What Is the PIF (Passive Investment Income) Tax?

The Internal Revenue Service (IRS) imposes a tax on certain S corporations that generate passive investment income, commonly known as the Passive Investment Income (PIF) tax. This tax aims to prevent S corporations from accumulating earnings from prior C corporation years while primarily operating as passive investment vehicles. This article explains what the PIF tax entails, identifies which S corporations are subject to it, details how the tax is calculated, and outlines the procedures for reporting and paying this tax liability.

Understanding the Passive Investment Income Tax

Passive investment income (PII) refers to specific types of gross receipts that, in the context of S corporations with a history as C corporations, can trigger a corporate-level tax. Common examples of PII include gross receipts from royalties, rents, dividends, interest, and annuities. Gains derived from the sale or exchange of stock or securities also fall under this definition. However, certain exceptions exist, such as interest earned on installment sales of inventory to customers or gross receipts from specific lending and financing businesses.

This tax primarily applies to S corporations that have accumulated earnings and profits (E&P) from tax years when they operated as a C corporation. An S corporation becomes subject to the PIF tax if its passive investment income exceeds 25% of its total gross receipts for a taxable year, provided it also possesses accumulated E&P from prior C corporation operations at year-end.

If an S corporation consistently meets these criteria for three consecutive tax years, its S corporation election can be involuntarily terminated. This termination occurs on the first day of the first tax year following the third consecutive year. S corporations that have always operated under S corporation status and therefore never accumulated C corporation E&P are not subject to this specific tax.

Calculating the PIF Tax

This tax is imposed on “excess net passive income,” which is calculated from “net passive income.” Net passive income is determined by subtracting deductions directly connected to the production of passive investment income from the gross passive investment income. These deductions must have a proximate and primary relationship to the income generated.

The formula for excess net passive income involves multiplying the net passive income by a fraction: (passive investment income – 25% of total gross receipts) / passive investment income. The tax rate applied to this excess net passive income is the highest corporate income tax rate, which is currently 21%.

The amount subject to this tax cannot exceed the corporation’s taxable income for the year. This taxable income is determined as if the S corporation were a C corporation, meaning certain S corporation-specific adjustments are disregarded for this calculation.

Reporting and Paying the PIF Tax

S corporations that incur the Passive Investment Income tax must report it on their annual tax return, Form 1120-S, U.S. Income Tax Return for an S Corporation. The calculated tax on excess net passive income is specifically entered on Line 23a of this form. A separate statement detailing the computation of this tax should be attached to the Form 1120-S.

Corporations expecting to owe this tax are generally required to make estimated tax payments throughout the year. For calendar-year S corporations, these estimated payments are typically due by the 15th day of April, June, September, and January of the following year. If any of these dates fall on a weekend or holiday, the deadline shifts to the next business day.

The Form 1120-S itself is generally due by the 15th day of the third month following the end of the corporation’s tax year. For S corporations operating on a calendar year, this means the return is due by March 15. Any remaining tax liability after accounting for estimated payments must be paid by this filing deadline. Payments can typically be made electronically or by mail, along with the filed return.