U.S. taxpayers who own foreign mutual funds, foreign ETFs, investment funds, or shares of certain foreign corporations may be subject to the Passive Foreign Investment Company (PFIC) rules and may be required to file IRS Form 8621.
PFIC taxation can be substantially more complicated than the taxation of comparable U.S. investments. Problems frequently arise because taxpayers purchase foreign investments without being told that the investment may be a PFIC. Years later, they may discover that one or more Forms 8621 should have been filed with their U.S. income tax returns.
Colorado Legal assists taxpayers with determining PFIC filing obligations, preparing Form 8621, analyzing the U.S. tax consequences of PFIC investments, and addressing previously unreported PFIC holdings.
Have you owned a foreign fund for years without filing Form 8621?
Long-held PFIC investments can present significantly different issues than simply preparing a current-year form. The acquisition date, cost basis, distributions, prior sales, elections, and length of the holding period can all matter.
What Is a PFIC?
A foreign corporation generally qualifies as a Passive Foreign Investment Company if it satisfies either of two tests under U.S. tax law:
- Income test: 75% or more of the corporation’s gross income for the taxable year is passive income; or
- Asset test: at least 50% of the corporation’s assets, measured under the applicable PFIC rules, produce passive income or are held for the production of passive income.
Foreign mutual funds and similar pooled foreign investment products are among the most common investments that create PFIC issues for individual U.S. taxpayers.
A taxpayer therefore may own a PFIC without realizing that the investment is treated differently from an ordinary U.S. mutual fund for federal tax purposes.
Who May Need to File Form 8621?
A U.S. person who directly or indirectly owns stock of a PFIC may have a filing requirement on Form 8621, Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund.
Depending on the circumstances, filing obligations can arise when a taxpayer:
- owns shares in a PFIC and is subject to annual PFIC reporting;
- receives certain distributions from a PFIC;
- sells or otherwise disposes of PFIC shares;
- makes or maintains a Qualified Electing Fund (QEF) election;
- uses the mark-to-market rules for eligible PFIC shares; or
- makes certain other PFIC elections.
There are exceptions and filing thresholds in some circumstances. Whether an exception applies should be evaluated based on the taxpayer’s particular investment and tax situation.
A taxpayer with several foreign funds can potentially have multiple Form 8621 filing obligations. This is one reason an investment account containing numerous foreign mutual funds may become considerably more complicated than its account value alone suggests.
I Owned a PFIC for Years but Never Filed Form 8621
This is a common PFIC compliance problem.
A taxpayer may have purchased a foreign mutual fund, ETF, or other foreign investment many years ago without knowing that special U.S. tax and reporting rules applied. The taxpayer may even have timely filed U.S. income tax returns every year while never filing Form 8621.
Discovering the problem does not necessarily mean that the correct response is simply to prepare a stack of identical prior-year Forms 8621. The appropriate analysis depends on the investment, transactions involving the investment, available records, elections, and the taxpayer’s filing history.
A review may require determining:
- when the investment was acquired;
- whether the foreign corporation was a PFIC during each relevant period;
- the taxpayer’s original cost and adjusted basis;
- the number and classes of shares owned;
- the value of the investment during relevant years;
- whether distributions were received;
- whether shares were sold, redeemed, transferred, or otherwise disposed of;
- whether a QEF or mark-to-market election was available or made;
- which Forms 8621 were required; and
- how any prior noncompliance should be addressed.
For a PFIC acquired many years ago, reconstructing the history of the investment can sometimes be as important as preparing the tax form itself.
Why PFIC Taxation Can Be Expensive
When no applicable election provides an alternative regime, a PFIC can become subject to the special rules of Internal Revenue Code Section 1291.
Under the Section 1291 regime, certain PFIC distributions and gain from a disposition can be allocated over the taxpayer’s holding period. Amounts allocated to prior PFIC years may be subject to tax determined under special rules together with an interest charge.
Consequently, the tax result from selling a long-held PFIC can be very different from simply reporting the difference between sales proceeds and basis as ordinary long-term capital gain.
Considering selling a significant foreign fund?
For a long-held PFIC, it can be worthwhile to analyze the U.S. tax consequences before the investment is sold rather than discovering the Section 1291 consequences after the transaction has already occurred.
QEF and Mark-to-Market Elections
Depending upon the investment and the information available from the foreign fund, alternative PFIC tax regimes may include a Qualified Electing Fund election or a mark-to-market election.
Qualified Electing Fund (QEF)
Under the QEF regime, a qualifying shareholder generally includes the shareholder’s applicable share of the PFIC’s ordinary earnings and net capital gain in income annually. Proper QEF treatment generally depends on receiving the necessary information from the PFIC.
Mark-to-Market
Certain marketable PFIC stock may qualify for a mark-to-market election. This regime generally requires annual recognition under specialized PFIC rules based upon changes in the value of the investment.
Whether either election is available or beneficial depends on the particular investment, the taxpayer’s holding period, prior PFIC history, prior elections, and other facts. An election that would have been useful when an investment was originally acquired may not necessarily produce the same result after the PFIC has already been held for many years.
PFICs and Other Foreign Reporting Requirements
Form 8621 is only one component of U.S. international tax compliance. Depending on the taxpayer’s assets and circumstances, the same investment or account may raise additional reporting questions involving:
- FBAR / FinCEN Form 114;
- Form 8938, Statement of Specified Foreign Financial Assets;
- Form 5471;
- Form 8865;
- foreign trusts and Forms 3520 or 3520-A; and
- other international information returns.
These reporting requirements can overlap, but they are not interchangeable. Reporting a foreign account on an FBAR, for example, does not by itself resolve a separate Form 8621 requirement.
For a broader discussion of foreign tax reporting and compliance, see our International Tax practice page.
Information Useful for a PFIC Review
If you believe you own or previously owned a PFIC, useful records may include:
- name of each foreign fund or investment;
- country in which the fund or corporation is organized;
- date or dates the shares were purchased;
- original purchase price and available basis records;
- number and class of shares owned;
- current or disposition value;
- annual brokerage or investment statements;
- records of dividends and other distributions;
- records of sales, redemptions, transfers, or other dispositions;
- prior Forms 8621, if any;
- relevant federal income tax returns; and
- any PFIC Annual Information Statements provided by the foreign investment.
For older holdings, complete historical records may no longer be readily available. Part of the initial analysis may therefore involve identifying what information exists and what additional documentation should be obtained.
PFIC and Form 8621 Services
Colorado Legal can assist with matters including:
- determining whether a foreign investment constitutes a PFIC;
- determining whether Form 8621 is required;
- preparing current-year Forms 8621;
- reviewing previously unreported PFIC investments;
- Section 1291 calculations;
- QEF and mark-to-market election analysis;
- analyzing PFIC consequences before a proposed sale;
- prior-year and amended-return compliance issues;
- coordinating PFIC reporting with FBAR, Form 8938, and other international filings; and
- reviewing complex PFIC matters involving substantial or long-held foreign investments.
PFIC matters can range from a relatively straightforward annual filing to a multi-year tax analysis involving significant investment value. The scope of the engagement depends on the number of PFICs, holding periods, transaction history, available records, and filing history.
Frequently Asked Questions About PFICs and Form 8621
Is a foreign mutual fund a PFIC?
Many foreign mutual funds qualify as PFICs for U.S. federal income tax purposes, but the classification ultimately depends on the applicable income and asset tests and the characteristics of the particular foreign entity.
Do I need a separate Form 8621 for every foreign fund?
Multiple PFIC holdings can result in multiple Forms 8621. The precise filing requirement depends on the taxpayer’s ownership, transactions, elections, and any applicable exceptions.
What if I have owned the PFIC for 10 or 20 years?
The length of the holding period can be extremely important, particularly when Section 1291 applies. Historical acquisition records, distributions, transactions, elections, and PFIC status should be reviewed before determining the filing and tax consequences.
What if I never filed Form 8621?
The appropriate response depends on the taxpayer’s particular facts. Before filing amended returns or prior-year forms, it is generally useful to determine when the filing requirement arose, what transactions occurred, whether an exception applied, and whether tax computations are also required.
Is Form 8621 the same as an FBAR?
No. Form 8621 and the FBAR are separate reporting regimes. A foreign investment can potentially implicate more than one international information-reporting requirement.
Can you determine the tax consequences before I sell a PFIC?
Yes. A pre-sale analysis may be particularly important for a PFIC that has appreciated substantially or has been held for many years because the applicable PFIC regime can materially affect the tax treatment of a disposition.
Get Help With a PFIC or Form 8621
If you recently discovered that you own a PFIC—or have held foreign investments for years without filing Form 8621—the first step is to determine the extent of the filing and tax issue before deciding how to proceed.
For an initial review, it is helpful to provide the name of each foreign investment, approximate purchase date, original investment amount or basis, current value, whether any shares have been sold, and whether distributions were received.
This page provides general information and is not legal or tax advice. PFIC consequences depend on the taxpayer’s individual facts and applicable law.
Related International Reporting and Correction Issues
PFIC reporting often overlaps with other international tax obligations. Depending on the asset and ownership structure, a taxpayer may also need to consider Form 8938 / FATCA reporting, Form 5471 foreign corporation reporting, or other foreign-asset disclosures.
If Form 8621 or related international information returns were omitted in prior years, review the delinquent international information return procedures. Where broader non-willful foreign income or asset reporting failures exist, the Streamlined Filing Compliance Procedures may also require analysis.
For an overview of the broader reporting system, see International Tax and Offshore Compliance.