NO CHANGE IN PFIC REPORTING, YET

New Code Section 1298(f) (recently enacted under the HIRE Act) requires shareholders of a passive foreign investment company (PFIC) to report such information as the IRS requires on an annual basis. Questions have been raised as to what and when taxpayers should now be reporting.

Even though this new provision is now in effect, the IRS is advising taxpayers that Form 8621, Return by a Shareholder of a Passive Foreign Investment Company or a Qualified Electing Fund, need only be filed under the old rules. New guidance will eventually be forthcoming that implements the new annual reporting requirements.

Notice 2010-34

BUNDLED INVESTMENT FEES GAIN ANOTHER REPRIEVE

In the 2008 Supreme Court case of Knight v. Comm., investment advisory fees paid by a trust were held to be subject to the “greater than 2% of adjusted gross income” deduction limits of Code Section 67(a). Oftentimes, banks, brokers, and trust companies impose only one “bundled” fee for all services performed. Proposed regulations indicated that taxpayers would need to unbundle the fee somehow to allocate the fees among investment fees that are subject to the 2% limit and those that items that are deductible without regard to the 2% limit.

These regulations have not been finalized yet. In Notice 2008-32, the IRS provided interim guidance that for tax years before 2008, taxpayers would not be required to unbundle the fee to determine a portion of the fee that is subject to the 2% floor. It extended this guidance to tax years beginning before January 1, 2009 in Notice 2008-116.

The IRS has now extended the same guidance to tax years beginning before January 1, 2010, thus allowing full deductibility for bundled fees without regard to the 2% floor. This guidance applies to nongrantor trusts and estates.

Notice 2010-32

TAX PROVISIONS IN HIRE ACT IMPOSE NEW COMPLIANCE BURDENS ON INTERNATIONAL COMMERCE AND INVESTING

Capital, and all of its blessings, flows to where it is treated best. The recently passed Hiring Incentives to Restore Employment Act of 2010 (the "HIRE" Act) imposes new obstacles to the flow of capital into and out of the U.S. While ostensibly limited to "reporting" requirements to address offshore tax evasion by U.S. persons, at some point U.S. investors will balk at the level of reporting and forego profitable investments in the world at large, and foreign investors will simply move on to greener pastures and avoid the U.S. in making capital available. While such enforcement legislation may be considered to be tax revenue enhancing, the lost national revenue from reduced capital investment and tax compliance costs doesn't seem to be on anyone's radar screen – indeed, there is almost a complete absence of attention to the new rules in the national media. Once upon a time, U.S. tax policy was influenced by the impact of the tax code on U.S. economic growth and capital development – sadly for the U.S. economy, such concerns have taken a backseat in the ongoing campaign to root out tax dodgers.

I have prepared a general overview of the new provisions, which can be viewed here.

In addition to increasing the compliance burden of investors and businesses (including the imposition of foreign account disclosure requirements that essentially duplicate disclosures already required under FBAR reporting), the new provisions include several traps for the unwary. For example, U.S. persons that purchase stock of a U.S. corporation from a foreign entity are required to obtain certification regarding “substantial” U.S. ownership (or nonownership) of the foreign entity. If the U.S. person does not obtain the required certification, the U.S. buyer is obligated to withhold 30% of the purchase price from the foreign seller (at least that is how I read the new statute). If the U.S. buyer is not aware of these rules, the IRS can come after it for the 30% withholding even if the buyer has already fully paid the foreign seller. Tax and business counsel need to familiarize themselves with these rules to avoid the inadvertent application of these rules to their clients.