The IRS is looking to rewrite the playbook on how it taxes foreign government investment funds operating in the United States, and some of the world's largest sovereign wealth funds might not love what they're reading.

How the Tax Exemption Currently Works

Right now, Section 892 of the U.S. tax code gives foreign governments and entities they control—think sovereign wealth funds and certain public pension funds—a pass on U.S. taxes for investment activities. The catch? If the IRS decides what you're doing looks more like running a business than passive investing, you're on the hook for taxes.

The new proposal would broaden what the IRS considers commercial activity. That could hit sovereign wealth funds that lend money to companies or take direct equity positions in private firms.

Here's where it gets interesting: under the proposed rules, participating in a company's debt restructuring would count as commercial activity. That's true even if the sovereign wealth fund bought those bonds years earlier when everything looked fine and default risk was practically nonexistent.

Comments on the proposals are due by February 13.

The Big Picture on Sovereign Wealth Funds

Sovereign wealth funds are government-owned investment vehicles, typically funded by commodity revenues, foreign exchange reserves, or budget surpluses. They deploy capital into stocks, real estate, and infrastructure projects worldwide.

The stakes are considerable. In 2025, state-owned investors held $550 billion in private credit globally, according to Global SWF. Their direct U.S. private equity investments more than tripled to $73 billion, primarily through co-investments.