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IRS Issues Final and Proposed PFIC Regulations

On December 4, 2020, the IRS and Treasury issued final and proposed regulations addressing the passive foreign investment company (PFIC) rules. The regulations generally follow proposed regulations issued in July 2019 (which we discussed here), with some modifications.


A foreign corporation is a PFIC if 75% or more of its gross income consists of interest, dividends, capital gains, or certain other “passive” income, or if 50% or more of its assets produce passive income. A U.S. taxpayer that holds PFIC stock generally is required to include in income, on a current basis, its proportionate share of the PFIC’s ordinary earnings and net capital gain, whether or not distributed. By contrast, a U.S. taxpayer that holds stock in a non-PFIC foreign corporation generally is not taxed on the foreign corporation’s earnings until the foreign corporation distributes the earnings or the U.S. taxpayer sells the stock. Accordingly, U.S. taxpayers typically would prefer a foreign corporation not to be a PFIC.

“Active Insurance” Exemption  

As discussed in our analysis of the proposed regulations, the Tax Cuts and Jobs Act of 2017 amended the PFIC regime's “active insurance” exception to treat a foreign insurance company as a PFIC unless (1) it is a “qualifying insurance corporation” (a QIC) and (2) its income is derived in the “active conduct of an insurance business.”

A foreign insurance company is QIC only if, in general, (1) its active insurance liabilities exceed 25% of the total assets reported on its applicable financial statements or (2) due to runoff- or ratings-related circumstances, it fails to meet the 25% test but meets an alternative test that requires its active insurance liabilities to equal or exceed 10% of its total assets.

The final regulations, among other things, (1) conform the definition of active insurance liabilities to industry terminology, (2) specify that amounts held as a deposit liability or certain reserves for life insurance and annuities are not active insurance liabilities, (3) provide that a related company's active insurance liabilities do not count toward determining a corporation's QIC status, and (4) relax the runoff-related circumstances test.

The proposed regulations, among other things, (1) provide ordering rules on the priority of multiple financial statements, (2) adopt a more flexible “active conduct” test, and (3) clarify that securitization vehicles and insurance-linked securities funds that invest in securitization vehicles generally cannot meet the active conduct test.

Ownership Attribution

Under Section 1298(a), stock owned by a partnership, estate, or trust is treated as owned proportionately by its partners or beneficiaries, while stock owned by a non-PFIC corporation generally is treated as owned proportionately only by 50%-or-greater shareholders (and is not attributed to minority shareholders).  

These rules historically have created uncertainty in tiered ownership structures. Suppose, for example, that a U.S. person owns 49% of a partnership, the partnership owns 100% of a non-PFIC corporation, and the non-PFIC corporation owns 100% of a PFIC. Should the U.S. person's ownership of the PFIC stock be determined under a bottom-up approach, so that the U.S. person is treated as owning 49% of the PFIC stock because (1) 100% of the PFIC stock is owned by a non-PFIC corporation, (2) 100% of the non-PFIC corporation is owned by a partnership, and (3) the U.S. person owns 49% of the partnership? Or should the U.S. person's ownership be determined under a top-down approach, so that the U.S. person is not treated as owning any PFIC stock because (1) the U.S. person owns only 49% of the non-PFIC corporation through the partnership, and (2) stock owned by a non-PFIC corporation is attributed only to 50%-or-greater shareholders?

The final regulations adopt the “top-down” approach, regardless of entity type. Under the proposed regulations, the top-down approach applied only to structures involving pass-through entities.

Other Changes

The proposed regulations make certain changes to the “asset test” for PFICs, including (1) declining to adopt the proposed regulations' active financing exception to the definition of passive income and (2) providing a “working capital” exception to treat a limited amount of cash as a non-passive asset.

Key Contacts

Linda Z. Swartz
T. +1 212 504 6062


Adam Blakemore
T. +44 (0) 20 7170 8697

Jon Brose
T. +1 212 504 6376

Andrew Carlon
T. +1 212 504 6378

Mark P. Howe
T. +1 202 862 2236

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