A Passive Foreign Investment Company is any non-US corporation where 75% or more of gross income is passive, or at least 50% of assets produce passive income. For US founders and investors holding shares in foreign mutual funds, ETFs, holding companies, or even certain operating businesses with significant cash holdings, PFIC classification can arise unexpectedly. The consequences of being caught in the default PFIC regime — known as the excess distribution regime — are severe: gains and distributions are allocated back over the holding period, taxed at the highest ordinary income rate for each prior year, and subjected to an interest charge that compounds the liability further.
Two elections exist to avoid the punishing default regime. The Qualified Electing Fund election requires the foreign entity to provide annual PFIC Annual Information Statements disclosing its ordinary earnings and net capital gains, which the US shareholder then includes in income currently regardless of whether distributions are made. The Mark-to-Market election applies only to PFIC shares that are traded on a qualified exchange, and requires the investor to recognise unrealised gains each year as ordinary income, with losses allowed only to the extent of prior MTM gains. The QEF election is generally more favourable for growth-oriented investments, while MTM is the only practical option where the PFIC does not provide the required information statements. Both elections must be made on a timely-filed Form 8621.
Form 8621 must be filed for every PFIC in which the US taxpayer holds a direct or indirect interest, and there is no de minimis exception. A separate Form 8621 is required for each PFIC, making this filing burdensome for investors in foreign fund-of-funds structures where the underlying funds may themselves hold PFICs. Founders who relocated to the US, dual-status aliens, and NRIs who became US tax residents mid-year are particularly exposed, as their pre-immigration foreign fund holdings are often PFICs. The first step in any cross-border tax review for these individuals is a full audit of foreign holdings to identify PFIC exposure before the election window closes.