G Election Trues Up Timing to Recognize CFC & PFIC Income for Net Investment Income Tax

The “G” election,  provided for under U.S. Treas. Reg. Section 1.1411-10(g), impacts U.S. direct and indirect individual shareholders of controlled foreign corporations (“CFCs”) and passive foreign investment companies (“PFICs”). A U.S. individual shareholder of a CFC or PFIC with a qualified electing fund (“QEF”) election is required to report and pay U.S. federal tax on certain undistributed income from the CFC or PFIC/QEF. This undistributed income is generally treated as a deemed dividend inclusion, which is subject to both regular U.S. federal individual income tax and the net investment income tax.

The G election allows the U.S. individual shareholder of a CFC or PFIC/QEF to report and pay U.S. tax on undistributed income from a CFC or PFIC/QEF in the same year for both regular tax and net investment income tax purposes. Without the election, the shareholder does not recognize CFC or PFIC income for net investment income tax until the year when an actual cash distribution is made. While the opportunity for deferral may seem favorable, the recordkeeping necessary to keep track of the information to substantiate the deferral and later recognition is not practical for many taxpayers and their tax preparers.

U.S. individuals typically may own indirect interests in CFCs and PFICs through investment fund partnerships, which are pass-through entities. For the tax year ending 12/31/2013, many investment funds have reported footnote disclosures in the investor’s annual Schedule K-1 which advise the individual investor to make the G election on their respective Form 1040 individual income tax return. The disclosures typically advise the U.S. investor that the CFC or PFIC/QEF income is already included in the Schedule K-1 amounts and that the fund did not make the G election. A pass-through entity has the option to make the G election for the year 2013 if the fund obtains consent from all of its direct investors. The fund also has the option to make the G election for years after 12/31/2013.

The technical area of PFIC tax compliance already has very impractical reporting consequences for U.S. taxpayers. The G election is another consideration in specialized U.S. foreign reporting that should not be overlooked.

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