Could your SAFE be a tax trap?

Your Guide to State, Local, Federal, Estate + International Taxation

A Simple Agreement for Future Equity (SAFE) is a debt-like agreement between an investor and a company, often a startup. The agreement provides the investor with equity rights in the company at a future point after certain events have occurred, called a triggering event. Triggering events depend on the agreement, but can include sales, mergers or the company entering another round of funding.

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If your SAFE investment is used to invest in foreign companies, the investment could be deemed a Passive Foreign Investment Company (PFIC) subject to special rules.

An investment is a PFIC if one or both of the following apply:

  1. At least 75% of the corporation’s gross income is “passive” or derived from investments or other sources not related to regular business operations.
  2. At least 50% of the company’s assets are investments which produce income in the form of earned interest, dividends or capital gains.

Like most topics dealing with foreign tax policy, the IRS has not issued clear guidance on how agreements like this should be treated. The IRS has not taken a position on whether being in a SAFE agreement is considered owning equity that is generating passive income and therefore subject to the PFIC rules. Like most foreign investments, thought should be taken before entering into these agreements as the foreign reporting requirements can be extensive. In addition to penalties for missed filings, your income from the investment could be subject to the highest ordinary rates and possibly an interest charge going back to the date of initial investment.

This information is general in nature and should not be relied upon as tax advice. If you have any questions and SAFE agreements, contact your Henry+Horne tax advisor.

Haley M. Braun, CPA