U.S. persons who own foreign mutual funds can sometimes be in for an unpleasant surprise when it comes to filing their taxes. The tax treatment of overseas funds differs considerably from those of domestic funds under the Internal Revenue Code’s rules for “Passive Foreign Investment Companies” (PFICs). Passive income includes dividends, interest, gains from the disposition of stocks and securities, and gains from commodities trading. A foreign company is considered a PFIC if at least 75% of its gross income is passive income and/or if at least 50% of its assets produce passive income.
Because most of the income of a mutual fund consists of items that can be defined as passive income, nearly all overseas mutual funds are PFICs. This can be the case even if such funds are held through a tax-deferred savings account (e.g., U.K. individual savings accounts (“ISAs”) and Canadian tax-free savings accounts (“TFSAs”)) or a non-qualified pension and retirement account. A PFIC is not the account – but each investment inside of the account may be a PFIC.
PFIC investment income is generally subject to highly punitive U.S. federal tax rates. A non-deductible penalty interest charge can also compound regularly while holding an interest in a PFIC.
Several elections are available to mitigate the more onerous aspects of PFIC taxation (e.g., a so-called “QEF election” or “mark-to-market” election). Special rules apply if such elections are not made by the taxpayer for the first year of PFIC stock ownership.
When a shareholder makes a QEF election, he will be required to include each year in gross income the pro rata share of earnings of the QEF and include as long-term capital gain the pro rata share of net capital gain of the QEF.
Under the mark-to-market election, shareholders must include each year as ordinary income, the excess of the fair market value of the PFIC stock as of the close of the tax year over its adjusted basis in the shareholder´s books. If the stock has declined in value, an ordinary loss deduction is allowed, but it is limited to the amount of gain previously included in income.
Tax Tip: U.S. expats considering an investment in a foreign mutual fund should proceed with caution because this type of investment is often subject to the onerous PFIC regime.
When is Form 8621 required?
You have to file when you have direct or indirect ownership of a PFIC.
- There is a Mark to Market election in place
- There is a QEF election in place
- The shareholder wants to make an election
- No election in place, but the shareholder receives a distribution from or disposes of a PFIC
- Absent any of the above bullets – Form 8621 does not need to be filed unless:-
-The aggregate direct and indirect ownership at the end of the year for all §1291, §1295 & § 1296 PFICs exceeds $25,000 ($50,000 MFJ), or
-The indirect ownership at the end of the year for all §1291, §1295 & §1296 PFICs exceeds$5,000
Note: Your ownership can be direct or indirect. If you own stock in a PFIC you are a direct owner. Check your investments carefully because one of your mutual funds or custodial accounts could include shares in a PFIC, making you a direct owner which could mandate 8621 filing requirements.
Disclaimer: Information provided by Sigma Accountants LLC on this site is not to be construed as legal, tax, or accounting advice. Every effort is made to provide current and accurate information but tax laws and regulations can change and errors can occur. This information is provided “as is” with no guarantees of completeness or accuracy and without warranties of any kind- express or implicit.