Reg. § 1.1411-10 — Controlled foreign corporations and passive foreign investment companies.

(a) In general This section provides rules that apply to an individual, estate, or trust that is a United States shareholder of a controlled foreign corporation (CFC), or that is a United States person that directly or indirectly owns an interest in a passive foreign investment company (PFIC). In addition, this section provides rules that apply to an individual, estate, or trust that owns an interest in a domestic partnership or an S corporation that is either a United States shareholder of a CFC or that has made an election under section to treat a PFIC as a qualified electing fund (QEF). References in this section to an election under of this section being in effect relate to an election that is applicable to the person that is determining the section consequences with respect to holding a particular CFC or QEF.

(b) Amounts derived from a trade or business described in § 1.1411-5

(1) In general Except as provided in of this section, an amount included in gross income under section or section that is also income derived from a trade or business described in section and (applying the relevant rules in ) is taken into account as net investment income under section and for purposes of section and the regulations thereunder when it is taken into account for purposes of chapter 1, and the rules in through of this section do not apply to that amount. For purposes of section and the regulations thereunder, an amount included in gross income under section that is also income derived from a trade or business described in section and (applying the relevant rules in ), is net investment income within the meaning of section and , and the rules in of this section do not apply to that amount.

(2) Coordination rule for changes in trade or business status With respect to stock of a CFC or QEF for which an election under of this section is not in effect, the rules in through of this section apply to a distribution of earnings and profits described in of this section that was not taken into account as net investment income under of this section.

(c) Calculation of net investment income

(1) Dividends For purposes of section and , net investment income is calculated by taking into account the amount of dividends described in this .

(i) Distributions of previously taxed earnings and profits

(A) Rules when an election under paragraph (g) of this section is not in effect with respect to the shareholder

(1) General rule Except as otherwise provided in this , with respect to stock of a CFC or QEF for which an election under of this section is not in effect, a distribution of earnings and profits that is not treated as a dividend for chapter 1 purposes under section or section is a dividend for purposes of section and if the distribution is attributable to amounts that are or have been included in gross income for chapter 1 purposes under section or section in a taxable year beginning after December 31, 2012. Solely, for this purpose, distributions of earnings and profits attributable to amounts that are or have been included in gross income for chapter 1 purposes under section or section are considered first attributable to those earnings and profits, if any, derived from the current taxable year, and then from prior taxable years beginning with the most recent prior taxable year, and with respect to amounts included under section , without regard to whether the earnings and profits are described in section or section .

(2) Exception for distributions attributable to earnings and profits previously taken into account for purposes of section 1411 A distribution of earnings and profits that is not treated as a dividend for chapter 1 purposes under section or section is not treated as a dividend for purposes of section and , to the extent that an individual, estate, or trust establishes, by providing information that is similar to, and in the same manner as, the information described in (relating to previously taxed earnings and profits), that the distribution is attributable to—

(i) Amounts included in gross income by any person for chapter 1 purposes under section or section that have been taken into account by any person as net investment income by reason of of this section or an election under of this section; or

(ii) Amounts included in gross income by any person as a dividend pursuant to section that, by reason of of this section, have been taken into account by any person as net investment income under section and .

(B) Rule when an election under paragraph (g) of this section is in effect with respect to the shareholder Except as otherwise provided in this , if an election under of this section is in effect, a distribution of earnings and profits that is not treated as a dividend for chapter 1 purposes under section or section is not treated as a dividend for purposes of section and .

(C) Special rule for certain distributions related to 2013 taxable years

(1) Scope The rule in this applies to individuals, estates, and trusts that were subject to section during a taxable year that began after December 31, 2012, and before January 1, 2014, and that satisfy all of the conditions set forth in of this section. This rule also applies to all domestic partnerships and S corporations that satisfy all of the conditions set forth in of this section.

(2) Rule A distribution of earnings and profits from a CFC or QEF, with respect to which an election under paragraph (g) is in effect, that is not treated as a dividend for chapter 1 purposes under section or section is a dividend for purposes of section and to the extent that—

(i) The distribution of earnings and profits is attributable to an amount included by an individual, estate, trust, domestic partnership, S corporation or common trust fund in gross income for chapter 1 purposes under section or section with respect to the CFC or QEF for a taxable year that began after December 31, 2012, and before January 1, 2014;

(ii) The individual, estate, trust, domestic partnership, S corporation, or common trust fund made the election under of this section with respect to the CFC or QEF in a taxable year that began after December 31, 2013; and

(iii) The individual, estate, trust, domestic partnership, S corporation, or common trust fund did not make the election described in of this section (concerning making an election under of this section for a taxable year that begins before January 1, 2014).

(3) Ordering rule Solely, for purposes of this , distributions of earnings and profits attributable to amounts that have been included in gross income for chapter 1 purposes under section or section are considered first attributable to the earnings and profits derived from a taxable year that began after December 31, 2012, and before January 1, 2014.

(ii) Excess distributions that constitute dividends To the extent an excess distribution within the meaning of section constitutes a dividend within the meaning of section , the amount is included in net investment income for purposes of section and .

(2) Net gain For purposes of section and , the rules in this apply in determining net gain attributable to the disposition of property.

(i) Gains treated as excess distributions Gains treated as excess distributions under section are included in determining net gain attributable to the disposition of property for purposes of section and .

(ii) Inclusions and deductions with respect to section 1296 mark to market elections Amounts included in gross income under section and amounts allowed as a deduction under section are taken into account in determining net gain attributable to the disposition of property for purposes of section and .

(iii) Gain or loss attributable to the disposition of stock of CFCs and QEFs With respect to stock of a CFC or QEF for which an election under of this section is not in effect, for purposes of calculating the net gain under and -4(d) that is attributable to the direct or indirect disposition of that stock (including for purposes of determining gain or loss on the direct or indirect disposition of that stock by a domestic partnership, S corporation, or common trust fund), basis is determined in accordance with the provisions of of this section.

(iv) Gain or loss attributable to the disposition of interests in domestic partnerships or S corporations that own directly or indirectly stock of CFCs or QEFs With respect to stock of a CFC or QEF for which an election under of this section is not in effect, for purposes of calculating the net gain under and -4(d) that is attributable to the disposition of an interest in a domestic partnership or S corporation that directly or indirectly owns that stock, basis is determined in accordance with the provisions of of this section.

(3) Application of sections 1248 and 367(b) With respect to stock of a foreign corporation that is a CFC (or that was a CFC at any time during the 5-year period ending on the date of sale or exchange) or QEF for which an election under of this section is not in effect, for purposes of section and —

(i) In determining the amount of gain recognized on the sale or exchange of stock of a foreign corporation under section or the amount of gain realized on the exchange of stock of a foreign corporation under or , basis is determined in accordance with the provisions of of this section; and

(ii) Section , and and apply without regard to the exclusions for certain earnings and profits under section and (6), except that those exclusions will apply with respect to the earnings and profits of a foreign corporation that are attributable to:

(A) Amounts taken into account as net investment income under of this section; and

(B) Amounts previously included in gross income for chapter 1 purposes under section or section in a taxable year beginning before December 31, 2012, and that have not yet been distributed. For this purpose, the determination of whether earnings and profits that are attributable to amounts previously taxed in a taxable year beginning before December 31, 2012, have been distributed is determined based on the rules described in of this section.

(4) Amounts distributed by an estate or trust Net investment income of a beneficiary of an estate or trust includes the beneficiary's share of distributable net income, as described in sections and and as modified by of this section, to the extent that the beneficiary's share of distributable net income includes items that, if they had been received directly by the beneficiary, would have been described in this .

(5) Properly allocable deductions

(i) General rule For purposes of section and , the section investment expense deduction may be calculated by—

(A) Increasing the amount of investment income determined for chapter 1 purposes under section by the amount of dividends described in that are derived from a CFC or QEF with respect to which an election under of this section is not in effect;

(B) Decreasing the amount of investment income determined for chapter 1 purposes under section by the amount included in gross income for chapter 1 purposes under section or section that is attributable to a CFC or QEF with respect to which an election under of this section is not in effect; and

(C) Increasing or decreasing, as applicable, the amount of investment income for chapter 1 purposes under section by the difference between the amount calculated with respect to a disposition under and of this section and the amount of the gain or loss attributable to the relevant disposition as calculated for chapter 1 purposes.

(ii) Additional rules For purposes of section and , if the method of calculation described in of this section is applied:

(A) The amount of investment interest not allowed as a deduction under section must be calculated consistent with the method of calculation described in paragraph (c)(5)(i).

(B) The method of calculation must be adopted by an individual, estate, or trust no later than the first year in which the individual, estate, or trust is subject to section .

(C) The method of calculation must be applied with respect to all CFCs and QEFs for all taxable years with respect to which an election under of this section is not in effect.

(D) A method of calculation under this paragraph is a method of accounting, which must be applied consistently, and may only be changed by the taxpayer by securing the consent of the Commissioner in accordance with and following the administrative procedures issued under .

(d) Conforming basis adjustments

(1) Basis adjustments under sections 961 and 1293

(i) Stock held by individuals, estates, or trusts With respect to stock of a CFC or QEF which is held by an individual, estate, or trust, either directly or indirectly through one or more entities each of which is foreign, for which an election under of this section is not in effect—

(A) The basis increases made pursuant to sections and for amounts included in gross income for chapter 1 purposes under sections and in taxable years beginning after December 31, 2012, are not taken into account for purposes of section and the regulations thereunder; and

(B) The basis decreases made pursuant to sections and attributable to amounts treated as dividends for purposes of section under of this section are not taken into account for purposes of section and the regulations thereunder.

(ii) Stock held by domestic partnerships or S corporations

(A) Rule when an election under paragraph (g) of this section is not in effect The rules of this apply with respect to stock of a CFC or QEF held directly by a domestic partnership or S corporation, or indirectly through one or more entities each of which is foreign, for which an election under of this section is not in effect. If an individual, estate, or trust is a shareholder of an S corporation, or if an individual, estate, or trust directly, or through one or more tiers of passthrough entities (including an S corporation), owns an interest in a domestic partnership, the S corporation or domestic partnership, as the case may be, will not take into account for purposes of section and the regulations thereunder the basis increases made by the domestic partnership or S corporation pursuant to sections and for amounts included in gross income for chapter 1 purposes under sections and for taxable years beginning after December 31, 2012, and the basis decreases made by the domestic partnership or S corporation pursuant to sections and attributable to amounts treated as dividends for purposes of section under of this section (the section recalculated basis). If the domestic partnership or S corporation disposes of the stock of a CFC or QEF, the section recalculated basis will be used to determine the distributive share or pro rata share of the gain or loss for purposes of section for partners or shareholders.

(B) Rules when an election under paragraph (g) of this section is in effect If an election under of this section is in effect with respect to stock of a CFC or QEF held directly or indirectly by a domestic partnership or S corporation, the partner's distributive share or the shareholder's pro rata share of the gain or loss for purposes of section is the same as the distributive share or pro rata share of the gain or loss for purposes of chapter 1. See Example 6 of of this section.

(2) Special rules for partners that own interests in domestic partnerships that own directly or indirectly stock of CFCs or QEFs The rules of this apply with respect to stock of a CFC or QEF for which an election under of this section is not in effect, and that is held by a domestic partnership, either directly or indirectly through one or more entities each of which is foreign. In such a case, the basis increases provided under section to the partners for purposes of chapter 1 that are attributable to amounts that the domestic partnership includes or included in gross income under section or section for a taxable year beginning after December 31, 2012, are not taken into account for purposes of section . Instead, each partner's adjusted basis in the partnership interest is increased by its share of any distributions to the partnership from the CFC or QEF that are treated as dividends for purposes of section under of this section. Similar rules apply when the stock of the CFC or QEF is held in a tiered partnership structure. For purposes of determining net investment income under section and the regulations thereunder, the partner's adjusted basis in the partnership interest as calculated under this is used to determine all tax consequences related to tax basis (for example, loss limitation rules and the characterization of partnership distributions).

(3) Special rules for S corporation shareholders that own interests in S corporations that own directly or indirectly stock of CFCs or QEFs The rules of this apply with respect to stock of a CFC or QEF for which an election under of this section is not in effect, and that is held by an S corporation, directly or indirectly through one or more entities each of which is foreign. In such case, the basis increases provided in section to its shareholders for chapter 1 purposes that are attributable to amounts that the S corporation includes or included in gross income for chapter 1 purposes under section or section for taxable years beginning after December 31, 2012, are not taken into account for purposes of section . Instead, each shareholder's adjusted basis of stock in the S corporation is increased by its share of the distributions to the S corporation from the CFC or QEF that are treated as dividends for purposes of section under of this section. Similar rules apply when the S corporation holds an interest in a CFC or QEF through a partnership. For purposes of determining net investment income under section and the regulations thereunder, the shareholder's adjusted basis in the stock of the S corporation as calculated under this is used to determine all tax consequences related to tax basis (for example, loss limitation rules and the characterization of S corporation distributions).

(4) Special rules for participants in common trust funds Rules similar to the rules in and of this section apply to ownership interests in common trust funds (as defined in section ).

(5) Basis adjustments under section 367(b) With respect to stock of a foreign corporation that is exchanged in a transaction subject to section , the portion of the basis increase provided by by reason of of this section is made solely for purposes of section .

(e) Conforming adjustments to modified adjusted gross income and adjusted gross income

(1) Individuals Solely for purposes of section and the regulations thereunder, the term modified adjusted gross income means modified adjusted gross income as defined in —

(i) Increased by amounts included in net investment income under , , , and of this section that are not otherwise included in gross income for chapter 1 purposes;

(ii) Increased or decreased, as applicable, by the difference between the amount calculated with respect to a disposition under and of this section and the amount of the gain or loss attributable to the relevant disposition as calculated for chapter 1 purposes;

(iii) Decreased by any amount included in gross income for chapter 1 purposes under section or section attributable to a CFC or QEF with respect to which no election under of this section is in effect; and

(iv) To the extent the section investment interest expense deduction is calculated using the method of calculation set forth in of this section and the deduction is taken into account under , increased or decreased, as appropriate, by the difference between the amount of the section investment interest expense deduction calculated under of this section and the amount calculated for chapter 1 purposes.

(2) Estates and trusts Solely for purposes of section and the regulations thereunder, the term adjusted gross income means adjusted gross income as defined in adjusted by the following amounts to the extent those amounts are not distributed by the estate or trust—

(i) Increased by amounts included in net investment income under , , , and of this section that are not otherwise included in gross income for chapter 1 purposes;

(ii) Increased or decreased, as applicable, by the difference between the amount calculated with respect to a disposition under and of this section and the amount of the gain or loss attributable to the relevant disposition as calculated for chapter 1 purposes;

(iii) Decreased by any amount included in gross income for chapter 1 purposes under section or section attributable to a CFC or QEF with respect to which no election under of this section is in effect; and

(iv) To the extent the section investment interest expense deduction is calculated using the method of calculation set forth in of this section and taken into account under , increased or decreased, as appropriate, by the difference between the amount of the section investment interest expense deduction calculated under of this section and the amount calculated for chapter 1 purposes.

(f) Application to estates and trusts All of the items described in of this section are included in the net investment income of an estate or trust or its beneficiaries. The amounts described in through of this section, regardless of whether the estate or trust receives those amounts directly or indirectly through another estate or trust, increase or decrease, as applicable, the estate's or trust's distributable net income for purposes of section . The estate or trust, or the beneficiaries thereof, must take those amounts into account in a manner reasonably consistent with the general operating rules for estates and trusts in and subchapter J in computing the undistributed net investment income of the estate or trust and the net investment income of the beneficiaries.

(g) Election with respect to CFCs and QEFs

(1) Effect of election If an election under of this section is made with respect to a CFC or QEF, amounts included in gross income for chapter 1 purposes under section or section with respect to the CFC or QEF in taxable years beginning with the taxable year for which the election is made are treated as net investment income for purposes of , and amounts included in gross income under section with respect to the QEF in taxable years beginning with the taxable year for which the election is made are taken into account in calculating net gain attributable to the disposition of property under . See and of this section for the effect of this election on certain distributions of previously taxed earnings and profits.

(2) Years to which election applies

(i) In general An election under of this section applies to the taxable year for which it is made and all subsequent taxable years, and applies to all subsequently acquired interests in the CFC or QEF. An election under of this section is irrevocable.

(ii) Termination of interest in CFC or QEF Complete termination of a person's interest in the CFC or QEF does not terminate the person's election under of this section with respect to the CFC or QEF. Thus, if the person reacquires stock of the CFC or QEF, that stock is considered to be stock for which an election under of this section has been made and is in effect.

(iii) Termination of partnership If a domestic partnership that makes the election under of this section is terminated pursuant to section , the election is binding on the new partnership.

(3) Who may make the election An individual, estate, trust, domestic partnership, S corporation, or common trust fund may make an election under of this section with respect to each CFC or QEF that it holds directly or indirectly through one or more entities, each of which is foreign. In addition, an individual, estate, trust, domestic partnership, S corporation, or common trust fund may make an election under of this section with respect to a CFC or QEF that it holds indirectly through a domestic partnership, S corporation, estate, trust, or common trust fund if the domestic partnership, S corporation, estate, trust, or common trust fund does not make the election. The election, if made, for an estate or trust must be made by the fiduciary of that estate or trust.

(4) Time and manner for making the election

(i) Individuals, estates, and trusts

(A) General rule Except as otherwise provided in this paragraph, in order for an election under of this section by an individual, estate, or trust (other than a CRT) with respect to a CFC or QEF to be effective, the election must be made no later than the first taxable year beginning after December 31, 2013, during which the individual, estate, or trust—

(1) Includes an amount in gross income for chapter 1 purposes under section or section with respect to the CFC or QEF; and

(2) Is subject to tax under section or would be subject to tax under section if the election were made with respect to the stock of the CFC or QEF.

(B) Special rule for charitable remainder trusts (CRTs) Except as otherwise provided in this paragraph, in order for an election under of this section by a CRT with respect to a CFC or QEF to be effective, the election must be made no later than the first taxable year beginning after December 31, 2013, during which the CRT includes an amount in gross income for chapter 1 purposes under section or section with respect to the CFC or QEF.

(ii) Certain domestic passthrough entities Except as otherwise provided in this paragraph, in order for an election under of this section by a domestic partnership, S corporation, or common trust fund with respect to a CFC or a QEF to be effective, the election must be made no later than the first taxable year beginning after December 31, 2013, during which the domestic partnership S corporation, or common trust fund—

(A) Includes an amount in gross income for chapter 1 purposes under section or section with respect to the CFC or QEF; and

(B) Has a direct or indirect owner that is subject to tax under section or would be subject to tax under section if the election were made.

(iii) Taxable years that begin before January 1, 2014

(A) Individuals, estates, or trusts An individual, estate, or trust may make an election under of this section for a taxable year that begins before January 1, 2014.

(B) Certain domestic passthrough entities A domestic partnership, S corporation, or common trust fund may make an election under of this section for a taxable year that begins before January 1, 2014, provided that all of its partners, shareholders, or participants, as the case may be, consent to the election. In the case of a partner, shareholder, or participant that is a partnership, S corporation, or common trust fund, all of the partners, shareholders, and participants also must consent to the election.

(iv) Time for making election In all cases, the election under of this section must be made in the manner prescribed by forms, instructions, or in other guidance on the individual's, estate's, trust's, domestic partnership's, S corporation's, or common trust fund's original or amended return for the taxable year for which the election is made. An election can be made on an amended return only if the taxable year for which the election is made, and all taxable years that are affected by the election, are not closed by the period of limitations on assessments under section . An individual, estate, trust, domestic partnership, S corporation, or common trust fund may not seek an extension of time to make the election under any other provision of the law, including .

(h) Examples The following examples illustrate the rules of this section. In each example, unless otherwise indicated, the individuals, the foreign corporation (FC), the QEF (QEF), and the partnership (PRS) use a calendar taxable year. Further, the gross income or gain with respect to an interest in FC is not derived in a trade or business described in .

Example 1.

(i) Facts. A, a United States citizen, is the sole shareholder of FC, a controlled foreign corporation (within the meaning of section ). A is a United States shareholder (within the meaning of section ) with respect to FC. In 2012, A includes $40,000 in gross income for chapter 1 purposes under section with respect to FC. On December 31, 2012, A's basis in the stock of FC for chapter 1 purposes is $500,000, which includes an increase to basis under section of $40,000. The amount of FC's earnings and profits that are described in section is $40,000, the amount of FC's earnings and profits that are described in section is $20,000, and FC does not have any earnings and profits that are described in section . No election is made under of this section. During 2013, A does not include any amounts in income under section with respect to FC, A does not receive any distributions from FC, and there is no change in the amount of FC's earnings and profits. In 2014, A includes $10,000 in gross income for chapter 1 purposes under section with respect to FC. As a result, A's basis in the stock of FC for chapter 1 purposes increases by $10,000 to $510,000 pursuant to section . During 2015, FC distributes $30,000 to A, which is not treated as a dividend for purposes of chapter 1 under section . As a result, A's basis in the stock of FC for chapter 1 purposes is decreased by $30,000 to $480,000 pursuant to section .

(ii) Results for section purposes. In 2014, A does not include the $10,000 section income inclusion in A's net investment income under section and . Pursuant to of this section, A decreases A's modified adjusted gross income for section purposes by $10,000 in 2014, and pursuant to of this section, A's adjusted basis is not increased by $10,000 and remains at $500,000. In 2015, pursuant to of this section, A includes $10,000 of the distribution of previously taxed earnings and profits as a dividend for purposes of determining A's net investment income because $10,000 of the $30,000 distribution is attributable to amounts that A included in gross income for chapter 1 purposes under section in a tax year that began after December 31, 2012. Pursuant to of this section, A increases A's modified adjusted gross income for section purposes by $10,000 in 2015. Under of this section, A's adjusted basis is not decreased by the $10,000 that is treated as a dividend for section purposes, and thus, A's adjusted basis in FC for section purposes is decreased under section only by $20,000 to $480,000.

Example 2.

(i) Facts. Same facts as Example 1. In addition, during 2016, A includes $15,000 in gross income for chapter 1 purposes under section with respect to FC. As a result, A's basis in the stock of FC for chapter 1 purposes increases by $15,000 to $495,000 pursuant to section . During 2017, A sells all of A's shares of FC for $550,000 and, prior to the application of section , recognizes $55,000 ($550,000 minus $495,000) of long-term capital gain for chapter 1 purposes. For purposes of calculating the amount included in income as a dividend pursuant to section for chapter 1 purposes, the earnings and profits of FC attributable to A's shares in FC which were accumulated after December 31,1962 and during the period which A held the stock while FC was a controlled foreign corporation is $55,000, $35,000 of which is excluded pursuant to section . Therefore, after the application of section , for chapter 1 purposes, upon the sale of the FC stock, A recognizes $35,000 of long-term capital gain and a $20,000 dividend.

(ii) Results for section purposes. (A) In 2016, A does not include the $15,000 section income inclusion in A's net investment income under section and . Pursuant to of this section, A decreases A's modified adjusted gross income for section purposes by $15,000, and, pursuant to of this section, A's adjusted basis remains at $480,000.

(B) During 2017, prior to the application of section , A recognizes $70,000 ($550,000 minus $480,000) of gain for section purposes. Pursuant to of this section, for section purposes, section applies to the gain on the sale of FC calculated for section purposes ($70,000) and section does not apply, except with respect to the $20,000 of earnings and profits of FC that are attributable to amounts previously included in income for chapter 1 purposes under section for a taxable year beginning before December 31, 2012. Accordingly, for purposes of calculating the amount of income includible as a dividend under section , A has $55,000 of earnings and profits, $20,000 of which is excluded pursuant to section . Therefore, after the application of section , for section purposes A has $35,000 of long-term capital gain and a $35,000 dividend. For purposes of calculating net investment income in 2017, A includes $35,000 as a dividend under section and and $35,000 as a gain under section and .

Example 3.

(i) Facts. Same facts as Example 2, except that A timely makes an election under of this section for 2014 (and thus for all subsequent years).

(ii) Results for section purposes. A does not have any adjustments to A's modified adjusted gross income for section purposes for 2014, 2015, 2016 or 2017 because the election under of this section was timely made. Pursuant to of this section, for purposes of calculating A's net investment income in 2014, the $10,000 that A included in income for chapter 1 purposes under section is net investment income for purposes of section and . A has no amount of net investment income with respect to FC in 2015. Pursuant to of this section, for purposes of calculating A's net investment income in 2016, the $15,000 that A included in income for chapter 1 purposes under section is net investment income for purposes of section and . For purposes of calculating A's net investment income in 2017, the amount of gain on the disposition of the FC shares is the same as the amount calculated for chapter 1 purposes. Applying section , A includes $35,000 as a gain under section and , and $20,000 as a dividend under section and .

Example 4. Domestic partnership holding QEF stock.

(i) Facts. (A) C, a United States citizen, owns a 50% interest in PRS, a domestic partnership. D, a United States citizen, and E, a United States citizen, each own a 25% interest in PRS. All allocations of partnership income and losses are pro rata based on ownership interests. PRS owns an interest in QEF, a foreign corporation that is a passive foreign investment company (within the meaning of section ). PRS, a United States person, made an election under section with respect to QEF applicable to the first year of its holding period in QEF. As of December 31, 2012, for chapter 1 purposes, C's basis in his partnership interest is $100,000, D's basis in his partnership interest is $50,000, E's basis in his partnership interest is $50,000, and PRS's adjusted basis in its QEF stock is $80,000, which includes an increase in basis under section of $40,000. As of December 31, 2012, the amount of QEF's earnings that have been included in income by PRS under section , but have not been distributed by QEF, is $40,000. PRS also has cash of $60,000 and domestic C corporation stock with an adjusted basis of $60,000. During 2013, PRS does not include any amounts in income under section with respect to QEF, PRS does not receive any distributions from QEF, and there are no adjustments to the basis of C, D, or E in their interests in PRS.

(B) During 2014, PRS has income of $40,000 under section with respect to QEF and has no other partnership income. PRS does not make an election under of this section.

(C) During 2015, QEF distributes $60,000 to PRS. PRS has no income for the year.

(ii) Results for 2014. (A) For chapter 1 purposes, as a result of the $40,000 income inclusion under section , PRS's basis in its QEF stock is increased by $40,000 under section to $120,000. Under and section , C's, D's, and E's distributive shares of the section income inclusion are $20,000, $10,000, and $10,000, respectively. Under section , C increases his adjusted basis in his partnership interest by $20,000 to $120,000, and D and E each increase his adjusted basis in his partnership interest by $10,000 to $60,000.

(B) For section purposes, pursuant to of this section, PRS's basis in QEF is not increased by the $40,000 income inclusion (it remains at $80,000). Because PRS did not make an election under of this section, C, D and E do not have net investment income with respect to the income inclusion, and pursuant to of this section, they do not increase their adjusted bases in their interests in PRS (each remains at $50,000). Pursuant to of this section, C reduces his modified adjusted gross income by $20,000, and D and E each reduce their modified adjusted gross income by $10,000.

(iii) Results for 2015. (A) For chapter 1 purposes, the distribution of $60,000 from QEF to PRS is not a dividend under section , and PRS decreases its basis in QEF by $60,000 under section to $60,000.

(B) Pursuant to of this section, $40,000 of the distribution is a dividend for section purposes because PRS included $40,000 in gross income for chapter 1 purposes under section in a tax year that began after December 31, 2012. For section purposes, pursuant to of this section, section will not apply to reduce PRS's basis in QEF to the extent of the $40,000 of the distribution that is treated as a dividend under of this section. Thus, PRS's basis in QEF is decreased only by $20,000 for purposes of section and is $60,000. The $40,000 distribution of previously taxed earnings and profits that is treated as a dividend for section purposes is allocated $20,000 to C, $10,000 to D, and $10,000 to E. Because PRS did not make an election under of this section, pursuant to of this section, C has $20,000 of net investment income, and D and E each has $10,000 of net investment income as a result of the distribution by QEF, and pursuant to of this section, C increases his adjusted basis in PRS by $20,000 to $120,000, and D and E each increases his adjusted basis in PRS by $10,000 to $60,000. Pursuant to of this section, C increases his modified adjusted gross income by $20,000, and D and E each increases his modified adjusted gross income by $10,000.

Example 5. Sale of partnership interest.

(i) Facts. Same facts as Example 4. In addition, in 2016, D sells his entire interest in PRS to F for $100,000.

(ii) Results for 2016. For chapter 1 purposes, D has a gain of $40,000 ($100,000 minus $60,000). For section purposes, D has a gain of $40,000 ($100,000 minus $60,000), and thus, has net investment income of $40,000. No adjustments to modified adjusted gross income are necessary under of this section.

Example 6. Domestic partnership's sale of QEF stock.

(i) Facts. Same facts as Example 4. In addition, in 2016 PRS has income of $60,000 under section with respect to QEF, and in 2017, PRS sells its entire interest in QEF for $170,000.

(ii) Results for 2016. (A) For chapter 1 purposes, as a result of the $60,000 income inclusion under section , PRS's basis in its QEF stock is increased by $60,000 under section to $120,000. Under and section , C's, D's, and E's distributive shares of the section income inclusion are $30,000, $15,000, and $15,000 respectively. Under section , C increases his adjusted basis in his partnership interest by $30,000 to $150,000, and D and E each increases his adjusted basis in his partnership interest by $15,000 to $75,000.

(B) For section purposes, pursuant to of this section, PRS's basis in QEF is not increased by the $60,000 income inclusion (it remains at $60,000). Because PRS did not make an election under of this section, C, D and E do not have net investment income with respect to the income inclusion, and pursuant to of this section, they do not increase their adjusted bases in their interests in PRS (C remains at $120,000, and D and E each remain at $60,000). Pursuant to of this section, C reduces his modified adjusted gross income by $30,000, and D and E each reduce their modified adjusted gross income by $15,000.

(iii) Results for 2017. (A) For chapter 1 purposes, PRS has a gain of $50,000 ($170,000 minus $120,000), which is allocated 50% ($25,000) to C, 25% ($12,500) to D, and 25% ($12,500) to E.

(B) Based on PRS's basis in the stock of QEF for section purposes, PRS has a gain for section purposes of $110,000 ($170,000 minus $60,000), which in the absence of an election by PRS under of this section, results in gain of $55,000 to C, $27,500 to D, and $27,500 to E. Therefore, C has net investment income of $55,000, and D and E each have net investment income of $27,500. Pursuant to of this section, C increases his modified adjusted gross income by $30,000, and D and E each increase their modified adjusted gross income by $15,000.

(i) Effective/applicability date This section applies to taxable years beginning after December 31, 2013. However, taxpayers may apply this section to taxable years beginning after December 31, 2012, in accordance with . of this section, to the extent it references regulations issued under section , and of this section, apply to transactions completed on or after October 5, 2023, and to any transactions treated as completed before October 5, 2023, as a result of an entity classification election made under that is filed on or after October 5, 2023.

Reg. § 1.1411-10 Controlled foreign corporations and passive foreign investment companies.