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The IRS has published a "Notice of Proposed Rulemaking" in the U.S. Federal Register. If you'd like to comment on the proposed rule, your comment must be received by July 23, 2015. Since the proposed regulation deals with PFIC-related issues, it may be of interest to U.S. persons residing overseas. I suggest reviewing the proposed regulation to see if it would have any unintended consequences. Spend a bit of time looking through this notice if you currently hold (or might hold) a stake in any non-U.S. insurance company.

The proposed regulation clarifies the PFIC status of certain foreign reinsurance companies, slightly tightening the rules for when such companies are deemed PFICs. The primary reason for the regulation is that some U.S. hedge funds have created offshore reinsurance companies solely or predominantly as vehicles for U.S. tax avoidance.

Here's the heart of the proposed regulation:

As the terms “active conduct” and “insurance business” are not defined in (Internal Revenue Code) section 1297, Treasury and the IRS are proposing regulations to clarify the circumstances under which investment income earned by a foreign insurance company is derived in the active conduct of an insurance business for purposes of determining whether the income is passive income, and thus the extent to which the company's assets are treated as passive assets for purposes of determining whether the company is a PFIC.

The IRS is particularly seeking feedback on how to establish "appropriate methodologies for determining the extent to which assets are held to meet obligations under insurance and annuity contracts" and on how to write the definition of "predominantly engaged in the insurance business." This is all to separate "fake" insurance companies that exist solely or predominantly to help the wealthy avoid tax from real insurance companies that are actively and predominantly engaged in the insurance business.

Real foreign insurance companies are generally excluded from PFIC (Passive Foreign Investment Company) treatment. That is, you can hold equity shares in a real foreign insurance company -- Aviva plc in the U.K., to pick an example -- and have that holding treated the same as if you held shares in U.S. insurance companies like State Farm, Allstate, or Metlife. U.S. hedge funds (and other wealthy entities) are taking advantage of this PFIC exemption for insurance companies to create essentially fake foreign insurance companies that invest in all kinds of strange, otherwise PFIC-triggering things under the "umbrella" tax code protection of an insurance company wrapper. Those "strange" underlying investments are then financially manipulated so that tax is at least improperly deferred -- the raison d'être for PFICs. It's a big loophole, and (at Congress's urging) the IRS is now seeking to close it. These wealthy entities will still be permitted to create and/or invest in fake foreign insurance companies, but then they'll have to take annual "mark to market" or QEF elections, like any other PFIC. They'll also still be allowed to invest in real foreign insurance companies that are predominantly and actively engaged in the real business of insurance, that carefully use investments (and make investment decisions) to support real insurance policies and underwriting rather than in furtherance of some rent-seeking tax avoidance scam.

Of course the other category of companies generally exempt from PFIC treatment is banks, so will the hedge funds (and other wealthy entities) simply start creating fake overseas banks once fake insurance companies are no longer available in the U.S. tax code? Hopefully the IRS has already blocked that other potential tax dodge.

Note that this proposed regulation has nothing particularly to do with CBT v. RBT. The beneficiaries of this particular loophole are solely or predominantly U.S. residents. Overseas Americans just happen to get caught up, disproportionately, in the tax avoidance strategies that the wealthy practice. Thanks, rich people, for messing things up for the rest of us. :( If you have some feedback to the IRS on how they might avoid ensnaring "mere mortal" overseas Americans as they close this particular loophole, let them know.
 
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