1) Is there an exemption or grace period under which a new Green card holder can dispose of these investments, without the substantial and adverse tax consequences? To include this in ordinary income seems extraordinarily unfair.
There are no exemptions for new green card holders
2) As I understand it, if he elects mark-to-market on the Form 8621, we would need to determine the FMV of each of the funds at 1/1/12 and 12/31/12 and include that difference as ordinary income for 2012? What if the FMV at 1/1/12 is less than the original cost of that fund--must I still use the higher amount?
Sorry his adjusted cost basis would be the fair market value as of Jan 1st. The way IRC 1296 works is that you cannot take a loss in excess of any gains already taken, unless you have disposed of the stock. So if in the first year you have a loss, it cannot be taken for tax purposes as you have not recognized any gain (i.e. providing no 1296 basis). Once you recognized gain for the particular PFIC you can take a loss up to the gain prior to disposition.
3) If we dispose of these PFIC's in 2013 to get out of this draconian taxation, any and all gains would still be treated as ordinary income, in spite of the holding periods?
Yes, it will.
Would the cost basis be the FMV at 12/31/12 that was used for the mark-to-market calculation?
Ahhh finally some good news, Yes it will.
4) What about the dividends Yes, they will not be allowed the advantage as qualified dividends, and if the funds are REQUIRED to distribute, the FMV on 12/31 will have been adjusted for that.
Also, remember that all of the PFIC 1296 MTM will be netted together to arrive at a total PFIC income.
And finally, the foreign tax credits
would still be available against the foreign sourced passive income
(PFIC income in this case).