Taxes can be complex, particularly when they involve foreign investments. A Passive Foreign Investment Company (PFIC) is a foreign corporation that earns mostly passive income or holds assets that produce such income. Foreign mutual funds, pension funds, and real estate investment vehicles are the most common examples. For US citizens, green card holders, and residents who own shares in a PFIC, the tax consequences can be severe if not managed correctly.
A corporation qualifies as a PFIC under either of two tests. Under the Income Test, 75% or more of the corporation's gross income must be passive — derived from investments such as dividends, interest, rents, royalties, and capital gains rather than active business operations. Under the Asset Test, 50% or more of the corporation's average assets must produce passive income or be held for the production of passive income. Passive income typically includes returns from stocks, bonds, real estate holdings, and similar investment assets. It is important to note that even entities not structured as standard corporations — including certain trusts and holding companies — can be classified as PFICs if they meet these thresholds.
If you are a US person — a citizen, resident, company, partnership, trust, or estate — and you own shares in a PFIC, you are required to file Form 8621 with the IRS. There is no de minimis exception: a separate Form 8621 must be filed for each PFIC in which you hold a direct or indirect interest. US founders who relocated to the US and retained foreign fund holdings, 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.
Without a timely election, the default PFIC regime — known as the excess distribution regime — applies. Under this regime, any gain on disposal and any distributions that exceed 125% of the average distributions received in the prior three years are treated as excess distributions. These amounts are allocated rateably back over your entire holding period, taxed at the highest ordinary income rate applicable in each prior year, and then subjected to an interest charge that compounds the liability further. The result is a materially higher tax cost than if the investment had been held domestically, with no ability to apply long-term capital gain rates.
Two elections exist to step out of the punishing default regime. The Qualified Electing Fund (QEF) election requires the foreign entity to issue annual PFIC Annual Information Statements disclosing its ordinary earnings and net capital gains. The US shareholder then includes their pro-rata share of those amounts in income each year, regardless of whether any distribution is made. This current inclusion approach allows future gains to be taxed at capital gain rates rather than ordinary rates, making QEF generally the more favourable election for growth-oriented investments — provided the PFIC is willing to supply the required statements. The Mark-to-Market (MTM) election applies only to PFIC shares traded on a qualified exchange. Under MTM, the investor recognises unrealised gains each year as ordinary income, and losses are allowed only to the extent of previously recognised MTM gains. MTM is often the only practical option where the PFIC does not or will not provide the annual information statements required for QEF.
To file Form 8621, you will need to gather: the date of acquisition, cost basis, and number of shares held in the PFIC; statements from the PFIC showing earnings, profits, distributions, and any gains or losses; and, if making a QEF or MTM election, the additional financial information required to compute current inclusions or year-end valuations. Errors on Form 8621 or a missed filing can trigger penalties, and the statute of limitations on the entire tax return can remain open until the form is correctly filed. Working with a US international tax advisor who specialises in PFICs is strongly recommended for anyone who holds, or suspects they may hold, an interest in a foreign fund or holding company.