Form 8621: Information Return by a Shareholder of a PFIC or Qualified Electing Fund
What is the Definition of a PFIC?
A foreign corporation qualifies as a passive foreign investment company (PFIC) if it meets either of the following two tests:
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It earns 75% or more of its gross income for the taxable year from passive income (generally investment income such as interest, dividends, royalties, rents, and annuities), or
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It holds at least 50% of its assets to produce passive income.
This PFIC definition covers most foreign mutual funds because mutual funds outside the United States usually organize as corporations (or fall under U.S. tax law as corporations). The PFIC category also includes ETFs, bond funds, currency tracking funds, precious metal funds, investment trusts, hedge funds, private equity funds, startups, and more. Many expats own PFICs—directly or indirectly—without realizing how harshly U.S. PFIC taxation law treats them.
Take a look at Form 8621 and the Form 8621 Instructions. But honestly, skip the instructions. You don’t want to attempt this alone, as PFIC taxation is a nightmare.
Why Is It The Worst Investment You Can Possibly Own?
Rather than trying to explain the technical tax rules, which would be even more sleep-inducing than the rest of this stuff, we will explain the rationale for the punitive treatment of PFIC taxation and the general results. US mutual funds essentially pass through the current taxation of the investment income to mutual fund shareholders. However, foreign corporations that hold foreign mutual funds can accumulate investment income for the benefit of the shareholders without current taxation to the shareholders. Therefore, to create a rough parity in tax treatment between shareholders of U.S. and foreign mutual funds, Congress enacted the PFIC rules. (IRC Sections 1291 - 1298). In doing so, the intent was clearly to discourage investing in foreign mutual funds.
As an example, there is a default calculation for what is called a section 1291 fund. Two alternative calculations are available by election:
- The "qualified electing fund" (QEF) election, and
- The mark-to-market election
Treatment under these elections is generally less harsh than the section 1291 fund calculation, but the QEF election is restrictive, and either election must be timely.
Section 1291 Calculation
Under the "default" section 1291 fund calculation, we determine "excess distributions" per share and allocate them to each day in the shareholder's holding period. We tax the portion of the excess distribution allocated to the current year as ordinary income. We compute a separate tax and interest charge for the portion of the excess distribution allocated to prior years of the PFIC. For each prior year of the PFIC, we calculate the tax hypothetically at the top individual tax rate. We then charge interest (again, hypothetically) as if the tax were due on the due date of each prior year. This process produces a considerable amount of tax and interest.
Because we treat each reinvested dividend or new purchase as a separate block of stock, and because we must perform the section 1291 fund calculation separately for each block, one PFIC taxation can require several worksheets. Even top-of-the-line practitioner tax software cannot handle these detailed calculations. To manage this task and ensure accuracy, we employ special PFIC taxation software.
Form 8621 Filing Requirements
IRC Section 1298(f) says:
Except as otherwise provided by the Secretary [in regulations], each United States person who is a shareholder of a passive foreign investment company shall file an annual report containing such information as the Secretary may require [Form 8621]."
Therefore, if you are the owner of a PFIC, either directly or indirectly, you must file Form 8621 annually. If you:
- Recognize gain on a direct or indirect disposition of PFIC stock
- Receive certain direct or indirect distributions from the PFIC, or
- Make an election reportable on the form, you might have a tax obligation
Indirect Ownership
Generally, indirect ownership includes ownership as the beneficiary of a foreign estate, trust, or retirement plan, but not a retirement plan that is exempt from US taxation. Unfortunately, most foreign retirement plans are not exempt from US taxation. If you are the "owner" of a foreign trust, including a foreign pension fund, you are considered an indirect owner of any PFIC owned by the trust and subject to PFIC taxation.
Employees' Trusts
You do not count as the owner of an "employees' trust." Neither the Code nor the regulations define this term. However, if a foreign pension:
- A foreign employer created it,
- The foreign employer administers it, and
- The foreign employer funds more than half of it,
Then the foreign pension (trust) appears to qualify as an "employees' trust."
If your pension plan meets these conditions, you do not need to file Form 8621. However, if you contributed more to the foreign pension than your foreign employer did, the IRS treats you as the owner of the portion of the plan tied to your contributions. Treas. Reg. Sec. 1.402(b)-1(b)(6). In that case, if the trust owns PFICs, you must report them unless the trust qualifies as a foreign pension fund whose income remains exempt by treaty until distribution. Temp. Treas. Reg. Sec. 1.1298-1(b)(3)(ii).
Exemption From Filing
PFIC shareholders subject to the interest-charge rules (the section 1291 fund calculation) are not required to file Form 8621 under §1298(f) if the following conditions are met:
- The shareholder is not subject to tax under §1291 on an excess distribution received (or treated as received) from the PFIC during the shareholder's tax year; and
- The shareholder has not made a QEF election with respect to the PFIC, and either:
- The aggregate value of all PFIC stock owned by the shareholder at the end of its tax year does not exceed $25,000 ($50,000 for married taxpayers filing a joint return); or
- The PFIC stock is owned by the shareholder through another PFIC, and the value of the shareholder's proportionate share of the upper-tier PFIC's interest in the lower-tier PFIC does not exceed $5,000. (Reg. Sec. 1.1298-1(c)(2)).
Additionally, Foreign insurance policies are usually not considered to be PFICs. (IRC Sec. 1297(b)(2)(B) & (f)). Form 8621 is not required if the holder of a life insurance contract does not have control over the available investment accounts. (IRC Sec. 1297(b)(2)(B)).
What Happens If You Don't File?
There is no penalty for not filing this form when you are supposed to. However, the statute of limitations for assessing penalties is suspended until you do file the form, if required. That means your entire return remains subject to audit until three years after you file the required Form 8621. See IRC Section 6501(c)(8).