The Tax Court’s decision in Toso v. Commissioner, was a mixed bag for taxpayers as it relates to Passive Foreign Investment Corporations (PFICs). The taxpayer argued that for purposes of extending the statute of limitations for assessment from 3 to 6 years under section 6501(e)(1)(A)(i) income taxed under section 1291 was not part of “gross income”. The taxpayer also argued that under section 1291 any PFIC gains should be offset by PFIC losses.
The Tax Court ruled for the taxpayer on the primary issue of whether income included under section 1291 was gross income for purposes of section 6501(e)(1)(A)(i). Under section 1291 the gain on the disposition of PFIC stock is allocated ratably to each day the taxpayer owned the stock. As such, the Tax Court delineated between “current-year PFIC gain” and “non-current-year PFIC gain” for the gain allocated to days of the taxpayer’s holding period.
The Tax Court reasoned that gross income refers to income defined in section 61(a), however, “[g]ain from the sale of PFIC stock…is taxed according to special rules.” In particular, “[s]ection 1291 expressly provides that ‘only’ current-year PFIC gains are included (as ordinary income) in gross income.” In contrast, “section 1291(a)(1)(C) provides that the ‘the tax imposed…for the current year shall be increased by the deferred tax amount’.” The deferred tax amount is computed by taking the highest ordinary income tax rate for each year of the holding period (other than the current year) multiplying that by the non-current year PFIC gain allocated to each tax year and then computing the interest on each year’s tax liability and then adding this sum to the current year’s tax liability. Because of the “method of taxation prescribed by section 1291 for non-current-year PFIC gains does not include them in gross income for taxable year” the non-current year PFIC gains are “not included in gross income for any year.”
While the Tax Court ruled in favor of the taxpayer regarding the extension of the statute of limitations, the Tax Court ruled against the taxpayer regarding whether PFIC losses could offset PFIC gains. The Tax Court based its decision the use of singular language in section 1291(a)(2) of “any gain recognized on such disposition.” Because of the use of “disposition” instead of “dispositions” it “indicates that “section 1291 applies to each disposition of PFIC stock separately.”
Other taxpayers who failed to file Form 8621 and report their disposition of PFIC stock in prior years will be breathing a sigh of relief since the IRS only has 3 years to assess the additional taxes (unless the non-reported current-year PFIC gain was 25% or more of the taxpayer’s gross income). However, for taxpayers correctly reporting their PFIC gains the inability to net gains and losses from the sale of different PFIC stocks will surely be disappointing. Finally, it should be noted that either party may appeal the Tax Court’s decision so this is not necessarily a settled case.