Taxation BillThe Tax Court case of Virginia-based taxpayers Toso & Salman tested several US tax principles which affect all US citizens and residents[1].


Those principles include the statute of limitations, the definition of ‘gross income’, and the ability to offset certain types of losses against gains.

In this case, the taxpayers had derived gains from the disposal of their investments in what is known for US tax purposes as a Passive Foreign Investment Company (‘PFIC’)[2].

However, they had failed to declare the gains on the sales of these investments in their US individual income tax returns.


The principles in the tax court case which were tested were:

  1. The definition of ‘gross income’ for the purposes of assessing whether the statute of limitations was extended to six years or not under §6605.
  2. Whether non-current year PFIC gains constituted gross income under §1291 or not.
  3. Whether PFIC losses could offset PFIC gains.

Upheld in the Tax Court:

  1. Non-current year PFIC gains do not constitute §1291 income.
  2. Notwithstanding the point in (1) above, the definition of ‘gross income’ for the purposes of assessing statute of limitations time frames included current year and non-current year PFIC gains.
  3. PFIC losses do not offset PFIC gains. These are capital losses, subject to the rules for capital losses, which include loss carry-forwards to offset future capital gains.


Toso and Salman had accounts at the Swiss financial institution UBS AG (‘UBS’). UBS was issued a John Doe summons[3]. Consequently, the taxpayers filed amended returns for 2006, 2007 and 2008, declaring the gains derived from their UBS investments as capital gains[4].

Assessments of deficiency for the aforementioned years were issued. These showed that amounts in the amended returns had been recognized as long term capital gains and taxed as such.[5]

The parties argued which of the gains constituted Passive Foreign Investments for US tax purposes, and were thus subject to the PFIC rules. The taxpayers conceded that some were PFIC stocks, which were incorrectly reported on their 2006, 2007 and 2008 returns.

The question was whether the statute of limitations (‘statute’) had expired. As the returns were for the 2006, 2007 and 2008 tax years, the taxpayers asserted that the statute had expired.

Insofar as the taxpayers were concerned, the assessments of deficiency issued to them were time-barred under the statute.

The Commissioner contended that more than 25% of gross income had been omitted from the 2006 return. Consequently, the Commissioner asserted that the statute was extended from three years to six years and that the notice of deficiency applied.

Whilst the parties agreed that the statute of limitations extension from three years to six years applied in principle, they did not agree on whether the gains from the PFIC investments constituted gross income for the purposes of determining the statute’s time frame as being three years or six years.

This involved determining whether or not 25% of gross income had been under-reported in the years concerned; 2006, 2007 and 2008.

Part of this process was determining what the exact amount of PFIC income was, using calculable §1291 income, for inclusion in the ‘gross income’ definition for the purposes of applying section §6605.

In doing so, consideration was given to the 2015 case of  CNT Inv’rs, LLC v. Commissioner and the 1985 case of Insulglass Corp. v. Commissioner.

Relevant is that §1291 expressly states that non-current year PFIC gains are not included in gross income.

This point was argued back and forth and it was held that the exclusion of non-current year gains in §1291 prevailed over other case law.

However, non-current gains are still included in the definition of ‘gross income’ for §6605 purposes.

The taxpayers asserted that if the statute hadn’t expired for the 2006 return, they could still offset their PFIC gains from the sale of PFIC stocks with losses under §1291.

The Commissioner contended that gains from sales of PFIC stocks were reportable under §1291, and losses were not; these are recognized as capital losses. Furthermore, as gains under §1291 are recognized as ordinary income, and not capital, there is no offset available for PFIC losses.

The outcome for the taxpayers:

  1. 2006 return: more than 25% of gross income was omitted – therefore the six-year statute applied and the assessment of deficiency was valid.
  1. 2007 & 2008 returns: less than 25% of gross income was omitted – therefore the three-year statute applied, and the assessments of deficiency were invalid.

The takeaway from this case

Ensure that all gross income is being reported accurately, especially gains from PFICs.

Furthermore, losses need to be correctly classified be they PFIC losses, capital losses or ordinary losses.



[1] The definition of the term ‘US residents’ is held to include Lawful Permanent Residents and persons resident in the US under the substantial presence test.

[2] In general, a foreign corporation is a PFIC if 75% or more of the gross income of the corporation for the taxable year is passive or if the average percentage of assets held during the taxable year that produce, or are held for the production of, passive income is at least 50% under §1297.

[3] A John Doe summons has been used by the IRS to force financial institutions to provide information about a class of US persons. In this case the financial institution was UBS. A John Doe summons can be used when the identity of a US person is known. It can also be issued by the IRS when for examination by the IRS of the accounts of the financial institution.

[4] Gains from passive investments can be subject to the PFIC rules, or they can be subject to tax under the comparatively favourably capital gains tax rules, which in this case the taxpayers had used to declare the gains from their UBS investments.

[5]Under the PFIC rules, current year gains are taxed as ordinary income under one of three methods. One of those is §1291. Under §1291, non-current gains are taxed by allocating the gain over the holding period of the investment, multiplying the amount allocated to each year by the highest ordinary income tax rate for that year, plus an interest charge.