If you’re a US taxpayer living abroad or investing internationally, you may have heard the term “PFIC” come up in discussions about tax compliance. PFIC stands for Passive Foreign Investment Company, and understanding how it works is critical to avoiding onerous tax treatment and reporting pitfalls.
What Qualifies as a PFIC?
A foreign corporation is considered a PFIC if it meets either of two tests in a given tax year:
Income Test: 75% or more of the corporation’s gross income is “passive income” (e.g., interest, dividends, rents, royalties).
Asset Test: 50% or more of the corporation’s assets produce or are held to produce passive income.
This definition captures many non-US mutual funds, exchange-traded funds (ETFs), and certain foreign holding companies.
Why PFICs Matter for US Taxpayers
PFICs are subject to a special set of US tax rules designed to discourage US persons from deferring tax through foreign passive investments. If you’re a US citizen, green card holder, or tax resident, and you own shares in a PFIC, the default tax treatment is highly punitive:
Excess Distribution Regime: Any “excess distribution” or gain from selling PFIC shares is taxed at the highest ordinary income tax rate, not favourable capital gains rates. Interest Charge: A non-deductible interest charge is applied to the tax liability as if the income were earned and untaxed over multiple years.
Common Examples of PFICs
Non-US mutual funds Foreign ETFs and index funds Certain foreign pension or insurance wrappers Foreign investment trusts
Even small, seemingly innocuous investments can trigger PFIC status.
Reporting Requirements: Form 8621
US taxpayers who own PFICs must file Form 8621 with their annual tax return. This form discloses:
Ownership information Distributions received Gains on disposal The method of taxation elected (if applicable)
Failure to file Form 8621 can result in penalties and extend the statute of limitations on your entire tax return indefinitely.
Can PFIC Treatment Be Avoided or Mitigated?
In some cases, yes. There are two alternative elections that can help avoid the default punitive regime:
Qualified Electing Fund (QEF) Election: Allows you to report your share of the PFIC’s income annually. However, the PFIC must provide detailed financial information, which many do not. Mark-to-Market Election: Available for market-traded PFICs, this treats shares as sold at fair market value at year-end. Gains are taxed annually at ordinary rates, but without the interest charge.
Both elections have strict requirements and must be made early in the investment lifecycle.
Final Thoughts
PFIC rules are among the most complex and punishing areas of US international tax. If you are a US taxpayer with foreign investments, understanding whether you hold PFICs and how to handle them is essential.
The information in this blog post is for general informational purposes only and does not constitute professional tax advice. We strongly recommend consulting a qualified tax professional before making any decisions. US Expat Tax Advisor is not liable for any actions taken based on this content.
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