Liquidating dividends and tax treatment
We need to know whether the 2 distributions from the PFIC undergoing liquidation is subject to the rules of distribution or gain. It is possible for a corporation to make a series of liquidating distributions, each of which is treated as a payment in exchange for the shares. As long as the corporation is in a state of liquidation, each of the distributions during the state of liquidation is a liquidating distribution under section 331. Whether a corporation is in a state of liquidation is a question of fact. The PFIC sold all its investments, paid its major liabilities, then distributed most of the cash to its investors.
When a shareholder receives a distribution in complete liquidation of a corporation, the distribution is treated as full payment in exchange for stock. This is a special treatment for liquidating distributions, so the transaction is treated as if the shareholder sold the shares in exchange for the liquidating distribution. Then, after paying small liabilities and formally dissolving, it paid the remaining cash to the investors. If you determine that a PFIC is liquidating, treat each liquidating distribution as payment in exchange for the shares.
After the final distribution has been made, if all your cost basis has not been paid back, at this point you can claim a capital loss for the remainder.
For partial liquidations (that meet IRS definitions), it is treated as a deemed redemption of stock (even though no shares are surrendered.) Each payment received is therefore a partial return of capital and a partial capital gain or loss.
We assume that the investor is a US person, and he has invested in a PFIC.
By default, proceeds from PFICs are subject to 2 sets of rules.
The IRS has not adopted any regulations on this matter, but the proposed regulations are fairly clear: Liquidating distributions are treated dispositions of the PFIC shares, not distributions in respect of shares; and a series of liquidating distributions is treated as a series of dispositions on each liquidating distribution date. Thus, the first cash payment is treated as payment in exchange for the PFIC shares.
Because our investor lost money on the investment, I assume the payment is less than his adjusted basis in the PFIC shares. Likewise, the second cash payment is treated as payment in exchange for the PFIC shares.
The tax treatment for a payment identified by the company as a "liquidation distribution" or "liquidating dividend" depends on whether it is a partial or complete liquidation.
The return of capital percentage is determined by dividing the distribution received per share by the market price of the stock before the distribution.
Take this percentage times your adjusted cost basis to compute your return of capital. To be eligible for this special tax treatment, a partial liquidation must be paid to a non-corporate taxpayer, must not be essentially equivalent to a dividend, must be made pursuant to a plan of liquidation, and must be paid by the end of the next tax year after the plan is adopted.
As far as I know, there is no special rule for treating losses from the sale of a PFIC.
Sometimes companies that you own make distributions that are eligible for special tax treatment and do not have to be reported as regular dividend income.