The Dreaded "PFIC" Rules: How to Limit the Damage

  Image courtesy iStock.

Image courtesy iStock.

In a world that is becoming smaller, money-making opportunities present themselves all over the globe.  However, with said opportunity comes the obligation to pay taxes.  Otherwise prudent investors can find themselves in a precarious tax situation when they discover that they have been investing in what the U.S. tax rules refer to as “PFICs,” or Passive Foreign Investment Companies.  PFIC investments come with a unique set of compliance rules, and failure to meet these requirements can come with a hefty tax bill and/or penalties.


There are two tests to determine if a foreign corporation falls into the PFIC category:

  • The Income Test: 75% or more of the corporation’s gross income for the taxable year is passive income. Passive income includes, but is not limited to, dividends, interest, royalties, rents, and annuities
  • The Assets Test: 50% or more of the corporation’s total assets are passive assets (based on average market value, or adjusted basis if qualified and elected)


So you determine that the foreign corporation is subject to PFIC rules.  There are three main ways the U.S. Government can tax a PFIC investment:

  • “Excess Distributions” Regime
  • Qualifying Elected Fund “QEF” Election
  • “Mark-to-Market” Election

By default, a PFIC will fall under the excess distribution method.  Tax recognition under this regime is not triggered by income earned but rather by distributions received. An excess distribution is a distribution that is greater than the base amount, defined as 125% of the average actual distributions received from the three prior years (or less, if owned for less time).  Once the base amount is determined, any part of the current year distribution that is above the base amount is considered excess.  The base amount is taxed as ordinary dividends, but the excess distribution is allocated to the entire holding period and taxed at the highest tax bracket for each year, thereby eliminating the deferral of yearly tax amounts.  There is also an interest charge associated with the excess distribution, calculated at the underpayment rate, which is the AFR short term rate plus 3%.  This would be considered a penalty regime, since you have been deferring foreign income from the U.S. Government, and as such they charge you interest to make up for it.  This default method is complex and cumbersome, to say the least.


Generally, the reporting for a PFIC is the responsibility of the first U.S. taxpayer owning the investment.  If this is the first year owning the PFIC, you can (and should – depending on your tax situation) make the QEF election to report all income currently.  A QEF election will treat the investment in the manner similar to that of a domestic mutual fund.  Your pro rata share of interest and dividends will be taxed at ordinary income tax rates and capital gains at the capital gains rate, even if you did not receive any distributions for the year.  Any distributions that you receive subsequently from the previously taxed income would be received tax free to you.  Important: a QEF election can generally only be made in the first year owning the investment.  There are retroactive elections and ways to “purge the PFIC taint,” thereby regaining the ability to make a QEF election, but those concepts are outside of the scope of this blog.  You should, however, be aware that they are available as a potential tax strategy.

If the QEF election cannot be made, another possibility to limit the damage would be the “Mark-to-Market” election.  This election was created to extend the current year income treatment that the QEF election offers for those investors that were unable to elect QEF.  If the PFIC stock is marketable (that’s an important qualification), you can elect to pick up the excess in fair market value over adjusted basis of the stock as ordinary income in the taxable year.  Your basis in the stock adjusts  accordingly in the year the income is recognized.  If there is a decrease in fair market value, losses can be taken to the extent of prior “unreversed inclusions”.  Prior unreversed inclusions are prior year mark-to-market gains that were previously picked up as income.  Any losses above and beyond the unreversed inclusions are lost.

The PFIC rules are extremely complicated, and we’ve only scratched the surface of navigating potential compliance issues.  If you think that you may have investments subject to the PFIC rules, you should reach out to a trusted professional to discuss your options.

Escape From New York (Taxes): Excluding Worldwide Income from New York Taxation

  Image courtesy of iStock.

Image courtesy of iStock.

Do you live and/or work outside of the US but maintain a home in New York? New York residency rules may be costing you over 10% of your income unnecessarily. In today’s REMcycle, I’ll explore a tax break referred to as the “548-Day Rule,” useful for New York domiciliaries who spend most of their time outside of the country.

New York is, and has been, one of the most desired states to live in for centuries. Rich and poor, American or immigrant, New York’s myriad opportunities draw taxpayers like a moth to the neon ATM sign outside of your favorite bodega. Unfortunately, that appeal translates directly into some of the highest living costs in the world, including high tax rates. Not only can New York income tax rates cap out at 8.82% with an additional 3.876% for New York City residents, but New York will tax your worldwide income if you are deemed a resident of the state. That means that income from foreign wages, real estate, investments, etc., will all be subject to these steep rates.

So what makes someone a “resident” of New York?


New York employs two different tests to determine if a taxpayer is a resident of New York and thus subject to taxation on their worldwide income: the Statutory Residence Test and the Domicile Test.

The Statutory Residence test, the quantitative view of residency, will sound familiar to taxpayers avoiding US residency status at the federal level due to the 183-Day Rule. Similar to the federal definition of a US resident, if a taxpayer spends more than 183 days in New York during the tax year, they have met one of the two tests to be classified as a statutory resident – the second and concurrent requirement being that the taxpayer maintains a permanent place of abode in New York. If you spend this much time in New York, the 548-Day Rule will not be able to save you.

Taxpayers defined as residents under the Domicile Test, however, have options. If you lived in New York previously and are attempting to break residency, the Domicile Test is a qualitative barrier to exit. New York auditors will review where you spend your time, where you do business, where you define your “home,” and a number of other items that can paint a subjective picture of money leaving your wallet. It can be very difficult to change your domicile away from New York if you maintain a home there.

Now that I’ve provided (over)simplified summaries of New York’s residency traps, let’s explore how the 548-Day Rule provides tax relief for those taxpayers deemed domiciliaries of New York.


First things first, why is it called the 548-Day Rule? Simple. The test allows a taxpayer to review 548 days (a year and a half) to determine if they are a resident of New York based on their physical presence during the chosen period. The period can be any 548 days the taxpayer chooses, as long as 365 of those days fall within the tax year in question. These 548 days chosen create the context for jumping through the three hoops necessary to avoid New York residency:

  1. The taxpayer must spend fewer than 90 out of 548 days inside New York;
  2. They must spend more than 450 out of 548 days outside of the country; and
  3. During the short period, or the section of the chosen 548 days that fall outside of the tax year under question, the ratio of days spent in New York divided by 90 cannot exceed the ratio of days in that short period divided by 548.

An important caveat to taxpayers’ reviewing these thresholds is that your spouse or minor children count in your stead. So if you head back to France to run Société Générale but leave your spouse behind to manage the home, your worldwide income will be taxed by New York.


Minor algebra aside, the most important and complex facet of the 548-Day Rule is the ability to shift the 548-day period at will. As an example, if a 2015 tax year is under review, and the taxpayer spent 91 days in New York at the end of 2014 (failing the first test) but zero days in New York during 2015, the taxpayer can shift the 548-day period forward to include the first half of 2016 instead. This shift is a blessing in its ability to alleviate taxation, but a curse in its complexity, as it can trip up even seasoned practitioners.

I’ve only grazed the edges of New York’s complicated residency rules here. New York is one of the most aggressive residency auditors among the 50 states, and a prudent taxpayer will trust this issue to an experienced professional.

Don’t Overlook the New York Investment Tax Credit

  Image courtesy iStock.

Image courtesy iStock.

There is a significant tax credit available to certain taxpayers doing business in New York State that, in many cases, may go unclaimed: the Investment Tax Credit (ITC).  The credit amount ranges from 4% to as much as 9% of the cost of property placed in service in New York.  In addition, the credit can be enhanced in subsequent years by an employment incentive credit which provides an additional 1.5% to 2.5% of the ITC.

What businesses are eligible for the credit?  A variety of industries are eligible, including manufacturing, retail, research and development, film production, and financial services, as well as others.

What property qualifies for the credit?  Generally, any property or equipment you place in service in New York that is principally used in your business.  Qualifying property may vary by industry.  For example, let’s say you’re a manufacturer, and you purchase a machine for use in your production facility.  By claiming that equipment as an investment in your business, you can receive a credit against NY taxes.

What if I can’t use the credit in the year I placed property in service?  Not to worry, you can carry the credit forward for up to 15 years (10 if you are an S Corporation shareholder).  If you qualify as a “new business”, you can even take the credit as a refund.

If you are planning to invest in your business in New York, you really do need to factor the value of this credit into the amount of your investment.  That being said, there is quite a bit of complexity involved in correctly identifying qualifying property and claiming the ITC.  If you need assistance with navigating the rules, or would like to hear more details on the ITC, contact us.

Health Insurance: Are You Required to Provide?

Posted by REM Cycle Staff

Small business owners may be surprised to learn that, starting in 2016, guidelines are changing dramatically for which employers are regarded as Applicable Large Employers (ALE) in regard to the Affordable Care Act (ACA). As of this year, this employer mandate is more complex. Put simply, you may be legally obligated to provide certain employees with health insurance, even if you weren’t required last year. Failure to do so could result in significant penalties.

A company or organization becomes an ALE when it employs an average of 50 or more full-time (FT) or full-time equivalent (FTE) employees. To determine whether the employer mandate is met, the total number of FT plus FTE employees is averaged across the months in the current year, and the result (over or under 50) is applied to the next calendar year.

Who is counted as an employee for ALE criteria? When determining whether an employer is an ALE, the employer must count all of its employees. An FT employee either has an average of 30 hours of service per week during the calendar month or has at least 130 hours of service in a calendar month. To calculate FTEs, the working hours of part-time employees are combined and counted as equivalent full-time employees.

A noteworthy exception is for employers of seasonal workers. If the employer’s workforce (both FT and FTE) exceeds 50 for 120 days or fewer, and any employees in excess of 50 employed during those 120 days are seasonal workers (e.g., a lifeguard hired to work June through August, or a retail cashier hired for the holidays), then that employer is exempt from the mandate.

Some workers should not be included in the calculation of ALE employees. These include sole proprietors, partners in a partnership, 2% or more S-corporation shareholders, temporary employees (hired and paid for through an agency), and independent contractors.

The point? Companies and organizations near the 50-employee mark need to keep careful employment records, and their payroll teams and external payroll providers should use these to determine if they meet the ALE criteria. These crucial protocols should be put in place now and continued moving forward.


Posted by David Roer, CPA

The subject of Interest-Charge Domestic International Sales Corporations (commonly known as an IC-DISC) is complex, but often worth exploring. The IC-DISC is a corporate tax remedy – one that provides U.S. exporters and manufacturers large tax incentives in order to mitigate potentially significant tax burdens. With international economic growth on the rise, it’s crucial for exporters and manufacturers to be privy to the IC-DISC concepts.

Congress created the Domestic International Sales Corporation (DISC) in 1971 to encourage U.S. exporters to help economic growth by engaging in activities. In simple terms, a U.S. exporter was allowed to allocate a portion of its export profits to a domestic subsidiary – a DISC, which per IRC Section 991 is not subject to US Corporate tax – to reduce its U.S. taxes.

How does this tax advantage work and do you qualify? First, the exporting company pays a commission to the IC-DISC based on foreign sales of products manufactured or produced within the United States (please consult your tax advisor regarding determination of the commission amount). This commission is then deducted from ordinary business income by the exporting company and acts as commission receipts received by the IC-DISC. From a kneejerk perspective, the IC-DISC receives and reports the commission income tax-free, while the exporting corporation receives a deduction at ordinary rates, at a maximum rate of 39.6%.

According to IRC section 995(b), a shareholder of an IC-DISC will treat any distributions as taxable dividend income at the favorable qualified dividend tax rate (maximum rate of 23.8% comprising qualified dividend rates and the net investment income tax). Effectively, the export company receives a deduction at the ordinary tax rate and the identical amount is paid out as a dividend, flowing through to the owners at qualified dividend rates.  It is important to remember that if the IC-DISC chooses to not pay dividends to its shareholders, an interest charge – these are interest-charged DISCS – will apply to the deferred tax, usually based on Treasury Bill Rates.

To attain IC-DISC status, four criteria must be met by the Corporation – it is important that you consult your tax advisor regarding whether or not your Corporation’s facts and circumstances are applicable.

Bottom line: The IC-DISC concept is a way to secure a 15.8% direct tax benefit by merely setting up a separate corporation and adhering to the necessary rules and restrictions. While this introduction hits the highlights, the remaining IRC rules and regulations are more complex. Proactive measures such as these can result in significant tax savings.