How To Report A Distribution From A Lower-Tier PFIC

Hello and welcome to The Friday Edition. Phil Hodgen here.

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A Question from Real Life

In the International Tax Pros community we have a monthly Ask Anyone Anything session. Those of us who are solo or in small firms need experienced practitioners to brainstorm with.

This week a members brought up a problem he’s working on: tiered PFICs and how to report the distributions from the lower-tier PFIC. We all know how the story should end (a dollar of income gets taxed only once), but how do you actually make that happen on a tax return? And why?

The client immigrated to the United States holding an interest in a family investment company structure: he owns 50% of Parent (a PFIC for which he made the QEF election) which in turn owns 10% of Subsidiary (a PFIC-PFIC, aka Section 1291 fund). Subsidiary distributed $100,000 to Parent, and as explained below, this creates two $50,000 hoses of taxable income aimed directly at the client, when in reality he should only be taxed on one.

We know how the story should end ($50,000 of income), but how do you make that happen on a tax return?

Listening to the question online, I thought I knew the answer, with instant certainty. This is a Clue that I might be wrong, so I decided to answer the member’s question. Seven or eight hours later, I more-or-less understand. This write-up is the result. Today I Learned.

Here’s a little diagram that shows ​​where the magic happens on Form 8621.

Another member of the International Tax Pros did something vastly more impressive. Travis Call, CPA has developed the skills to feed a tax problem to seven different LLMs, coax each of them to figure out an answer, then argue amongst themselves until they produce a correct and verifiable answer.

I am gratified to know that Travis’s bots agree with my analysis. 🙂 But they found far more nuance and detail than I did. That’s sobering. Travis has graciously agreed to share his memo. Download it here. You will see that the memo gives you the logic threads to independently verify, which is the key for why I think Travis’s work is so spectacular.

(Side question. Travis is showing us what life is like in 36 months. What does that do to your tax pro career–and mine?)

Anyway, let’s go learn a little bit about PFICs, double-counting income, where the magic adjusting entry goes, and why. And why we rely on Proposed Regulations from 1992 (!) to reach that answer.

The Facts

Shareholder is a U.S. taxpayer. He owns 50% of Parent, a foreign corporation that is a PFIC. He made a QEF election for Parent and he gets an Annual Information Statement every year.

Parent owns 10% of Subsidiary. Subsidiary is also a PFIC. It is a family holding company, and the family will not provide financial data to prepare an Annual Information Statement. No QEF election is possible for Subsidiary, and the shares are not marketable, so a mark-to-market election is impossible, too. Subsidiary is a section 1291 fund as to Shareholder.

Subsidiary made no distributions before 2025. In 2025, Subsidiary makes a $100,000 distribution to Parent. That is Parent’s only income for the year, and assume Parent has no expenses.

The Quick Answer

Shareholder is only $50,000 richer. (He is entitled to half of the $100,000 distribution received by Parent.)

Shareholder has two income items of $50,000 each (pro rata share of the distribution from Subsidiary, and pass-through pro rata share of Parent’s earnings). We solve the double-taxation problem on Parent’s Form 8621 at line 6b, basing the reporting position on strong authority from the Code and exceedingly weak authority in the form of antique Proposed Regulations.

Subsidiary’s Form 8621

Subsidiary’s $100,000 distribution to Parent is treated as a distribution pro rata to Shareholder: 50% of $100,000, or $50,000. This is where Shareholder’s tax liability comes from–not from the $100,000 sitting in Parent’s bank account.

IRC § 1298(b)(5)(A)(ii) says:

Under regulations, in any case in which a United States person is treated as owning stock in a passive foreign investment company by reason of subsection (a)—
(ii) any distribution of property in respect of such stock to the person holding such stock,
shall be treated as a disposition by, or distribution to, the United States person with respect to the stock in the passive foreign investment company.

The $50,000 that we pretend went straight to Shareholder goes on Subsidiary’s Form 8621, line 15a. Run that through the black box that is Part V (just kidding; it implements the excess distribution rules of IRC § 1291) and you get three outputs for Form 1040:

• Ordinary income (line 16b), which goes to the “other income” line on Form 1040, Schedule 1, line 8z (IRC § 1291(a)(1)(B)).
• Tax computed on the excess distribution, net of foreign tax credit (line 16e) goes to Form 1040, line 16, box 3, marked 1291TAX.
• Interest on the tax computed on excess distribution amounts (line 16f) goes to Form 1040, Schedule 2, line 17p (line 16f).

Parent’s Form 8621

Add Income

(Line 6a) Parent receives the $100,000 distribution from Subsidiary in real life. The distribution received by a QEF becomes “ordinary earnings” of the QEF. QEFs behave as passthroughs, so Shareholder (who owns 50% of Parent) has $50,000 of ordinary earnings on Form 8621, line 6a.

Remove Income: The Sloppy Authority Chain

The government does not want to tax income twice, so if the ordinary earnings on line 6a had been included in Shareholder’s income by some other mechanism, then we back it out of ordinary earnings to compute the amount of ordinary income reported on Shareholder’s Form 1040 from the QEF.

Congress, in a handwavy paragraph, said it wanted to see rules like IRC § 959(b) (distributions from previously-taxed earnings and profits of a CFC are not included in a U.S. shareholder’s income) in PFIC-land. IRC § 1298(b)(5)(B) says:

Rules similar to the rules of section 959(b) shall apply to any amount described in subparagraph (A) and to any amount included in gross income under section 1293(a) (or which would have been so included but for section 951(c)) in respect of stock which the taxpayer is treated as owning under subsection (a).

And Congress gave specific instructions to the IRS to go write regulations to make it so. IRC § 1293(g)(2) says:

The Secretary shall prescribe such adjustment to the provisions of this section as may be necessary to prevent the same item of income of a qualified electing fund from being included in the gross income of a United States person more than once.

There are no regulations and there never have been. The closest thing we have to regulations are proposed regulations from 1992 that have never been finalized. Prop. Reg. § 1.1291-2(f)(3) is a tiebreaker rule: if a distribution is taxable under IRC § 1291 and IRC § 1293, then apply IRC § 1291.

If, but for this paragraph (f)(3), an indirect distribution would be taxable to an indirect shareholder under this section and also included in the gross income of the indirect shareholder under section 551(a), 951(a)(1), or 1293(a), the indirect distribution is taxable only under this section.

This tells us exactly what we need to do: the distribution from Subsidiary is an indirect distribution to Shareholder, subject to tax under IRC § 1291. The distribution from Subsidiary is also part of Parent’s ordinary earnings, and includible in Shareholder’s gross income under IRC § 1293. Apply the tiebreaker, and we delete the income inclusion under IRC § 1293.

This is the best you’re going to get, Bucko: a 34-year old proposed regulation that the government never got around to finalizing. Proposed regulations are not authoritative in the least, but you will find the IRS relying on the proposed regulations and citing them in the Instructions for Form 8621. I think we can, too.

In short, your reporting position is:

• The Subsidiary distribution is included in Shareholder’s income as required by IRC § 1298(b)(5)(A)(ii).
• Parent’s ordinary earnings are included in Shareholder’s income as required by IRC § 1293(a)(1)(A).
• Congressional intent says don’t include a QEF’s income in a taxpayer’s income more than once. IRC § 1293(g)(2).
• The IRS did not write regulations for how to make the adjustment to prevent double inclusion, even though Congress told them to.
• (The weak link). The best indication of IRS administrative procedure is from the 1992 proposed regulations, which say if the same income is taxed under IRC § 1291 and also under IRC § 1293(a) (true for this example), then only include the income using IRC § 1291.

Attach an explanatory statement. Consider attaching Form 8275 to report that you are relying on an antique proposed regulation.

Remove Income (Line 6b)

Now that we know Form 8621, Part III is the place to remove the double-counting of income, the question is how.

Answer: put it on Form 8621, line 6b. This has the advantage of being directionally correct. Line 6b says that you enter the amount that “may be excluded under section 1293(g)” and you are relying specifically on IRC § 1293(g)(2).

Line 6a minus line 6b equals line 6c. $50,000 – $50,000 = $0. Line 6c is your income inclusion, and it is nice round number. Zero.

Conclusion

The point here is simply to demonstrate how the PFIC rules cause income inclusion in a multi-level structure. The intention is clear, and analogous to subpart F inclusions from lower-tier CFCs to U.S. shareholders. However, unlike the CFC situation, regulations haven’t been written for PFICs that tell you exactly how to handle the distribution of cash up the holding structure, so you have to cobble together your argument and document it carefully.

See you in a couple of weeks. And maybe I’ll see some of you in Milan in September.

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