(a) In general.—A shareholder (including a shareholder that is a pass-through entity, as described in
§ 1.1295-2(c)(1)) that makes a special preferred QEF election under § 1.1295-2 must, regardless of
the shareholder’s method of accounting, include in income in respect of each share subject to the
election, an annual amount (preferred QEF amount) determined according to the rules of
paragraph (b) of this section. A shareholder that makes a special preferred QEF election must
include the preferred QEF amount in income under this section for each year in which the
taxpayer continues to hold a share that is subject to the election. The rules of this section apply in
lieu of the general rules of section 1293 and § 1.1293-1.1
(b) Preferred QEF amount.—
(1) In general.—The preferred QEF amount for any share
subject to a special preferred QEF election is the sum of the ratable daily portion of each periodic
dividend amount (as described in paragraph (b)(2) of this section) on the share for the taxable
year of the shareholder to which that portion relates, plus the preferred discount amount (as
defined below), if any, for the taxable year. For purposes of this section, the preferred discount
amount for a taxable year is the amount that bears the same ratio to the total amount of preferred
discount (as described in § 1.1295-2(b)(2)(i)) on the share as the number of days that the taxpayer
held the share in the taxable year bears to the number of days after the date the taxpayer acquired
the share and up to (and including) the share’s redemption date as established under the
principles of § 1.305-5(b). Notwithstanding the preceding sentence, the preferred discount amount
for a taxable year is zero if the preferred discount on the share at the time of its acquisition by the
shareholder was less than an amount equal to 1 / 4 of 1 percent of the redemption price of the stock,
multiplied by the number of complete years from the date of acquisition of the stock to the
redemption date of the stock.
(2) Periodic dividend amount.—A periodic dividend amount is the amount payable with
respect to a share, whether on a cumulative or noncumulative basis, for a period (wholly or partly
within the shareholder’s taxable year) for which dividends on the share are calculated based upon
the redemption or liquidation price of the share multiplied by a fixed percentage rate.
(c) Special rules of application.—
(1) Earnings and profits disregarded.—The amounts to be
included in income pursuant to this section are determined without regard to the earnings and
profits of the foreign corporation with respect to which the special preferred QEF election applies.
(2) Year of inclusion.—The shareholder includes the preferred QEF amount in its
taxable year without regard to the taxable year of the foreign corporation with respect to which
the special preferred QEF election applies.
(3) Character of inclusions.—The shareholder includes all preferred QEF amounts in
income as ordinary earnings.
(4) Treatment of distributions.—Distributions received by a shareholder on shares sub-
ject to a special preferred QEF election that are paid out of earnings and profits of the foreign
corporation are not included in gross income of the shareholder to the extent the distributions do
not exceed the preferred QEF amounts (other than any portion of preferred QEF amounts
consisting of preferred discount amounts) previously includible in income pursuant to this section.
These distributions will, however, be treated as dividends for all other purposes of the Code and
regulations. Amounts distributed to a shareholder with respect to shares subject to a special
preferred QEF election that exceed amounts previously included in income under this section
with respect to such shares are treated for all purposes of the Code and regulations as a
distribution of property subject to the rules of section 301.
(5) Basis adjustment rules.—The adjusted basis of a shareholder in shares that are
subject to a special preferred QEF election shall be—
(i) Increased by any amount that is included in the gross income of the shareholder
under paragraph (a) of this section; and
(ii) Decreased by any dividends (not to exceed the amount included in gross
income under paragraph (a) of this section) actually paid to the shareholder in respect of such
shares.
(6) Effect limited to electing shareholder.—This section does not apply to the foreign
corporation with respect to which a special preferred QEF election applies. Accordingly, the
provisions of this section will not affect the foreign corporation’s calculation of its earnings and
profits for any purpose of the Code or regulations. In addition, the rules of this section apply only
for purposes of determining the tax consequences for holders of shares subject to the election.
Thus, the election shall have no effect on the application of the Code or regulations with respect to
the tax consequences of the ownership of shares that are not subject to the election, including for
purposes of determining whether any distributions from the foreign corporation with respect to
such shares should be treated as having been included in the income of any United States person
pursuant to section 1293(c) or section 959.
(d) Examples.—The following examples illustrate the rules of paragraphs (a), (b) and (c) of
this section. Although these examples assume a 30-day month, 360-day year, any reasonable
counting method may be used to compute the length of accrual periods. For purposes of
simplicity, the relevant amounts as stated are rounded to two decimal places. However, the
computations do not reflect any such rounding convention. The examples are as follows:
Example 1. Preferred QEF amount—
(i) Facts.
(A) On May 1, 1998, A, an individual who files
his returns on a calendar year basis, purchased for $10,000 in a single secondary market
transaction 100 shares of nonconvertible Class A $100 par value preferred stock (the Class A
Stock) of FC, a foreign corporation with a taxable year ending on March 31.
(B) The terms of the Class A Stock provide for a mandatory redemption of the Class A Stock
by the issuer at par on June 1, 2012. The Class A Stock is not redeemable pursuant to an issuer call
or holder put on any other date. Each share of Class A Stock provides for a semi-annual
cumulative distribution payable in dollars on June 1 and December 1 equal to one-half the product
of the par value of the Class A Stock and the applicable annual dollar LIBOR in effect on the
distribution date immediately prior to the relevant distribution date. The shares of the Class A
stock are qualified preferred shares in the hands of A. A purchases no other qualified preferred
shares of FC during its 1998 or 1999 taxable years.
(C) A made a special preferred QEF election for A’s taxable year ended December 31, 1998,
which applies to the Class A Stock acquired by A on May 1, 1998. FC is a PFIC under section 1296
for its taxable year ending March 31, 1999, but FC is not a PFIC for its taxable year ending March
31, 2000. FC paid no current dividends on June 1, 1998, and December 1, 1998, paid the June 1,
1999, dividend currently on June 1, 1999, together with accumulated distributions from June 1,
1998, and December 1, 1998, and paid the December 1, 1999, dividend currently on December 1,
1999. The applicable annual LIBOR is 8 percent on December 1, 1997, 7 percent on June 1, 1998, 9
percent on December 1, 1998, 10 percent on June 1, 1999, and 9 percent on December 1, 1999. FC
had sufficient earnings and profits, within the meaning of section 312, for its taxable year ending
on March 31, 2000, so that actual distributions to all shareholders of Class A Stock in that year
were treated as paid out of earnings and profits of FC.
(ii) Tax consequences to A for A’s taxable year ending December 31, 1998. As required under
paragraph (a) of this section, A must include in gross income for its 1998 taxable year the 1998
preferred QEF amount. The preferred QEF amount, as determined under paragraph (b) of this
section, for A’s 1998 taxable year is the ratable portion of each periodic dividend amount for that
year. For 1998, there are three periodic dividend amounts: The periodic dividend amount for the
period from December 1, 1997, to June 1, 1998 (periodic dividend amount 1), the periodic dividend
amount for the period from June 1, 1998, to December 1, 1998 (periodic dividend amount 2), and
the periodic dividend amount for the period from December 1, 1998, to June 1, 1999 (periodic
dividend amount 3). Periodic dividend amount 1 in respect of each share owned by A is $4 (1/2
multiplied by the applicable annual LIBOR of 8 percent set on December 1, 1997, multiplied by the
$100 amount payable on redemption). Because A acquired the shares on May 1, 1998, A’s ratable
portion of periodic dividend amount 1 for 1998 is approximately $.67 (30/180 multiplied by $4) per
share. Periodic dividend amount 2 in respect of each share owned by A is $3.50 (1/2 multiplied by
the applicable annual LIBOR of 7 percent set on June 1, 1998, multiplied by $100). Because A
owned the shares for the entire period associated with periodic dividend amount 2, A’s ratable
portion of periodic dividend amount 2 for 1998 is the full $3.50 per share. Periodic dividend
amount 3 in respect of each share owned by A is $4.50 (1/2 multiplied by the applicable annual
LIBOR of 9 percent set on December 1, 1998, multiplied by $100). Because the portion of 1998
associated with periodic dividend amount 3 is only the month of December, 1998, A’s ratable
portion of periodic dividend amount 3 for 1998 is approximately $.75 (30/180 multiplied by $4.50).
Accordingly, A’s preferred QEF amount for 1998 is approximately $4.92 ($.67 + $3.5 + $.75) per
share. A must include approximately $492 (approximately $4.92 per share, multiplied by 100
shares) in income as ordinary earnings for its 1998 tax year even though FC paid no actual
dividend to shareholders of Class A Stock for the period in 1998 during which A held the Class A
Stock.
(iii) Tax consequences to A for A’s taxable year ending December 31, 1999. As required under
paragraph (a) of this section, A includes in gross income for its 1999 taxable year its preferred
QEF amount for 1999. The preferred QEF amount, as determined under paragraph (b) of this
section, for A’s 1999 taxable year is the ratable portion of each periodic dividend amount for that
year. For 1999, there are three periodic dividend amounts: The periodic dividend amount for the
period from December 1, 1998, to June 1, 1999 (periodic dividend amount 1), the periodic dividend
amount for the period from June 1, 1999, to December 1, 1999 (periodic dividend amount 2), and
the periodic dividend amount for the period from December 1, 1999, to June 1, 2000 (periodic
dividend amount 3). Periodic dividend amount 1 in respect of each share owned by A is $4.50 (1/2
multiplied by the applicable annual LIBOR of 9 percent set on December 1, 1998, multiplied by
$100). Because A held each share of Class A Stock for five months in 1999 for the period
associated with periodic dividend amount 1, A’s ratable portion of periodic dividend amount 1 for
1999 is approximately $3.75 (150/180 multiplied by $4.50). Periodic dividend amount 2 in respect
of each share owned by A is $5 (1/2 multiplied by the applicable annual LIBOR of 10 percent set
on June 1, 1999, multiplied by $100). Because A owned the share for the entire period associated
with periodic dividend amount 2, A’s ratable portion of periodic dividend amount 2 for 1999 is the
full $5. Periodic dividend amount 3 in respect of each share owned by A is $4.50 (1/2 multiplied by
the applicable annual LIBOR of 9 percent set on December 1, 1999, multiplied by $100). Because A
held each share of Class A Stock for one month in 1999 for the period associated with periodic
dividend amount 3, A’s ratable portion of periodic dividend amount 3 for 1999 is approximately
$.75 (30/180 multiplied by $4.50). Accordingly, A’s preferred QEF amount for 1998 is approxi-
mately $9.50 ($3.75 + $5 + $.75). A must include approximately $950 ($9.50 per share, multiplied
by 100 shares) in income as ordinary income for its 1999 taxable year even though FC was not a
PFIC for FC’s taxable year ending in 2000. The current distributions and arrearages actually paid
to A with respect to the Class A Stock are not includible in income by A under paragraph (c)(4) of
this section because they constitute amounts previously included in income.
Example 2. Preferred Discount—
(i) Facts. The facts are the same as in Example 1 except that
A acquired the 100 shares of Class A Stock for $9000.
(ii) Tax Consequences to A for A’s taxable year ending December 31, 1998.
(A) Because the Class A Stock is fixed term preferred
stock (as described in § 1.1295-2(b)(1)(vii)) and A acquired
each share of the Class A stock with $10 of preferred discount, as described in § 1.1295-2(b)(2),
A’s preferred QEF amount to be included by A for the taxable year consists of the sum of the
ratable daily portion of each periodic dividend amount, as calculated in paragraph (d)(ii) of
Example 1 of this section, plus the preferred discount amount described in paragraph (b)(1) of this
section.
(B) The preferred discount amount with respect to each share is approximately $.47 ($10
multiplied by 240 days/5070 days to maturity). A must include approximately $47 ($.47 per share,
multiplied by 100 shares), together with the amount calculated in paragraph (d)(ii) of Example 1 of
this section, in income as ordinary earnings for its 1998 tax year even though FC paid no actual
dividend to shareholders of Class A Shares for the period in 1998 during which A held the Class A
Stock.
(iii) Tax consequences to A for A’s taxable year ending December 31, 1999. The portion of the
preferred discount on each share includible under paragraph (a) of this section is approximately
$.71 ($10 multiplied by 360 days/5070 days to maturity). A must include this amount, together
with the amount calculated in paragraph (d)(iii) of Example 1 of this section, in income as ordinary
earnings for its 1999 tax year even though FC was not a PFIC for FC’s taxable year ending in 2000.
The current distributions and arrearages actually paid to A in 1999 with respect to the Class A
Stock are not includible in income by A under paragraph (c)(4) of this section, because they
constitute amounts previously included in income.
(e) Effective date.—The rules under this section apply with respect to qualified preferred
stock subject to a special preferred QEF election made after the date that is 30 days after the date
of publication of this document as a final regulation. [Prop. Reg. § 1.1293-2.]
[Proposed 12-24-96.]
1 This proposed regulation was published on April 1, 1992, at 57 Fed. Reg. 11024.