PFIC tax: What US expats need to know about passive foreign investment companies

Many US citizens living abroad invest in financial products outside the United States. These can include foreign mutual funds, ETFs, or other investment options from local banks or financial institutions.

Some foreign investments may be considered Passive Foreign Investment Companies (PFICs) under US tax rules. If this is the case, US taxpayers may face special tax rules and reporting requirements.

PFIC rules are meant to stop people from delaying US taxes by using certain foreign funds. This means US citizens and green card holders abroad may come across PFIC rules when investing in financial products common in their country.

This article covers what PFICs are, how they can affect US expats, and what reporting rules might apply, including IRS Form 8621. The goal is to help readers understand PFIC rules and why they matter for Americans living abroad.

What is a PFIC?

A Passive Foreign Investment Company (PFIC) is a foreign company that meets certain rules about passive income or passive assets.

Under US tax rules, a foreign company is considered a PFIC if 75% or more of its income is passive income. Passive income generally refers to earnings from investments rather than from active business operations. Examples may include interest, dividends, capital gains, and certain types of rental income.

Asset test

A company also qualifies as a PFIC if 50% or more of its assets produce passive income. This means it mainly holds investments instead of assets used in a business.

These rules help identify foreign companies that mainly act as investment vehicles, not as businesses that actively operate.

Many foreign funds and investment structures may be classified as PFICs because they hold portfolios of financial assets rather than operating active businesses.

Why PFIC rules affect many US expats

US citizens, and green card holders usually have to report their worldwide income to the US, even if they live and work in another country. This means that certain foreign investments that are common in other countries may still be subject to US tax reporting requirements.

For example, many banks outside the US offer investment products like mutual funds and investment trusts for local customers. These are often popular with residents in those countries.

However, under US tax law, these types of investments may be considered PFICs.

As a result, US expats who invest through foreign financial institutions may unknowingly hold PFIC investments.

This situation can occur in several common scenarios, including:

• investing in foreign mutual funds
• holding non-US ETFs
• participating in foreign investment trusts
• maintaining investment accounts with non-US banks or financial institutions

Since PFIC classification depends on how the investment is structured, something that seems normal in one country can still trigger PFIC rules for US taxpayers.

Common examples of PFIC investments

Many types of foreign investment products can be PFICs. The exact classification depends on the company that issues the investment and how it is structured and operates.

Some common examples include:

Foreign mutual funds

Foreign mutual funds are also a very common way that US expats end up with PFICs. Foreign mutual funds collect the money from investors and then use that money to buy a portfolio of domestic and foreign stocks and/or bonds.

Non-US exchange-traded funds (ETFs)

Exchange Traded Funds (ETFs) that are listed on foreign stock exchanges may also be treated as PFICs due to the nature of their underlying assets. Typically, the underlying assets held by such foreign ETFs consist of passive securities.

Foreign investment trusts

Some investment trusts that hold financial assets instead of running businesses may fall under PFIC rules.

Insurance-based investment products

Some insurance products linked to investments, offered outside the US, may also involve PFIC structures.

Foreign holding companies

In certain cases, a foreign company that primarily holds financial assets rather than operating businesses could meet the PFIC criteria.

Because PFIC classification depends on income and asset composition, determining whether a specific investment qualifies as a PFIC may require reviewing the entity's structure.

How PFIC taxation works

PFIC taxation can differ significantly from how investment income is usually taxed. In general, PFIC rules aim to prevent US taxpayers from deferring tax on passive investment income earned through foreign corporations.

In some cases, income from PFIC investments is taxed differently when you get distributions or sell the investment. The tax treatment may involve:

• allocating gains over the entire holding period
• applying different tax rates depending on the timing of income
• applying interest charges related to deferred tax amounts

What is the PFIC tax rate?
Under the default excess distribution method, there's no special "PFIC rate" — instead, income allocated to prior years is taxed at the highest ordinary income tax rate in effect for each of those years (currently up to 37%), regardless of your actual bracket that year.

This is on top of an interest charge on the deferred tax, calculated as if it had been owed since that earlier year. Because gains don't qualify for preferential long-term capital gains rates under this method, the effective PFIC tax rate, after rate plus compounding interest, can run significantly higher than an equivalent US investment would face. A QEF or mark-to-market election (below) can avoid this outcome if made in time.

The exact tax treatment depends on which PFIC rules apply and what choices the taxpayer makes.

Because PFIC rules are detailed and depend on several factors, the calculations involved may become complex.

PFIC election options

US taxpayers with PFIC investments may have different ways to report them, depending on the information the investment provides and the type of asset.

There are three common ways PFIC investments are taxed.

Excess distribution method

The excess distribution method usually applies if you don’t make a special election.

With this method, some distributions or gains are spread out over the whole time you held the investment, which affects how the income is taxed.

Qualified Electing Fund (QEF) election

A Qualified Electing Fund (QEF) election lets a taxpayer report their share of the fund’s income each year.

However, this option usually needs the investment fund to give specific financial details, which foreign funds may not always provide.

Mark-to-market election

The mark-to-market election may apply to certain publicly traded PFICs. With this method, gains or losses are reported each year based on the investment’s value at the end of the tax year. Eligibility for these elections and their implications depend on the structure of the investment and the information available from the fund.

PFIC vs. CFC: what's the difference?

PFIC and CFC (Controlled Foreign Corporation) rules are often confused because both apply to foreign corporations and both create extra US reporting obligations, but they're triggered by different things. A PFIC is defined by what the company earns or holds: 75%+ passive income or 50%+ passive assets, regardless of who owns it. A CFC is defined by who owns it: US shareholders who each own at least 10% must collectively hold more than 50% of the company.

A foreign company can be both at once, most commonly, a small foreign business with mostly US owners. CFCs are reported on Form 5471 rather than Form 8621, and where a company qualifies as both, CFC treatment generally takes priority to avoid double reporting.

A worked example: $10,000 gain, two ways

Say you held a foreign mutual fund for 5 years and sold it for a $10,000 gain.

Under the default excess distribution method (no election made): The $10,000 is allocated evenly across your 5-year holding period — $2,000 per year. The current year's $2,000 is taxed as ordinary income at your actual rate. But the other $8,000 (the prior four years' worth) is taxed at the highest ordinary rate in effect for each of those years, currently up to 37%, regardless of your real bracket, plus an interest charge on each year's deferred tax, compounding from that year's original filing deadline to today. Depending on how long you held the fund, the combined tax-plus-interest can push your effective rate on that $8,000 well past 50%.

Under a QEF election (made from year one): You'd have reported your share of the fund's income annually as it was earned, at your ordinary rate each year, no allocation, no prior-year highest-rate treatment, no interest charge. The $10,000 gain is simply taxed at your actual capital gains or ordinary rate in the year it's realized, the same as a US-based investment would be.

The difference isn't marginal, it's the entire reason tax professionals push clients to make a QEF or mark-to-market election before a PFIC becomes a problem, not after. Once you're in default excess-distribution territory, there's often no way back for that investment.

PFIC reporting requirements

US taxpayers who own PFIC investments usually have to report them to the IRS.

The main form for PFIC reporting is IRS Form 8621.

IRS Form 8621

Form 8621 is used to report several types of information related to PFIC investments, including:

• ownership of PFIC shares
• distributions received from PFIC investments
• gains or losses related to PFIC assets
• elections such as QEF or mark-to-market

You may need to file this form for each PFIC investment you have, and it might be required every year, depending on your situation.

Because PFIC investments may involve multiple reporting considerations, taxpayers holding multiple foreign funds may need to file multiple Form 8621s.

Form 8621, part by part

Form 8621 has six parts, but you'll only complete the ones relevant to your election:

• Part I — Summary of Annual Information: Basic identifying details — share class, acquisition dates, number of shares held, and their value at year-end.
• Part II — Elections: Check the box for whichever election applies (QEF, mark-to-market, or neither — the default excess distribution method needs no box checked here).
• Part III — Income From a QEF: Only if you made the QEF election. Report your pro rata share of the fund's ordinary earnings and net capital gain, using the figures from the PFIC Annual Information Statement your fund is required to provide.
• Part IV — Gain or Loss From Mark-to-Market Election: Only if you made the mark-to-market election. Report the year-over-year change in the stock's fair market value.
• Part V — Distributions From and Dispositions of Stock of a Section 1291 Fund: This is where the default excess distribution method gets calculated — allocating gains across your holding period and applying prior-year highest rates plus interest.
• Part VI — Status of Prior Year Section 1294 Elections: Only relevant if you previously elected to defer tax on QEF earnings and need to report the status of that deferral.

A separate Form 8621 is generally required for each PFIC you hold — so five foreign funds means five forms, every year.

Interaction with other US expat reporting rules

PFIC Form 8621 reporting can come up alongside other international reporting rules for US citizens living abroad.

For example, US expats may also encounter reporting requirements such as:

FBAR (FinCEN Form 114)

The Foreign Bank Account Report (FBAR) may be required if the aggregate value of foreign financial accounts exceeds specified amounts at any time during the calendar year.

Form 8938 (FATCA reporting)

Form 8938, also known as a statement of specified foreign financial assets, is a form associated with the Foreign Account Tax Compliance Act (FATCA). This form is used to report specified foreign financial assets when they exceed certain reporting thresholds.

Tax Reporting on a PFIC requires the completion of Form 8621. FBAR and FATCA report entirely different segments of foreign accounts and assets.

Knowing how these forms work together can help US expats understand their reporting obligations.

Challenges PFIC rules create for expats

PFIC rules are often considered complex, particularly for individuals who invest outside the United States.

Several challenges may arise.

1. Identifying PFIC investments

Many foreign funds don’t clearly say they are PFICs. Because of this, investors might not realize when an investment is a PFIC.

2. Accessing required financial information

Some PFIC elections require specific financial data from the investment fund. Foreign funds may not always provide this information in a format compatible with US tax reporting.

3. Calculating tax obligations

PFIC tax calculations can involve complicated methods and require careful record-keeping.

4. Additional reporting paperwork

Filing Form 8621 and keeping records for PFIC investments can make things more complicated for US taxpayers abroad.

Because of these challenges, PFIC rules are often seen as one of the trickiest parts of US expat taxes.

How US expats can approach PFIC compliance

To protect foreign investments made by US citizen expats, the tax authority in the US has created a specific set of rules: the Passive Foreign Investment Company (PFIC) rules. It is therefore crucial to have some knowledge of the implications when investing abroad.

Here are some general steps that might help:

• understanding how foreign investment vehicles are structured
• maintaining records related to foreign investments
• consulting qualified professionals familiar with international tax reporting

Every taxpayer’s situation is different, and whether something is a PFIC depends on how the investment is set up. For many expats, maintaining a US residential address while living abroad can help simplify financial, banking, and tax-related documentation.

When PFIC rules may not apply

Not every foreign investment is automatically a PFIC.

For example, some investments may not be PFICs, depending on their structure. These can include:

• some foreign pension structures
• investments held through US-domiciled funds

A PFIC (Passive Foreign Investment Company) is determined based on the income and assets of the investment.

To determine whether a complex investment is considered a PFIC, you need to understand the basics of how the investment operates.

Summary

Passive Foreign Investment Companies (PFICs) are foreign investment entities that may cause the reporting of unusual events to the IRS for U.S. citizens and green card holders.

Many foreign mutual funds, ETFs and investment trusts are treated as investment vehicles and therefore could be considered a PFIC for US tax purposes.

US taxpayers who own PFIC investments (whether directly or indirectly) may have to report and pay tax on the income associated with these investments using Form 8621 and other specific reporting forms.

Although the rules governing PFIC can be complicated, a basic understanding of them may alert a US expat to the possibility that he or she may have to file forms with the IRS before investing in foreign funds.

Tax treatment and reporting of foreign investments is often dictated by the type of investment and your individual circumstances. With that in mind, it is not uncommon to run into PFIC (Passive Foreign Investment Company) issues when dealing with global investments.

Frequently asked questions

What is a PFIC for US tax purposes?

A Passive Foreign Investment Company (PFIC) is a foreign corporation that derives most of its annual gross income or losses, and/or has most of its assets, from passive sources.

While the IRS does not define all of the criteria for PFICs, some of the tests that have been imposed by the Service for a foreign corporation to be considered a PFIC include: 75% or more of its annual gross income for the taxable years is derived from passive sources; 50% or more of its annual gross assets for the taxable years are held for or consist of passive investment assets. A number of non-US mutual funds, ETFs and investment trusts are classified as PFICs.

Do US expats need to report PFIC investments?

A significant number of Americans and permanent residents earn income from all over the world. The tax agencies are becoming increasingly aware of foreign-sourced income and the assets that people around the world own. These citizens and permanent residents are viewed by the tax agencies as citizen-resident individuals. As such, all income derived by these individuals must be reported, regardless of where it was earned and from what source derived.

Shareholders in a Passive Foreign Investment Company (PFIC) will more than likely have to report the shares. The report will probably be Form 8621, but there are always exceptions to any general rule, and specific situations can be different from the general rule.

Are foreign mutual funds considered PFICs?

A large number of foreign mutual funds may be treated as a PFIC. Most foreign mutual funds earn income from a variety of sources including dividends, interest and capital gains. The particular characteristics of the fund will determine whether or not this treatment applies.

What is IRS Form 8621 used for?

The IRS Form 8621 is a form used to report shares of a Passive Foreign Investment Company (PFIC) held by a US taxpayer. The form can also be used to report dividends, capital gain distributions, sales of shares, and other elections.

Can US expats invest in foreign ETFs?

US expats are learning that their brokerage in their country of residence are beginning to make foreign ETFs available to them. Apparently, it’s becoming more widespread for US brokers to allow non-US-listed ETFs to be bought and sold on their platforms, although the source isn’t always clear. 

Apparently, this is becoming increasingly allowed. But in any case, the key concern is that not all foreign ETFs are non-PFIC, as a small percentage could be classified as a PFIC, triggering other reporting requirements, the source cautions, and says it’s “a good thing to look at” before investing in such a fund.

How much does it cost to file Form 8621?
Costs vary widely depending on complexity. A single straightforward PFIC under the QEF or mark-to-market method might run a few hundred dollars per form if you're working with a preparer. The default excess distribution method is far more labor-intensive, since it requires reconstructing historical cost basis, prior-year tax rates, and compounding interest calculations, and can cost significantly more per fund, especially for long-held positions or funds without clean historical data.

Do I need a CPA to file Form 8621?
It's not legally required, but PFIC calculations, especially under the default excess distribution method, involve historical rate lookups, day-by-day income allocation, and compounding interest that are easy to get wrong by hand. Most people with more than a small, simple holding work with a CPA or attorney who specializes in international tax rather than filing this form themselves.

What's the penalty for not filing Form 8621?
There's no flat, standalone dollar penalty the way there is for a missed FBAR. But the actual consequence is arguably worse: under IRC §6501(c)(8), failing to file a required Form 8621 keeps the statute of limitations open indefinitely for your entire tax return, not just the PFIC, until the form is filed. If the IRS later examines the return, unfiled PFIC reporting can also trigger a 20% accuracy-related penalty on any underpaid tax tied to it. In practice, "no penalty" is a misleading way to describe a rule that can leave you exposed to audit years or even decades later.