Source: https://hodgen.com/cfcs-and-mtm-elections/
Timestamp: 2019-04-18 22:51:37+00:00

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Let’s take a look at a common scenario.
A US person sets up a foreign corporation to hold his offshore investments (which include a mutual fund), thinking that he has perhaps arrived at a clever solution to avoid the treacherous PFIC rules that would ordinarily apply to individuals who own foreign mutual funds. Note that the foreign corporation is 100% owned by a US person, so it is a “controlled foreign corporation”, or CFC, under IRC § 957(a).
This is a common arrangement. Frequently US persons set up holding companies for their foreign investments. Often the holding company is a CFC. Often those foreign investments include mutual funds, ETFs, or other assets that would be considered PFICs if owned directly by the US person.
In this email I will talk about whether this is an effective solution for eliminating the PFIC taxation and reporting from your life (short answer: it is not), and whether the Mark to Market election can be made to help mitigate the effects of the PFIC treatment (short answer: maybe).
Has the US person avoided PFIC taxation?
If 50 percent or more in value of the stock of a corporation is owned, directly or indirectly, by or for any person, such person shall be considered as owning the stock owned directly or indirectly by or for such corporation in that proportion which the value of the stock which such person so owns bears to the value of all stock in the corporation.
The US person owns more than 50% of the stock in the foreign corporation. He is considered to own the stock that the foreign corporation owns. The ownership of the foreign mutual fund is attributed to him.
He is still subject to the PFIC reporting and taxation rules even though there is a foreign corporation in between him and the PFIC. He must file Form 8621 as if he owned the PFIC directly.
Let’s examine whether the Mark to Market election, commonly referred to with the acronym “MTM”, can provide some relief to our US person from the horrendous default rules under IRC § 1291. Recall that the default rules apply if no elections can be made. We will assume for this discussion that the mutual fund held by the CFC in our scenario qualifies as a “marketable security” under IRC § 1296(e). If it does not, you cannot make the MTM election.
Generally, the MTM election can only be made by persons who own the PFIC stock directly, or indirectly through foreign partnerships, trusts, or estates. IRC §§ 1296(a) and 1296(g)(1).
Recall that our US person has cleverly inserted a foreign corporation in between himself and the PFIC. A foreign corporation is not one of the entities named in IRC § 1296(g)(1) that cause the owner of the entity to be treated as the owner of the underlying PFIC. This means that the shareholder cannot make the MTM election for the PFIC owned by the CFC, because the shareholder is not treated as indirectly owning PFIC stock through a CFC.
The MTM election is actually made by the “controlling shareholders” of the CFC and not the CFC itself (“controlling shareholders” is a term that is defined in Regs. § 1.964-1(c)(5) if you are curious). In our scenario, there is only one shareholder of the CFC, so he is the controlling shareholder. The controlling shareholder makes the election on behalf of the CFC, and the election applies to all “US shareholders”.
A section 1296 election by a CFC shall be made by its controlling United States shareholders . . . and shall be included with the Form 5471, “Information Return of U.S. Persons With Respect To Certain Foreign Corporations”, for that CFC by the due date (including extensions) of the original income tax returns of the controlling United States shareholders for that year. A section 1296 election by a CFC shall be binding on all United States shareholders of the CFC. Regs. § 1.1296-1(h)(1)(ii).
Our US person must file Form 5471 because he is the 100% owner of a CFC. He is the controlling shareholder of the CFC, so he makes the MTM election on behalf of the CFC. Form 8621 is included with the Form 5471 that he files. The MTM election is made in Part II of Form 8621.
The MTM election applies to all “US shareholders” of the CFC. A “US shareholder” is a person who owns at least 10% of a CFC’s voting power. IRC § 951(b). Our US person is a “US shareholder” because he owns 100% of the value and voting power of the CFC, so he can utilize and benefit from the MTM election.
A brief aside: The MTM election applies to “US shareholders” of the CFC. What about US taxpayers who are not “US shareholders” because they own less than 10% of the CFC’s voting power? That will have to be a topic for another week’s newsletter. For now, just be aware that the rules I am discussing in this email do not apply to those people.
The MTM gain or loss is calculated in Part IV of Form 8621, and flows from there to Form 5471.
I will not go into detail about Subpart F income here; the main thing you should understand at this point is that the MTM PFIC income ends up being treated as foreign personal holding company income, which receives Subpart F treatment. Subpart F income will be reported on the shareholder’s Form 1040 on Line 21 as other income.
First, putting your PFICs in a foreign corporation will not neutralize the PFIC rules. The attribution rule of Section 1298(a)(2) treats you as an indirect owner of the PFIC shares.
Is the PFIC a marketable security?
Is it held in a CFC?
Are you a “US shareholder” of the CFC?
Is the CFC making the MTM election on a Form 8621 that is filed along with a Form 5471, and is that election being made on behalf of the CFC by the controlling shareholders?
Only if all of these are true will the MTM election work for PFICs owned by a CFC, and only for people who are US shareholders (as that term is defined for CFC purposes).

References: § 957
 § 1291
 § 1296
 § 1296
 § 1
 § 1
 § 951