Scariest Tax Form? Skip It, And IRS Can Audit Forever

Sep 10, 2014

Hello everyone! I just came across the Forbes article Scariest Tax Form? Skip It, And IRS Can Audit Forever and while I agree with Robert Wood and form 5471 is indeed scary, I would like to nominate another form for this contest ;)

That is the form 8621, looks just as scary but with the added factor that it has the potential to apply to everyone. Form 5471, on the other hand, apply for people who own more than 10% of a foreign corporation or are a director of such corporation.

When triggers for form 5471 apply to you, you are likely to be in a situation in which you might be interested to inquire an accountant/attorney.

If, on the other hand, you invest $50 in (foreign; i.e. non-US) mutual funds, well, you might not think about it much. The thing is that for tax years ending on or after Dec 31, 2013*, Section 1298(f) applies just as much to PFICs (such as foreign mutual funds) as it does to CFCs (the Controlled Foreign Corporations described in the Forbes article). That means potential $10,000 penalty for non-filing and statute of limitation extended forever (in theory the IRS can always go back and audit the entire return – although in practice the Internal Revenue Manual (IRM) usually restricts it to 6 years, but note that the IRM is not binding on the taxpayer so the IRS can always change its mind).

In its great kindness (yes, Sheldon, it was sarcasm – no Sheldon, my statement about sarcasm was not sarcastic), the IRS issued regulations on Dec 31, 2013 with de minimis rules such that taxpayers wouldn’t have to file form 8621 if their investment in PFIC was less than $25,000 ($50,000 for those married filing jointly). The thing is that the minimis rules didn’t apply to those making a QEF or mark-to-market election – hence you would be stuck with the excess distribution regime (a way for the mutual fund to be taxed at maximum tax rates and then some) ; also, taxpayers would also need to file form 8621 (or else face section 1298(f) ) if they disposed of a PFIC, regardless of the amount of capital gain (or rather “excess distribution”) realized.

Practically speaking, the enforcement has been lacking for those with minimal PFIC investment. Probably because the PFIC rules are so convoluted that even at the IRS, very few people are familiar with them – but the tools are here for the IRS to make it the scariest tax form.

* Although §1298(f) is effective as of March 18, 2010, the IRS suspended §1298(f) reporting in Notice 2011-55 for tax years beginning after March 18, 2010, until regulations under §1298(f) were issued and Form 8621 revised. Notice 2011-55 would have applied the §1298(f) reporting requirements retroactively to tax years beginning after March 18, 2010, once regulations were issued; however, the §1298(f) regulations issued on December 30, 2013, eliminate the retroactive filing requirement and apply §1298(f) reporting only for tax years ending on or after December 31, 2013.

Related: Filing Form 5471 as US owner of Foreign Corporations

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