Married investors get consent to make a retroactive QEF election for a foreign fund their advisors failed to flag as a PFIC

Plain-English summary

When a U.S. person owns shares in a "passive foreign investment company" (PFIC), the default tax rules are punitive, but the investor can soften them by making a "qualified electing fund" (QEF) election, generally due with the return for the first year. Here a married couple invested in a foreign corporation that turned out to be a PFIC. Their tax advisors, though qualified to give international tax advice, failed to tell them about the PFIC issue or the availability and consequences of a QEF election, so no timely election was made. Years later a new accounting firm flagged the problem. The couple asked the IRS to consent to a retroactive QEF election back to the first year under Treasury Regulation section 1.1295-3(f), which allows it when the taxpayer reasonably relied on a qualified tax professional, the government is not prejudiced, and the request comes before the IRS raises the PFIC issue on audit. The couple met those conditions, paid an amount to remove any prejudice to the government under a signed closing agreement, and the IRS granted consent to make the retroactive election. This lets them apply the more favorable QEF regime from the start of their investment.

Ruling snapshot

• Question: Should the IRS consent to a retroactive QEF election for the investors' first year, where their tax advisors failed to advise them about the PFIC and the election?
• Outcome: Approved (consent granted for a retroactive QEF election back to the first year, under a closing agreement removing government prejudice).
• Key authorities: IRC § 1295(a), (b); IRC § 1297(a); Treas. Reg. § 1.1295-3(f), (g).

Full text (IRS public release)

 Internal Revenue Service                                   Department of the Treasury
                                                            Washington, DC 20224

 Number: 202207001                                          Third Party Communication: None
 Release Date: 2/18/2022                                    Date of Communication: Not Applicable
 Index Number: 1295.02-02
                                                            Person To Contact:
 -------------------------------                            ----------------------------------, ID No. --------
 ----------------------------                               -----------------
 -----------------------------                              Telephone Number:
                                                            --------------------
                                                            Refer Reply To:
                                                            CC:INTL:B02
                                                            PLR-104567-17
                                                            Date:
                                                            November 23, 2021




                  TY:
Legend

 Spouse A           =               --------------------------------------------
 Spouse B           =               --------------------------------------
                    =
 FC                 =               ---------------------------
                    =
 Country            =               ----------
                    =
 Management Company =               -------------------------------------------------
 Tax Preparer       =               ---------------------------------
 Accounting Firm X  =               -----------------------------
 Accounting Firm Y  =               --------------------------------------------
                    =
 Date X             =               --------------------
 Year 1             =               -------
 Year 2             =               -------
 Year 3             =               -------


Dear ---------------------------:

This is in response to a letter submitted by your authorized representative that
requested the consent of the Commissioner of the Internal Revenue Service
(“Commissioner”) for Taxpayers to make a retroactive qualified electing fund (“QEF”)
PLR-104567-17                                   2

election under section 1295(b) of the Internal Revenue Code (the “Code”) and Treas.
Reg. §1.1295-3(f) with respect to Taxpayers’ investment in FC.

The ruling contained in this letter is based upon information and representations
submitted on behalf of Taxpayers by their authorized representative, and accompanied
by a penalty of perjury statement executed by an appropriate party. While this office
has not verified any of the material submitted in support of this request for ruling, such
material is subject to verification on examination. The information submitted in the
request is substantially as set forth below.

FACTS

Spouse A and Spouse B (collectively, “Taxpayers”) have filed their federal tax returns
as a married couple filing jointly for all tax years relevant to this letter ruling. In Year 1,
Spouse A invested in FC, a Country corporation managed by Management Company.
Taxpayers were unaware that FC was a passive foreign investment company (“PFIC”)
as defined in section 1297(a) of the Code.

During the relevant years, Taxpayers engaged the services of Tax Preparer and
Accounting Firm X (collectively, “Tax Advisors”) to prepare their Forms 1040 and advise
on their investment in FC, respectively. Tax Advisors were competent to render
international tax advice with respect to Taxpayers’ investment in FC.

In Year 2, Management Company informed the investors of FC that FC had been a
PFIC and that FC elected to be treated as a partnership for U.S. federal income tax
purposes effective Date X. Taxpayers related this information to Tax Advisors.
However, Tax Advisors failed to advise Taxpayers on the significance of FC being a
PFIC and of the availability of a QEF election and the consequences of making or failing
to make a QEF election with respect to FC. FC was a PFIC in Year 1, when Taxpayers
acquired an interest in FC, through and in each relevant subsequent year until Date X.

In Year 3, Taxpayers sold their interest in FC and engaged the services of Accounting
Firm Y, which advised Taxpayers of the significance of FC being a PFIC and of the
advisability of a QEF election.

Taxpayers submitted affidavits, under penalties of perjury, describing the events that led
to the failure to make the QEF election by the election due date.

Taxpayers have paid an amount sufficient to eliminate any prejudice to the United
States government as a consequence of their inability to file amended returns, in
accordance with a signed closing agreement between Taxpayers and the
Commissioner. Further, Taxpayers have agreed to file an amended return for each of
the subsequent taxable years affected by the retroactive election, if any.
PLR-104567-17                                 3

In addition, Taxpayers represent that, as of the date of their request for ruling, the PFIC
status of FC had not been raised by the IRS on audit for any of the taxable years at
issue.

RULING REQUESTED

Taxpayers request the consent of the Commissioner to make a QEF election retroactive
to Year 1 with respect to their investment in FC under Treas. Reg. § 1.1295-3(f).

LAW

Section 1295(a) provides that a PFIC will be treated as a QEF with respect to a
shareholder if (1) an election by the shareholder under section 1295(b) applies to the
PFIC for the taxable year; and (2) the PFIC complies with the requirements prescribed
by the Secretary for purposes of determining the ordinary earnings and net capital gains
of the company.

Under section 1295(b)(2), a QEF election may be made for a taxable year at any time
on or before the due date (determined with regard to extensions) for filing the return for
the taxable year. To the extent provided in regulations, the election may be made after
the due date if the shareholder failed to make an election by the due date because the
shareholder reasonably believed the company was not a PFIC.

Under Treas. Reg. §1.1295-3(f), a shareholder may request the consent of the
Commissioner to make a retroactive QEF election for a taxable year if:

       1. the shareholder reasonably relied on a qualified tax professional, within the
          meaning of Treas. Reg. §1.1295-3(f)(2);
       2. granting consent will not prejudice the interests of the United States
          government, as provided in Treas. Reg. §1.1295-3(f)(3);
       3. the request is made before a representative of the Internal Revenue Service
          raises upon audit the PFIC status of the company for any taxable year of the
          shareholder; and
       4. the shareholder satisfies the procedural requirements of Treas. Reg. §1.1295-
          3(f)(4).


The procedural requirements include filing a request for consent to make a retroactive
election with, and submitting a user fee to, the Office of the Associate Chief Counsel
(International). Treas. Reg. §1.1295-3(f)(4)(i). Additionally, affidavits signed under
penalties of perjury must be submitted that describe:
PLR-104567-17                                    4

       1. the events that led to the failure to make a QEF election by the election due
          date;
       2. the discovery of the failure;
       3. the engagement and responsibilities of the qualified tax professional; and
       4. the extent to which the shareholder relied on the professional.


Treas. Reg. §1.1295-3(f)(4)(ii) and (iii).

CONCLUSION

Based on the information submitted and representations made with Taxpayers’ ruling
request, we conclude that Taxpayers have satisfied Treas. Reg. § 1.1295-3(f).
Accordingly, consent is granted to Taxpayers to make a retroactive QEF election with
respect to FC for Year 1, provided that Taxpayers comply with the rules under Treas.
Reg. § 1.1295-3(g) regarding the time and manner for making the retroactive QEF
election. We have, consequently, approved a closing agreement with Taxpayers with
respect to those issues affecting their tax liability on the basis set forth above.

Except as expressly provided herein, no opinion is expressed or implied concerning the
tax consequences of any aspect of any transaction or item discussed or referenced in
this letter.

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of the Code
provides that it may not be used or cited as precedent.

A copy of this letter must be attached to any income tax return to which it is relevant.
Alternatively, taxpayers filing their returns electronically may satisfy this requirement by
attaching a statement to their return that provides the date and control number of the
letter ruling.

In accordance with the Power of Attorney on file with this office, copies of this letter
ruling are being sent to your authorized representatives.

                                          Sincerely,

                                          /s/ Kristine A. Crabtree

                                          Kristine A. Crabtree
                                          Senior Technical Reviewer, Branch 2
                                          (International)
cc: