Attorney-at-Law

“A CAMEL IS A HORSE”

In Uncategorized on 09/04/2018 at 16:49

As Enacted by Congress

As if more proof of this well-worn cliché were needed, we have Section 1291 (and no, I didn’t know about it before now either) and Roberto Toso and Marcela Salman, 151 T. C. 4, filed 9/4/18, as ex-Ch J Michael B (“Iron Mike”) Thornton really floors it going from the “on” ramp into the flow to start the Fall semester at the Glasshouse.

The question here is whether gain from disposition of PFIC (Passive Foreign Investment Company, like an offshore mutual fund) stock is gross income nor not. Before you quote Section 61 “money or money’s worth from whatever source derived,” take a look at what Congress did in 1986.

“Section 1291(a) provides that gain on the disposition of PFIC stock is allocated ratably to each day in the taxpayer’s holding period for the stock.*** The statute provides that gain allocated to the current year is included in the taxpayer’s gross income as ordinary income. Sec. 1291(a)(1)(B).  We shall refer to any gain that is included in the taxpayer’s gross income for the current year as current-year PFIC gain, and we shall refer to the rest of the gain, i.e., any gain on the sale of PFIC stock other than current-year PFIC gain, as non-current-year PFIC gain.

“Section 1291 treats current-year PFIC gains differently from non-current year PFIC gains.  Section 1291 expressly provides that ‘only’ current-year PFIC gains are included (as ordinary income) in gross income.  Sec. 1291(a)(1)(B) (‘[T]he taxpayer’s gross income for the current year shall include (as ordinary income) only * * * [current-year PFIC gains.]’).  Current-year PFIC gains are therefore taxed under the operation of sections 1, 11, 61, and 63 as ‘gross income’.

“By contrast, non-current-year PFIC gains are not included in gross income for the current year.  Instead, section 1291(a)(1)(C) provides that ‘the tax imposed* * * for the current year shall be increased by the deferred tax amount’.” 151 T. C. 4, at pp. 10-11. (Footnotes omitted.)

Now take a deep breath, and pay attention.

“Section 1291(c) generally provides that the deferred tax amount is calculated by (1) allocating the non-current-year PFIC gains to years in the taxpayer’s holding period (ratably by day pursuant to section 1291(a)(1)(A)), (2) multiplying the amount allocated to each particular year by the highest ordinary income tax rate in effect for that year, (3) computing an interest charge on that multiplicative product, and (4) taking the sum of all the products and interest charges for all years.  This sum, the deferred tax amount, is then added to the taxpayer’s income tax for the current year.” 151 T. C. 4, at pp. 11-12.

So any gain referable to years prior to the current year are not included in gross income for any year, but that gain is computed day-by-day at highest ordinary rate for each segment, and added to tax due for the current year, somehow never figuring in any year’s gross income.

The net result of these arithmetical double-back-jackknives is that Ron and Marcela are off the hook for two of the three years at issue, because their unreported PFIC gains, which are not included as gross income for those years, leave them under the 25% cutoff for 6SOL.

I agree with IRS. This produces a disparate result for onshore investors and offshore types like Rob and Marcela. Even though both are US persons and both invest in mutual funds, the onshore mutualist includes any gain (short or long, capital or ordinary) in gross income for 6 SOL purposes, but the offshore mutualist doesn’t.

Ex-Ch J Iron Mike, never one to shun a dictionary chaw or a duck-dive into the Joint Committee’s labyrinthine explications, finds that, pre-1986 (and also pre-2017 Tax Cuts and Jobs Creation Act), if a foreign corporation (like a mutual fund) had no effectively connected US income, and if antideferral provisions don’t apply, and earnings are retained offshore and not distributed to US onshores, tax is effectively indefinitely deferred. And when the onshore sells its offshore mutual fund shares, the onshore takes capital gains treatment, while the shares are bloated with deferred ordinary income.

So Section 1291 recaptures the ordinary for the years prior to the year of disposition at the highest ordinary rate in effect for those prior years.

A US mutual fund (known as a RIC or regulated investment company), to keep its tax status, has to distribute 90% of current year’s earnings to its shareholders.

So ex-Ch J Iron Mike goes to town.

“Upon close inspection of section 1291 and its legislative history, however, it is not immediately apparent that the PFIC provisions were enacted so that taxpayers investing in PFICs would be treated similarly to taxpayers investing in domestic investment companies in every respect.  We think any correspondence between PFICs and RICs is somewhat more attenuated than respondent would suggest.  For example, the definition of a PFIC (provided in section 1297) differs from the definition of a RIC (provided in section 851) in key respects:  In general, the PFIC provisions apply to a range of international investment companies that is broader than the range of domestic investment companies to which the RIC provisions apply.  As another example, the default rules of section 1291 do not provide for identical treatment of PFICs and RICs.  Among other differences, the entire amount of gain on the sale of PFIC stock is taxed under section 1291 as ordinary income or at the highest ordinary rates, whereas RICs may make capital gain dividends, sec. 852(b)(3), and sales of RIC stocks are generally treated as sales of capital assets, see sec. 852(b)(4).” 151 T. C. 4, at pp. 18-19.

So Section 1291 is an anti-deferral mechanism.

OK, Rob and Marcela are out for two years (3SOL has run and no fraud), but as to the third, they want to offset some PFIC losses against the gains wherewith they are grabbed by 6SOL.

No go.

“We agree with respondent that section 1291 does not provide for the netting of gains and losses on dispositions of PFIC stock.  Section 1291(a)(2) provides that the PFIC tax rules apply ‘to any gain recognized on such disposition [i.e., on a disposition of stock in a PFIC]”.  The use of the singular, ‘any gain recognized on such disposition’ (emphasis added), indicates that section 1291 applies to each disposition of PFIC stock separately, rather than to an annual aggregation of sales of multiple stocks.  Consequently, section 1291 applies to any disposition upon which gain is recognized.  Section 1291 does not address, and therefore does not apply to, dispositions upon which losses are recognized.  Accordingly, we conclude and hold that in applying the provisions of section 1291, petitioners are not entitled to offset gains from sales of PFIC stocks with losses from sales of PFIC stocks.” 151 T. C. 4, at pp. 23-24.

I give Rob’s and Marcela’s attorneys a Taishoff “good try, second class,” as they argue that they should be able to net per Section 165, before Section 1291 kicks in. Nope, says ex-Ch J Iron Mike; two different statutes, two different rules.

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