What Are the PFIC Filing Requirements?
Holding foreign investments may trigger complex U.S. tax reporting. Understand the PFIC rules to ensure compliance and choose the appropriate tax treatment.
A Passive Foreign Investment Company (PFIC) is a foreign-based corporation that generates income from passive sources or holds assets that produce passive income. These rules were established by the Tax Reform Act of 1986 to prevent U.S. taxpayers from deferring tax liabilities through foreign corporations. If an investment is classified as a PFIC, it triggers complex reporting requirements and potentially higher taxes for any U.S. person holding its shares, including common foreign investments like mutual funds and ETFs.
Identifying a PFIC and Filing Obligation
Determining if a foreign corporation is a PFIC involves two annual tests. The “income test” is met if 75% or more of the corporation’s gross income is passive. The “asset test” is met if at least 50% of the corporation’s assets produce, or are held to produce, passive income. A corporation is a PFIC if it meets either test, and its status can change yearly based on these results.
Passive income includes dividends, interest, royalties, rents, and certain capital gains. Assets like cash, bonds, and stocks are considered passive because they generate this type of income.
A filing obligation exists for any U.S. person who is a direct or indirect shareholder of a PFIC. The primary reporting instrument is IRS Form 8621, which must be filed for each PFIC investment held during the tax year. However, a de minimis exception applies if the total value of all PFIC stock owned is $25,000 or less at year-end, increasing to $50,000 for joint filers.
Required Information and Documentation for Form 8621
To comply with PFIC rules, taxpayers must file Form 8621, “Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund.” Completing the form requires gathering specific details about the investment. For each PFIC, the form requires the company’s name and address, a description of the shareholder’s stock, and the date the stock was acquired.
Certain tax elections, such as the Qualified Electing Fund (QEF) regime, require the shareholder to obtain specific documentation from the PFIC itself. This documentation provides the necessary figures to accurately report the investment’s performance on the shareholder’s U.S. tax return under the chosen rules.
PFIC Taxation Regimes
U.S. shareholders of a PFIC have three potential methods for taxation, and the choice determines how income from the investment is calculated and reported.
The Default Method (Section 1291 Fund)
If a shareholder makes no formal election, the PFIC is subject to the “excess distribution” regime under Section 1291. Under these rules, any gain from selling PFIC stock or receiving a distribution above a certain threshold is considered an “excess distribution.”
This excess amount is allocated over the shareholder’s holding period. The portion allocated to the current tax year is taxed as ordinary income. Amounts allocated to prior years are taxed at the highest marginal rate for those years, and an interest charge is applied to the deferred tax. This treatment eliminates the benefit of preferential capital gains rates.
The Qualified Electing Fund (QEF) Election
A shareholder can make a Qualified Electing Fund (QEF) election by obtaining a PFIC Annual Information Statement from the fund each year. With a QEF election, the shareholder includes their pro-rata share of the fund’s ordinary earnings and net capital gains in their income annually, whether or not distributions are received.
The primary benefit of the QEF election is that the character of the income flows through to the shareholder. The fund’s net capital gains are taxed at lower long-term capital gains rates, while ordinary earnings are taxed at ordinary income rates. This method avoids the interest charge of the Section 1291 regime.
The Mark-to-Market (MTM) Election
The Mark-to-Market (MTM) election is an alternative available only for “marketable” PFIC stock, such as shares regularly traded on a qualified exchange. Under the MTM method, the shareholder treats the stock as if it were sold at its fair market value on the last day of the tax year.
Any increase in the stock’s value is reported as ordinary income. If the stock’s value decreases, the shareholder can claim an ordinary loss, but only to the extent of MTM gains reported in prior years. This method converts all gains into ordinary income, forgoing capital gains treatment.
Making a PFIC Election
Making a PFIC election is done directly on Form 8621. A taxpayer using either the QEF or MTM tax regime must formally declare this choice on the form when filing their tax return.
To make a QEF election, the shareholder checks the appropriate box in Part II of Form 8621. This is a binding election that generally cannot be revoked without IRS consent. For an MTM election, the shareholder checks the box in Part IV of Form 8621, and this choice also remains in effect for subsequent years.
Filing Form 8621
Form 8621 must be attached to the taxpayer’s timely filed primary federal income tax return, such as a Form 1040 for individuals. The deadline for filing Form 8621 is the same as the deadline for the main tax return, including extensions. Failing to attach the form can invalidate an election, causing the investment to default to the Section 1291 regime.
A U.S. person must file a separate Form 8621 for each PFIC they own. For example, a taxpayer holding shares in three different foreign mutual funds classified as PFICs would need to complete and attach three separate forms. Because PFIC status and elections carry forward, maintaining thorough records is necessary for accurate reporting in future tax years.