JacobsReport
on International Financial Planning

The JacobsReport is a free email newsletter that will discuss investment, business, tax and financial planning in an international context. Reports will be issued as the author's work schedule permits, but will usually be issued on a weekly schedule.

Definition of "Passive Income"

QUESTION: Your controlled foreign corporation book says that passive
income includes interest, dividend, capital gain, etc. However, on the
IRS web site
(http://www.irs.gov/businesses/small/article/0,,id=147322,00.html), it
says those are not passive income. Am I missing anything there? Is the
definition of passive income different for different forms? Thanks.

REPLY: Yes, the term "passive income" has a different meaning with
respect to different parts of the tax law. This is a small example of
why the tax terminology (jargon) is such a huge obstacle for most
taxpayers.

The web page to which you referred is about "passive (business)
activities", which are subject to limitations for deducting losses by
investors who are not working in or for the business. These are
businesses that are organized as partnerships for tax purposes and the
business income or deductions pass through to the partners. However,
inactive (passive) partners are not allowed to deduct any losses in
excess of income from other passive business activities.

In the context of a controlled foreign corporation (CFC), the U.S.
shareholders who own 10% or more of the CFC are subject to current tax
on "foreign personal holding company" income (FPHC). FPHC income is
income from investments such as dividends, interest, capital gains,
rents or royalties. However, in some cases, the same types of income
might be treated as income from a trade or business and would not be
subject to the FPHC tax treatment.

Vern

The comments in this memorandum are not intended to constitute an
opinion regarding any specific tax issues because additional tax
issues may exist that could affect the tax treatment of the tax issues
addressed in this memo. This memorandum does not consider or reach a
conclusion with respect to those additional issues and was not written
and cannot be used for the purpose of avoiding penalties under code
section 6662(d). For further details see
http://www.offshorepress.com/vkjcpa/disclosurerules.htm