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The Nightmare of PFICs at the State Level – Answers to FAQs


Bloomberg BNA

The taxation of Passive Foreign Investment Companies is incredibly complicated because of the various ways these companies can be treated federally. In this article, Mary Beth Lougen of Expat Tax Tools brings up frequently asked questions intended to make tax professionals think about what their clients with state residency or domicile who also own a PFIC are facing.

If the federal treatment of passive foreign investment companies (PFICs) under I.R.C. §§1291–1298 isn’t enough to send you screaming from the room, have you ever considered how the various states view that same investment?

Once you start looking closely at the multiple federal treatments and how many ways a state can view those treatments, you quickly realize that the number of considerations and potential issues awaiting your clients is on a scale that is so large it can overwhelm the most seasoned professional. This article will bring up more questions than it answers and is intended to have you really think about what you are dealing with when you have a client with a U.S. state residency or domicile who also owns a PFIC.

You need to stop and thoughtfully evaluate how the state will treat income that is included in federal AGI but does not meet the definition for constructive receipt, income that is constructively received but not included in federal income, losses that are taxed differently than gains for the same investment, losses that are accounted for in different years than gains, income not included in AGI but instead subject to an additional tax by the IRS and just as many
variations of basis adjustments.

As I see it, the main issues are:

  • determining when state adjustments are required to accurately reflect state income,
  • how to recognize when state and federal basis may be different due to timing of income inclusions, and
  • lack of guidance by many state tax codes…