is a maximum amount of foreign earned income you can exclude from your taxable income. This limit is adjusted based on how many days you qualify for the exclusion during the year. So, if you only qualify for part of the year, the maximum amount you can exclude is reduced accordingly.
IE: Step 1: Max Annual Exclusion Amt set by IRS. If limit is 120k that year then start with that.
Step 2-Qualifying Days- the exclusion is prorated based on the # of days during the year that you meet either bona fide residence test/physical presence test. These tests determine if you qualify for the exclusion based on the time spent living/working in a foreign country.
Step 3: Proration Calculation
First calculate the daily exclusion Amy by dividing the max annual exclusion by 365. Then multiply the daily amount by the # of qualifying days.

Question 6

§911(b)(2)(A) Limitation of foreign earned income (FEI)
HYPO:
if the annual FEI exclusion limit is $120k and you qualify for 200 days during the year, how much foreign income can you exclude?

Answer 6

Daily exclusion: $120,000 ÷ 365 = $328.77
Multiply by qualifying days: $328.77 × 200 = $65,754

Question 7

What is the formula for calculating the foreign earned income exclusion amount under §911(b)(2)(D)?

Answer 7

ExclusionAmount=
80,000+
(80,000×Cost-of-LivingAdjustment)

Question 8

What are “housing expenses” for the purposes of calculating the housing cost amount exclusion?§911(c)(3)

Answer 8

Housing expenses are:
(1) reas expenses paid/incurred during that tax yr by or on behalf of an individual for housing for the individual (and if residing w/the individual, for their spouse & dependents) in a foreign country (aka General housing costs: Money spent on housing for you and your spouse or dependents.)
(2) Expenses attributable to the housing, such as utilities an insurance

Question 9

What do “housing expenses” for the purposes of calculating the housing cost amount exclusion NOT INCLUDE ?
§911(c)(3)

Answer 9

“Housing Expenses” do NOT include:
(1) Interest and taxes of the kind deductible under §163/164 (Mortgage Interest * property taxes)
(2) Any amount allowable as a deduction under §216(a) aka allowed ded for renters or shareholders of coops

Question 10

What is the formula for determining the limit on housing expenses for the housing cost amount exclusion under §911(c)(2)?

Answer 10

Limit=30%×ForeignEarnedIncomeExclusion×NumberofQualifyingDays

Question 11

§1297:What is a Passive Foreign Investment Company (PFIC)?

Answer 11

A PFICis any foreign corp that meets either of the following tests:

(1).Income Test: If 75% or more of the company’s income comes from passive sources (like dividends, interest, or rents) during the tax year.

(2)Asset Test: If at least 50% of the company’s assets are made up of investments that generate passive income or are held for producing passive income.

Question 12

What is the purpose of §911(d)(6) (Denial of Double Benefits) & how does it affect TP’s claiming the Foreign Earned Income Exclusion?

Answer 12

§911(d)(6) prevents TP’s from getting double benefits for the same foreign earned income they’ve already excluded using the Foreign Earned Income Exclusion.

It means you can’t take a ded, exclude that income, or claim a tax credit for income that has already been excluded.

This rule ensures that people using the Foreign Earned Income Exclusion don’t receive extra tax breaks on the same income.

Example: A U.S. citizen working overseas who claims the Foreign Earned Income Exclusion cannot also claim a foreign tax credit for taxes paid on that same income. The foreign tax credit is connected to the income that was excluded, so this rule applies.’
can’t do foreign tax credit unrelated to this section and 911 (a) at the same time

Question 13

What is “passive income” when figuring out if a foreign corporation is a PFIC? §1297

Answer 13

Passive income is money a foreign corporation makes from things like investments rather than from active business activities. It includes income that qualifies as “foreign personal holding company income” according to tax rules, but there are some exceptions to this definition.

In simpler terms, if a foreign company earns money mainly from investments or passive sources, that income is considered passive.

Question 14

Name 3 examples of income that are considered passive income for PFIC purposes.

Answer 14

1.Dividends.
2.Interest.
3.Royalties
4. Rents *unless from active business
5. gains from the sale of certain assets

Question 15

What is NOT considered passive income for purposes of determining if a foreign corporation is a PFIC? §1297

Answer 15

Passive income does not include:
●Income from an active banking business by a US-licensed bank
●Income from an active insurance business by a qualifying insurance company
●Interest, dividends, rents, or royalties received from a related person, if those payments are linked to the related person’s active business income
●Export trade income

Question 16

When does income from a related party not count as passive income under the PFIC rules?
§1297(b)(2)(C)

Answer 16

If a foreign corporation earns income from a related person (like interest, dividends, rent, or royalties), it is not considered passive income if it comes from the related person’s non-passive income. In other words, if the related person earns that income from active business activities, it won’t count as passive income for the PFIC rules.

Question 17

What is the “look-through rule” for PFICs?

Answer 17

If a foreign corp owns at least 25% (by value) of the stock of another corp, for purposes of determining whether the foreign corp is a PFIC, the foreign corp is treated as if it:

1.Held its proportionate share of the assets of the other corp.

2.Received directly its proportionate share of the income of the other corp.

Layman’s
This means the foreign corp is treated as if it:

(1)Directly owns its share of the other company’s assets+
(2)Earns its share of the other company’s income

For example, if a foreign corporation owns 30% of another company, it’s considered to directly own 30% of that company’s assets (like cash, property) and 30% of its income (like interest, dividends). This rule helps determine if the foreign corporation meets the tests for being a Passive Foreign Investment Company (PFIC) based on its share of the underlying company’s passive assets and income.

Question 18

What is an “excess distribution” for purposes of §1291?

Answer 18

Any distribution from a PFIC that surpasses a calculated limit. This limit is generally 125% of the average amount received by the TP from the PFIC over the preceding 3 years (or holding period, whichever is shorter)

is any payment made to a S’er for their stock that goes above the usual amount expected for that year. If a S’er gets more than their fair share of the total distributions for the year, the extra part is considered an excess distribution

Step-by-Step Breakdown
Amount Received This Year (A):
This is the total amount of distributions you got in the current taxable year.
Average Amount from the Past Three Years (B):
Look at the distributions you received in the last three years.
Add them up and divide by 3 to get the average distribution.
If you’ve owned the stock for less than three years, only use the years you’ve owned it.
Calculate the Threshold (C):
Multiply the average amount (B) by 125% (or 1.25).
This gives you the threshold amount.
Determine the Total Excess Distribution:
Subtract the threshold (C) from the amount you received this year (A):
TotalExcessDistribution
=
A
−
C
TotalExcessDistribution=A−C
If this result is positive, that amount is considered the “total excess distribution.” If it’s zero or negative, there’s no excess distribution.

Question 19

How is an excess distribution from a PFIC taxed under §1291?

Answer 19

in simple terms, when you get extra money from a PFIC, it gets taxed as if you earned it gradually over the time you owned the stock, and you may have to pay extra tax because of it.

When you receive the “excess distribution” aka extra $ from a PFIC, this amount is spread out evenly over each day you owned the stock. The IRS adds the part of this extra money that falls within the current year to your GI for that year. And It includes any amount you earned before the PFIC’s first tax year after 12/31/86 . Also, your tax for the current year will be higher because of any taxes you deferred in previous years.

STEPS
1-Determine Holding Period
2-Daily Allocation of ED
3- Calculate the Amount Allocated to the Current Year
4-Include Previous Years
5-Total Amount to Include in GI
6-Extra Tax Calculation

Question 20

What is §1291 about?

Answer 20

Deals with the taxation of excess distributions from PFICs. It imposes an interest charge on distributions that exceed a certain threshold, discouraging US TPs from using PFICs to defer US tax liability on passive income

Question 21

What is the deferred tax amount §1291

Answer 21

Penalties imposing an interest charge on “excess distributions” which are unusually large distributions relative to the average of the past 3 years

represents the additional tax liability imposed on excess distributions. It consists of 2 components: (1) aggregate increase in taxes, calculated by applying the highest tax rate for each applicable year to the portion of the excess distribution allocated to that year and
(2) the interest accrued on those tax increases

Question 22

Does §1291 apply if a PFIC becomes a Qualified Electing Fund (QEF)

Answer 22

No, 1291 does not apply if the PFIC becomes a QEF and the TP elects to be taxed currently on their share of the QEF’s income. Similarly, 1291 does not apply if a 1296 election (mark to market is in effect).

Question 23

How does §1291 coordinate with FTC rules?

Answer 23

If a distribution from a PFIC is subject to foreign withholding taxes, and those taxes are creditable under US rules, the excess distribution calculation takes those taxes into account. Creditable foreign taxes allocated to pre-1987 holding periods are credited in the current year, while those allocated to later periods reduce the increase in tax determined under 1291(c)(2)

Question 24

What is §1293 about (QEFs)

Answer 24

Allows US TP’s to elect to be taxed currently on their share of PFICs income, as if it were distributed, through QEFs election

Question 25

Why would a TP make a QEF election? §1293

Answer 25

It exempts them from interest charge penalties on excess distributions from PFICs in §1291, offering potential tax savings

Question 26

What are the key req’s of a QEF election?

Answer 26

The PFIC, NOT the s’er, must make the election and agree to:
(1) maintain records using tax accounting principles
(2) provide neccesarry info to the IRS

Question 27

What is a PFIC and why are there special tax rules for them?

Answer 27

Passive Foreign Investment Company

Special rules aim to prevent indefinite deferral of US taxes on passive income earned in low-tax jurisdictions/tax havens

Question 28

How does QEF (1293) differ from the 1291 (interest on excess distribution)

Answer 28

QEF allows for current taxation of PFICs income avoiding the interest charge penalties 1291

Question 29

Who must make the QEF election for it to be valid?

Answer 29

PFIC itself, not the individual US shareholder

Question 30

What income must a U.S TP include if the QEF election is in effect?

Answer 30

TP must include heir pro rata share of the PFIC’s income on their US tax return in the year the income is earned

Question 31

How is ordinary income from a PFIC treated under QED election

Answer 31

TP includes their share of the PFICs ordinary earnings as ordinary income

Question 32

How is net capital gain from a PFIC treated under the QEF election?

Answer 32

The TP reports their share of the PFICs net capital gain as long-term capital gain, which is typically taxed at lower rates

Question 33

How are 10% corporate shareholders of a PFIC treated under QEF election

Answer 33

Similarly to US S’ers of CFC for foreign tax credit purposes

Question 34

What is high-taxed income exception under the QEF election?

Answer 34

Income subject to a high foreign tax rate or certain US source income may be exempt from inclusion in the shareholders’ gross income

Question 35

what is an alternative to the QEF election for PFIC s’ers?

Answer 35

The mark-to-market election, which allows Tps to treat PFIC stock as if it were sold at fair market value each year, recognizing gain or loss accordingly

Question 36

What is market to market election?

Answer 36

An alternative to the QEF election, available only to US TP’s holding PFIC stock that is readily traded on a qualified stock exchange. It allows them to:
-Treat the PFIC stock as if it were sold at its FMV at the end of each year
-Recognize any resulting gain or loss on their US tax return

Question 37

What are 3 main anti-deferral tax regimes in the US for foreign income?

Answer 37

Subpart F, GILTI, and PFIC

Question 38

To whom does Subpart F mainly apply?

Answer 38

US Corporations controlling CFCs

Question 39

Who is primarily affected by GILTI?

Answer 39

US Corporations with CFCs and individual S’ers of Non-US corps

Question 40

When do PFIC rules apply?

Answer 40

To U.S individuals who own les than 10% of a foreign corporation or more than 10% of a foreign corporation that is not a CFC.

Question 41

What’s the goal of PFIC rules?

Answer 41

prevent tax deferral on passive investments held through foreign corporations

Question 42

What are 2 ways PFIC rules impose tax

Answer 42

(1) current taxation on U.S investor’s share of PFIC earnings
(2) An interest charge on deferred taxes, calculated annually

Question 43

What election can TPs make to avoid pFIC interest charges?

Answer 43

QEF- qualifying electing fund 1293

Question 44

What does 911- do for US citizens living and working abroad ?

Answer 44

Limited exclusion on foreign earned income + housing expenses

Question 45

What types of income does 911 exclusion apply to?

Answer 45

Foreign earned income; salary, wages, housing expenses

Question 46

How can individuals qualify for 911 exclusion

Answer 46

Meeting
(1) Physical pResence test
(2) Bona Fide residence test

Question 47

What is required for the physical presence test?

Answer 47

Being outside the US for atleast 330 days in a 12 mo period

Question 48

What does Bona Fide residence test require

Answer 48

establishing a foreign country as one’s home for an entire calendar year