John Boyd - What do skis, a motorboat, a bicycle, and toy tractors have in common?

During my latest wanderings on the internet, I came across a writing by the brilliant military strategist John Boyd. The writing was a presentation entitled The Strategic Game of ? And ? (June 1987).

For those who haven't heard that name before, Colonel Boyd developed the OODA loop, which stands for Observe, Orient, Decide, and Act and was originally applied to combat operations and has since been expanded to analyze systems and processes in general.  Definitely an interesting topic (and man).

So, what does Col. Boyd have to do with the title of this post?  Simply this:

Illustration

• Imagine that you are on a ski slope with other skiers—retain this image.
• Imagine that you are in Florida riding in an outboard motorboat—maybe even towing water-skiers—retain this image.
• Imagine that you are riding a bicycle on a nice spring day—retain this image.
• Imagine that you are a parent taking your son to a department store and that you notice he is fascinated by the tractors or tanks with rubber caterpillar treads—retain this image.

Now imagine that you:

• Pull skis off ski slope; discard and forget rest of image.
• Pull outboard motor out of motorboat; discard and forget rest of image.
• Pull handlebars off bicycle; discard and forget rest of image.
• Pull rubber treads off toy tractors or tanks; discard and forget rest of image.

This leaves us with: skis, outboard motor, handlebars, rubber treads.  Pulling all this together, what do we have?

• A snowmobile.

 (source:  http://www.dnipogo.org/boyd/pdf/strategy.pdf, starting at page 6)


Note:  I believe the passage above is permitted to be reproduced under the Fair Use doctrine.  If the legal copyright owner disagrees, I will certainly consider its removal.

White House releases proposal for 100% expensing of investments in qualified assets

The White House today also released the following (original pdf at http://bit.ly/cb3bpu). While it is also just a proposal at this point (and would still need to get through Congress), it would retroactively (to September 8, 2010) allow businesses to write off 100% of their investment in qualified depreciable assets in the year purchased and/or placed in service.

President Obama Proposes Accelerating Business Investment to Promote Job Creation

Largest Temporary Investment Incentive in History

As part of a targeted set of proposals the President will talk about on Wednesday – including an investment in infrastructure to rebuild our roads, railways and runways and an enhanced , permanent Research and Experimentation tax credit – the President will propose to jump-start private investment and job creation by allowing companies to fully deduct qualified capital investments through the end of 2011. This measure would provide tax incentives for businesses to invest in the United States when our economy needs it most, which should both help create jobs now and expand the capital stock to support future growth. This unprecedented step would be the largest temporary investment incentive in American history.

• 100 percent expensing through the end of 2011. Businesses in 2008 and 2009 were allowed to depreciate 50 percent of qualified investments up-front, and the current small business bill would extend this through 2010. The Administration proposes to expand this benefit for qualified investments to 100 percent expensing through the end of 2011. In order to begin encouraging additional investment immediately and to avoid capital waiting on the sidelines, the benefit would be retroactive to September 8, 2010.
• Accelerates nearly $200 billion in tax cuts over the next two years—with most paid back over time. Expensing would put nearly $200 billion in the hands of businesses over the next two years—helping companies that make new investments in the United States at a time they need it most. Furthermore, most of this relief would be recouped by the Treasury as businesses regain their strength. Specifically, businesses would get the upfront deduction for their investment—now when they most need it—but would give up their future annual depreciation allowances in future years when the economy is stronger. With this recoupment taken into account, the provision has a net cost of about $30 billion over the next ten years.
• Would provide incentives for millions of businesses to expand investment. Expensing would benefit 1.5 million corporations and several million individuals.

What Outside Voices Say about Expensing

• Chamber of Commerce: "[These] accelerated cost recovery proposals would, in the short run, act as an insurance policy by encouraging immediate investment, and, in the long run, would increase productivity and further the prospects for long-term economic growth." (Bruce Josten, Executive Vice President)
• Alan Auerbach: UC Berkeley Professor: "Unlike an investment credit, however, bonus depreciation is ideally suited to firms facing credit constraints. By deferring tax payments rather than simply reducing them, it can provide a much bigger benefit to firms facing a high cost of funds than it costs the government." (National Journal Online)
• Chris Edwards: Director of Tax Policy Studies, Cato Institute: "The right tax policy can speed up the economy's return to growth… we need small businesses and entrepreneurs to take up the slack by starting new businesses and investing. Let's make these risky decisions easier for them by cutting their tax burden…(we should) move to expensing which would eliminate many investment distortions. Workers would be the beneficiaries as more capital investment would raise worker productivity and produce higher wages. (2001 Testimony for House Subcommittee on Tax, Finance, and Exports)

White House releases research tax credit proposal

The White House today released the following (original pdf at http://bit.ly/9Dy8XU).  While it *is* just a proposal at this point (and would still need to get through Congress), it would arguably make it easier for businesses to make use of the research tax credit.

Also, as I suspected, the proposal expressly seems to eliminate the traditional 1984 - 1988 "base period" that in my experience has caused some serious headaches for businesses that hadn't kept records going back that far.  Next step, Congress!

EXPANDED, SIMPLIFIED AND PERMANENT RESEARCH AND EXPERIMENTATION TAX CREDIT

The President proposes to expand, simplify, and permanently extend the Research and Experimentation Tax Credit in order to help companies create good jobs in America now while increasing future productivity and growth. This is a win-win—encouraging job growth and investment now that will pay off with stronger economic growth in the future.

Specifically, the President proposes to:

• Expand the R&E credit by about 20 percent. This would be the largest increase in the credit in its history. In total, the expanded credit would devote about $100 billion over the next 10 years to leverage additional R&D investment. Like the current credit, eligible research and experimentation needs to be performed in the United States, keeping high-skilled jobs in America.
• Simplify the credit. Currently, businesses must choose between using a complex formula for calculating their R&E credit that provides a 20 percent credit rate for investments over a certain base and a much simpler one that provides a 14 percent credit in excess of a base amount. The complex formula is, in fact, so outdated that it takes into account the amount of a business’s R&D expenses from 1984 to 1988. The Administration proposes to increase the rate of the simpler credit to 17 percent, which would make it more attractive and simplify tax filing for businesses. Simplifying the credit in this manner will increase its salience and impact on encouraging investment in research in the United States.
• Permanent credit. The President would make the credit permanent so that businesses could make investments and create jobs today confident that they will continue to benefit from the credit in the future. The President supports fully paying for this permanent tax policy, for example with the over $300 billion in loophole closers and other measures proposed in the FY 2011 Budget.

An expanded, simplified, and permanent R&E credit will help keep the U.S. economy at the cutting-edge of 21st century technologies, while expanding high-tech jobs, encouraging innovation, and increasing future productivity and growth:

• Increasing business certainty. The credit has been extended 13 times since its creation in 1981, with some extensions lasting just 6 months, and has also been allowed to lapse since the end of last year. However, although Republicans have supported extension in the past, they have voted against it multiple times this year, and are now blocking legislation that would renew this credit, creating uncertainty with two-thirds of the year already complete. Making this provision permanent would avoid this type of outcome and give businesses the certainty they need to accelerate R&E investments to create jobs today and in the future.
• 80 percent of the benefit directly supports jobs in the United States, and every dollar spent encourages U.S.-based investment. Four-fifths of tax credits are attributable to salaries of U.S. workers performing U.S.-based research—meaning that the credit helps create high-skilled jobs, as well as encouraging new innovations and future productivity. The entire credit goes to research and experimentation in the United States, with additional spillover benefits for jobs.
• Increase competitiveness to prevent the United States from falling further behind other countries in tax incentives for R&E. Increasing the R&E tax credit will strengthen innovation at home and make the United States more competitive abroad—helping us to reach our goal of bringing total R&D to 3 percent of GDP. In the 1980s, the United States was the leader in generous tax treatment of R&D; however, today many nations now provide far more generous tax incentives for research than does the United States. By 2008, we had fallen to 17th in generosity for general R&D amongst OECD nations. (Information Technology and Innovation Foundation) Among nations with tax incentives for R&D, the United States now provides one of the weakest incentives, below our neighbors Canada and Mexico, and behind many Asian and European nations. Leverage—each $1 spent on the tax credit creates $2 of benefits for the economy. Studies have shown that every dollar of tax benefit stimulates as much as an additional dollar of private R&D spending in the short run and two dollars in the long run. Every $1 of R & D adds about $2 of benefit to our economy and society as a whole.

What Outside Voices Say about the R&E Credit

• Chamber of Commerce: “The R&D tax credit creates high-wage, American jobs….Extension and expansion of the R&D tax credit will encourage investment in R&D in the United States that will enhance high-wage job growth and contribute to the revitalization of the American economy.” (Chamber website)
• Rob Atkinson, President of the Information Technology and Innovation Foundation: “If the United States is to remain the world’s preeminent location for technological innovation (and the high paying jobs that result), Congress will need to significantly expand and reform the Research and Experimentation Tax Credit.” (Foundation papers)
• Kevin Hassett, American Enterprise Institute: The R&E credit is “one of the most successful government tax provisions on the books….If the credit were to become permanent, then the benefits could well be higher, since the uncertainty surrounding its renewal would be removed.” (testimony)
• Douglas Holtz-Eakin (when John McCain’s top economic adviser): “Give companies a permanent R&D credit because we know if the R&D is done here, the manufacturing is more likely to be done here, according to the research literature.” (US News and World Report)

President Obama to propose 100% bonus depreciation / section 179 fixed asset write-offs?

Well, this has certainly been an active couple of days for tax breaks (reportedly) being proposed by the Obama Administration!

First it's announced that the President will ask Congress on Wednesday to expand and make permanent the research credit.  Now, the Wall Street Journal is reporting

President Barack Obama, in one of his most dramatic gestures to business, will propose that companies be allowed to write off 100% of their new investment in plant and equipment through 2011, a plan that White House economists say would cut business taxes by nearly $200 billion over two years.

The proposal, to be laid out Wednesday in a speech in Cleveland, tops a raft of announcements, from a proposed expansion of the research and experimentation tax credit to $50 billion in additional spending on roads, railways and runways. But unlike those two ideas, both familiar from Mr. Obama's 2008 campaign, the investment incentive would embrace a long-held wish by conservative economists that had never won support from either Republican or Democratic administrations.

(See here for the rest of the article.  You may need to register at online.WSJ.com to see it.)

For what it's worth, I haven't found anything about either this item or the research credit proposal on the White House website.

Stay tuned!

President Obama to reportedly outline a proposal to make Research Tax Credit permanent

According to numerous sources, President Obama will ask Congress on Wednesday to both expand, and make permanent, the research tax credit under section 41.  Under current law, the federal research credit expired for qualified expenses (as defined under section 41(b)) paid or incurred after December 31, 2009.

While details are still scarce, here is what I've seen so far.  Please note that until something official comes out, these are just unconfirmed rumors.

• Would expand the credit percentage under the Alternative Simplified Method (under section 41(c)(5)) from the generally-applicable pre-2010 amount of 14% to 17%.
• The $100 billion proposal will be announced at a speech in Cleveland on September 8, as part of a discussion on the economy.
• Of the $100 billion, $85 billion represents the 10-year cost of making the credit permanent.  The other $15 billion is the reported cost of expanding it.
• I have seen no mention of whether these proposals would apply retroactively (i.e., starting January 1, 2010).  My personal expectation is that it would, especially in light of the upcoming midterm elections, but we're likely to find out on Wednesday.
• No information is available regarding the standard computation method, but if House Bill 422 and Senate Bill 1203 are any indication (and which seem to have substantial bipartisan support), I suspect that the standard computation method will not be brought back.  Observation:  The standard method is a thorn in many sides due to taxpayers generally being required to base their research credit computations in part on their activities during the 1984 - 1988 time frame.  Not surprisingly, many taxpayers don't have information (much less documentation) going back that far.

Sources:

• New York Times:  http://nyti.ms/alAYBQ
• Washington Post (via Associated Press):  http://bit.ly/c7oEKq

More to come...

Joint Committee on Taxation releases description of revenue provisions in President's FY2011 budget proposal

On August 16, Joint Committee on Taxation released its "Description Of Revenue Provisions Contained In The President’s Fiscal Year 2011 Budget Proposal" which is available at http://bit.ly/b6WD70.

The full document runs 521 pages, here's the outline.

Notes:

• Some of the proposed items have already been enacted (e.g., several of the items under "Reform U.S. International Tax System" were part of H.R. 1586 discussed at http://tax-fishing-and-other.blogspot.com/2010/08/hr-1586-signed-into-law-today.html).

• These are the President's revenue (i.e., tax) proposals, not current law (nor necessarily even pending legislation).  Nevertheless, they do provide some insight into the Administration's views and *may* ultimately find their way into future legislation.

I.             INDEX THE INDIVIDUAL ALTERNATIVE MINIMUM TAX AMOUNTS FOR INFLATION

II.            MAKE PERMANENT AND MODIFY CERTAIN TAX CUTS ENACTED IN 2001 AND 2003

A.            Dividends and Capital Gains Tax Rate Structure

B.            Extend Temporary Increase in Expensing for Small Business

C.            Marginal Individual Income Tax Rate Reductions

D.            Child Tax Credit

E.            Increase of Refundable Portion of the Child Credit

F.            Marriage Penalty Relief and Earned Income Tax Credit Simplification

G.           Education Incentives

H.            Modify and Make Permanent the Estate, Gift, and Generation Skipping Transfer Taxes After 2009

I.             Other Incentives for Families and Children (includes extension of the adoption tax credit, employer-provided child care tax credit, and dependent care tax credit)

J.             Reinstate the Overall Limitation on Itemized Deductions and the Personal Exemption Phase-out

III.           TEMPORARY RECOVERY MEASURES

A.            Extend the Making Work Pay Credit for One Year

B.            Provide $250 Economic Recovery Payment and Special Tax Credit

C.            Extend COBRA Health Insurance Premium Assistance

D.            Provide Additional Tax Credits for Investment in Qualified Property Used in a Qualifying Advanced Energy Manufacturing Project

E.            Extend Temporary Bonus Depreciation for Certain Property

F.            Extend Option for Cash Assistance to States in Lieu of Low-Income Housing Tax Credit for 2010

IV.          TAX CUTS FOR FAMILIES AND INDIVIDUALS

A.            Increase in the Earned Income Tax Credit

B.            Expand the Child and Dependent Care Tax Credit

C.            Automatic Enrollment in Individual Retirement Arrangements

D.            Saver’s Credit

E.            Extend American Opportunity Tax Credit

V.            TAX CUTS FOR BUSINESSES

A.            Increase Exclusion of Gain on Sale of Qualified Small Business Stock

B.            Make the Research Credit Permanent

C.            Remove Cell Phones from Listed Property

VI.          OTHER REVENUE CHANGES AND LOOPHOLE CLOSERS

A.            Reform Treatment of Financial Institutions and Products

1.            Impose a financial crisis responsibility fee

2.            Require accrual of the time-value element on forward sale of corporate stock

3.            Require ordinary treatment for dealer activities with respect to section 1256 contract

4.            Modify the definition of control for purposes of the section 249 deduction limitation

B.            Reinstate Superfund Excise Taxes and Corporate Environmental Income Tax

C.            Permanent Extension of Federal Unemployment Surtax

D.            Repeal Last-In, First-Out Inventory Accounting Method

E.            Repeal Gain Limitation on Dividends Received in Reorganization Exchanges

F.            Reform U.S.       International Tax System

1.            Defer deduction of interest expense related to deferred income

2.            Determine the foreign tax credit on a pooling basis

3.            Prevent splitting of foreign income and foreign taxes

4.            Tax currently excess returns associated with transfers of intangibles offshore

5.            Limit shifting of income through intangible property transfers

6.            Disallow the deduction for excess nontaxed reinsurance premiums paid to affiliates

7.            Limit earnings stripping by expatriated entities

8.            Repeal 80/20 company rules

9.            Prevent the avoidance of dividend withholding taxes

10.          Modify the tax rules for dual capacity taxpayers

G.           Combat Under-Reporting of Income on Accounts and Entities in Offshore Jurisdictions

1.            Require reporting of certain transfers of assets to or from foreign financial accounts

2.            Require third-party information reporting regarding the transfer of assets to or from foreign financial accounts and the establishment of foreign financial accounts

H.            Reform Treatment of Insurance Companies and Products

1.            Modify rules that apply to sales of life insurance contracts

2.            Modify dividends received deduction for life insurance company separate accounts

3.            Expand pro rata interest expense disallowance for company-owned life insurance (“COLI”)

4.            Permit partial annuitization of a nonqualified annuity contract

I.             Eliminate Fossil Fuel Tax Preferences

J.             Treat Income of Partners for Performing Services as Ordinary Income

K.            Modify the Cellulosic Biofuel Producer Credit

L.             Eliminate Advance Earned Income Tax Credit

M.          Deny Deduction for Punitive Damages

N.           Repeal the Lower-of-Cost-or-Market Inventory Accounting Method

O.           Reduce the Tax Gap and Make Reforms

1.            Require information reporting on payments to corporations

2.            Require information reporting for rental property expense payments

3.            Require information reporting for private separate accounts

4.            Require a certified taxpayer identification number from contractors and allow certain withholding

5.            Increased information reporting for certain government payments for property and services

6.            Increase information return penalties

7.            Require e-filing by certain large organizations

8.            Implement standards clarifying when employee leasing companies can be held liable for their clients’ Federal employment taxes

9.            Increase certainty with respect to worker classification

10.          Codify economic substance doctrine

11.          Allow assessment of criminal restitution as tax

12.          Revise offer-in-compromise application rules

13.          Allow Internal Revenue Service expanded access to information in the National Directory of New Hires

14.          Make repeated willful failure to file a tax return a felony

15.          Facilitate tax compliance with local jurisdictions

16.          Extension of statute of limitations where state tax adjustment affects Federal tax liability

17.          Improve investigative disclosure statute

18.          Clarify that the bad check penalty applies to electronic checks and other payment forms

19.          Impose a penalty on failure to comply with electronic filing of returns

20.          Require consistency in value for transfer and income tax purposes

21.          Modify rules on transfer tax valuation discounts

22.          Require minimum term for grantor retained annuity trusts (“GRATs”)

VII.         UPPER-INCOME TAX PROVISIONS

A.            Limit the Tax Rate at Which Itemized Deductions Reduce Tax Liability

VIII.        SUPPORT CAPITAL INVESTMENT IN THE INLAND WATERWAYS

IX.           OTHER INITIATIVES

A.            Extend and Modify the New Markets Tax Credit

B.            Reform and Extend Build America Bonds

C.            Restructure Transportation Infrastructure Assistance to New York City

D.            Implement Unemployment Insurance Integrity Legislation

E.            Authorize Post-Levy Due Process

F.            Increase Levy Authority to 100 Percent for Vendor Payments

G.           Allow Offset of Federal Income Tax Refunds to Collect Delinquent State Income Taxes for Out-of-State Residents

HR 1586 signed into law today - Say hello to some revenue raisers re international taxes

Don't let HR 1586's title(s) ("FAA Air Transportation Modernization and Safety Improvement Act," "Education Jobs and Medicaid Assistance Act," and several others) fool you.  It's chock-full of revenue raisers (i.e., tax increases) mostly in the area of international tax.

Further information (and explanations) will follow, but here are the key revenue offsets and corresponding effective dates:

• Rules to Prevent Splitting Foreign Tax Credits from the Income to Which They Relate - Effective with respect to foreign income taxes paid or accrued by U.S. taxpayers and section 902 corporations in taxable years beginning after December 31, 2010.
• Denial of Foreign Tax Credit with Respect to Foreign Income Not Subject to U.S. Taxation by Reason of Covered Asset Acquisitions - Effective for covered asset acquisitions after December 31, 2010.
• Separate Application of Foreign Tax Credit Limitation, etc., to Items Resourced Under Treaties - Effective for taxable years beginning after the date of enactment (i.e., August 10, 2010).
• Limitation on the Amount of Foreign Taxes Deemed Paid with Respect to Section 956 Inclusions - Effective for acquisitions of United States property after December 31, 2010.
• Special Rule with Respect to Certain Redemptions by Foreign Subsidiaries - Effective for acquisitions after the date of enactment.(i.e., August 10, 2010).
• Modification of Affiliation Rules for Purposes of Rules Allocating Interest Expense - Effective for taxable years beginning after the date of enactment (i.e., August 10, 2010).
• Termination of Special Rules for Interest and Dividends Received from Persons Meeting the 80-Percent Foreign Business Requirements - Effective for taxable years beginning after December 31, 2010.
• Limitation on Extension of Statute of Limitations for Failure to Notify Secretary of Certain Foreign Transfers - Effective for returns filed after March 18, 2010.
• Elimination of Advance Refundability of Earned Income Tax Credit - Effective for taxable years beginning after December 31, 2010.

Source data:

• HR 1586 on Thomas (part of the Library of Congress):  http://bit.ly/ciHQse
• Joint Committee on Taxation's writeup:  http://bit.ly/cEZ5MN

The Passive Foreign Investment Company (“PFIC”) Provisions – A Quick Q&A

(or “Just when you thought you were safe because your foreign corporation isn’t a CFC…”)

Background – There seems (understandably) to be a fair amount of confusion on how to treat PFICs, whether directly owned by US taxpayers or by entities (e.g., partnerships) in which they have an ownership interest.  The purpose of this Q&A is to clarify some of the questions and provide guidance for further research if needed.  This is not meant to be an exhaustive discussion of the PFIC rules, but simply a starting point.  If you have further questions, please ask someone with experience in this area (e.g., me!).

1.            What is a PFIC and why is that classification relevant?

A PFIC (short for Passive Foreign Investment Company) is a foreign corporation that meets either an asset test (at least 50% of the foreign corporation’s assets either actually produce, or are held to produce, passive income) or an income test (at least 75% of the foreign corporation’s gross income is passive income).  PFICs are subject to special rules meant to limit a US taxpayer’s benefit from deferring income earned by the PFIC (e.g., section 1291, which imposes an interest charge on “excess distributions”).

Passive income in this context is any income treated as “foreign personal holding company income” under section 954(c).  This generally (but with exceptions) includes dividends, interest, royalties, rents, annuities, net gains on property that give rise to the aforementioned items, certain net commodity transaction gains, certain net foreign currency gains, income equivalent to interest and dividends, certain net derivative gains, and certain personal service contracts that can be fulfilled by others.

While there are a number of exceptions to these general rules, they are beyond the scope of this Q&A.  For further information, please start with sections 1291 through 1298.

2.            What is a QEF and why is it relevant?

A QEF (short for Qualified Electing Fund) is a PFIC for which the US shareholders (whether direct or indirect) have elected under section 1295 to recognize their proportionate share of the PFIC’s current earnings and profits (as ordinary earnings and net long-term capital gain, as the case may be).  Please see below for further information.

In addition, a QEF election (if made for the year in which the electing US shareholder first held the PFIC’s stock) will generally prevent the application of the otherwise-required anti-deferral rules (e.g., section 1291).

3.            How is a PFIC’s US shareholder taxed if the PFIC does not have a QEF election in place?

If no QEF election was made, the US shareholder will generally be taxed as follows:

·         Income/gains earned by the PFIC – No impact.

·         Deductions/losses incurred by the PFIC – No impact.

·         Distributions by the PFIC:

o    Distributions by the PFIC will be treated as dividends to the extent of the US shareholder’s share of the PFIC’s E&P (short for “Earnings & Profits”), with any excess applied first against stock basis (until zero) and then to capital gain.

o    In addition, “excess distributions” are subjected to the interest charge rules of section 1291 (as well as a historical lookback/grossup re the taxes that would have been paid, using the highest applicable ordinary income rates for those years).  This requires the US shareholder to track taxable distributions for the preceding 3 years and if the current year distributions exceed 125% of that 3-year average, the excess is considered an “excess distribution.”

Note:  If the US shareholder held the stock for less than 3 years, they use the average for that shorter preceding period.  In addition, there can be no excess distributions in the 1^st year in which the US shareholder held the PFIC’s stock.

Note: All distributions “in respect of stock” of the PFIC are included for purposes of determining excess distributions, even if those amounts would otherwise have been nontaxable to the US shareholder (e.g., distributions in excess of the PFIC’s E&P which would otherwise have been treated as returns of capital).

·         Gain on disposition of the PFIC stock by the US shareholder – Treated as an excess distribution in its entirety, which includes taxation at ordinary income rates.

·         Loss on disposition of the PFIC stock by the US shareholder – Treated as a capital loss.

4.            How is a PFIC’s US shareholder taxed if the PFIC has a QEF election in place?

If a QEF election was made, the US shareholder will generally be taxed as follows (but see also the comment below regarding situations in which the US shareholder doesn’t make the QEF election with respect to a particular PFIC in the 1st year of stockholding):

·         Income/gains earned by the PFIC – Included in income and an increase to basis in PFIC stock.

o    Ordinary income – As ordinary income, the US shareholder's pro rata share of the ordinary earnings of the QEF for such year.

o    Capital gain – As long-term capital gain, the US shareholder's pro rata share of the net capital gain of the QEF for such year.

·         Deductions/losses incurred by the PFIC – No impact.

·         Distributions by the PFIC:

o    Distributions of previously recognized/taxed income – Excluded from income, but reduces basis in PFIC stock.

o    Distributions of current-year recognized/taxed income – Excluded from income, but reduces basis in PFIC stock.

o    Distributions in excess of cumulatively recognized/taxed income – Reduces basis in PFIC stock as a return of capital; amounts in excess of basis are capital gains.

·         Gain on disposition of the PFIC stock by the US shareholder – Treated as a capital gain (long or short as the facts dictate).

·         Loss on disposition of the PFIC stock by the US shareholder – Treated as a capital loss.

5.            What if the PFIC is also a CFC (a Controlled Foreign Corporation)?

A CFC is defined under section 957(a) and is a foreign corporation controlled (more than 50%) by US shareholders that each own at least 10% of the foreign corporation.

If a PFIC is also a CFC, section 1297(d)(1) generally treats the foreign corporation as not being a PFIC during the “qualified portion” of such shareholder’s holding period with respect to stock in that corporation.  The “qualified portion” means the portion of the shareholder’s holding period which is after 12/31/97, and during which the shareholder is a “United States shareholder” (i.e., owns at least 10% of the foreign corporation) and the foreign corporation is a CFC.

Caveat:  Just because a CFC isn’t generally subject to the PFIC rules doesn’t mean there aren’t issues to deal with.  There are, but they are beyond the scope of this Q&A.

6.            Who makes the QEF election, and when/how is it made?

The QEF election may only be made by the first US person (including a domestic partnership, S corporation, or estate) that is a direct or indirect shareholder of the PFIC.  For example, if a US individual (“USI”) is a partner in a US partnership (“USP”), which is a partner in a foreign partnership (“FP”), which is a shareholder in a PFIC, the QEF election could only be made by the US partnership (“USP”).

A US shareholder generally must make a QEF election by the due date (including extensions) for filing the US shareholder’s federal income tax return for the first year to which the election is desired to apply.  The election will then apply to that (and all subsequent) years of that foreign corporation.  The election is made by completing the applicable parts of Form 8621 (instructions here) and attaching it to the US shareholder’s timely-filed federal income tax return.

7.            Is the QEF election required to be made in the first year the US shareholder owns the PFIC stock?

No.  However, if the US shareholder does not make the election in the 1^st year of holding the stock, it will be subject to both the section 1291 rules and the QEF rules.

8.            If the US shareholder doesn’t make the QEF election with respect to a particular PFIC in the 1^st year of stockholding, how can they avoid the section 1291 rules?

There are several ways to do so, including (but not limited to) the following:

·         Deemed sale election – The US shareholder may prospectively treat the PFIC as if it had been a QEF from the 1^st year in which they held stock (i.e., a “pedigreed PFIC”) by electing under section 1291(d)(2)(A) to recognize gain on the sale of that PFIC’s stock on the first day of the year for its fair market value (with the gain, if any, treated as an excess distribution for section 1291 purposes).  Caveat:  The US shareholder must meet 3 tests to qualify for this election:

o    The PFIC becomes a QEF with respect to the US shareholder for a taxable year which begins after December 31, 1986,

o    The US shareholder holds stock in that PFIC on the first day of such taxable year, and

o    The US shareholder establishes to the IRS’s satisfaction the fair market value of such stock on such first day.

·         Deemed dividend election – The US shareholder may prospectively treat the PFIC as if it had been a QEF from the 1^st year in which they held stock (i.e., a “pedigreed PFIC”) by electing under section 1291(d)(2)(B) to include in gross income as a dividend an amount equal to the portion of the post-1986 earnings and profits of such company attributable to the stock in the PFIC. This amount will be treated as an excess distribution.  Note/Caveat:  The US shareholder must meet 3 tests to qualify for this election, but this election is generally relevant to less-than-10% US shareholders due to the elimination of the CFC/PFIC overlap (as noted above) in 1997.

o    The PFIC becomes a QEF with respect to the US shareholder for a taxable year which begins after December 31, 1986,

o    The US shareholder holds stock in that PFIC on the first day of such taxable year, and

o    The PFIC is a CFC.

·         Retroactive election – The US shareholder may retroactively treat the PFIC as if it had been a QEF from the 1^st year in which they held stock (i.e., a “pedigreed PFIC”) by electing under Treas. Reg. section 1.1295-3(b) if they:

o    Reasonably believed that as of the election due date the foreign corporation was not a PFIC for its taxable year that ended during the retroactive election year;

o    Filed a Protective Statement with respect to the PFIC, applicable to the retroactive election year, in which the shareholder described the basis for their reasonable belief and extended the periods of limitations on the assessment of PFIC-related taxes for all taxable years of the shareholder to which the Protective Statement applies; and

o    Complied with any other terms and conditions of the Protective Statement.

9.            Do dividends from a PFIC qualify for the federal 15% capital gains tax rate (whether or not a QEF election has been made)?

No.  Section 1(h)(11)(C)(iii) specifically excludes dividends from a PFIC from the special beneficial rate.

10.         Does California conform to these rules?

No.  As a result, you will often see differences in both income recognized (as well as differences in stock basis) between federal and California.  California taxes distributions from a PFIC when made to the US shareholder.

Therapeutic Discovery Project Tax Credit / Grant - IRS Releases Form 8942, Instructions, and Additional Guidance

More information to follow as soon as I've had a chance to review, but in the interim:

• Form 8942: http://bit.ly/cNFF2Y
• Form 8942 instructions: http://bit.ly/9hdjI9
• IRS Q&A: http://bit.ly/depaMx

Let me know if you have any questions, I'd love to help!

 

How's this for Random and Fishing (Library of Congress)

Did you know that the Library of Congress has a YouTube channel where it stores old (and I mean really old) videos and cartoons?  Here's a link to a 1903 video of a guy bass fishing: http://www.youtube.com/user/LibraryOfCongress#p/u/114/93RpuHxFY2g.

The main channel has hundreds of old (and apparently recent) videos and is at http://www.youtube.com/user/LibraryOfCongress.  Very cool!