IRS Form 8621: Understanding PFIC taxation

Feb 8, 2024

Navigating the complexities of US tax obligations can be a daunting task, especially for Americans living abroad. Among the myriad of forms and regulations, Form 8621 and the concept of Passive Foreign Investment Companies (PFICs) stand out as particularly challenging for US expats. This guide aims to demystify PFICs and the requirements surrounding Form 8621, ensuring you stay compliant while maximizing your financial strategy overseas.

What is a PFIC?

A Passive Foreign Investment Company (PFIC) is a foreign corporation that meets either the income or asset test specified by the IRS. Specifically, if 75% or more of the corporation’s gross income is passive income, or if at least 50% of the corporation’s assets produce or are held to produce passive income, it is considered a PFIC. Passive income includes dividends, interest, rents, royalties, and certain other types of income.

Here’s a concise summary of the essential definitions and rules:

  • Income Test: A foreign corporation qualifies as a PFIC if 75% or more of its gross income for the tax year is considered passive income, as defined in section 1297(b) of the tax code.
  • Asset Test: Alternatively, a foreign corporation meets the PFIC criteria if at least 50% of its average percentage of assets, determined under section 1297(e), are either producing passive income or are held for the purpose of producing passive income during the tax year.
  • Basis for Measuring Assets: For the asset test, a foreign corporation can use the adjusted basis to determine PFIC status if it is not publicly traded during the tax year, and either qualifies as a controlled foreign corporation (CFC) under section 957 or opts to use the adjusted basis. Publicly traded corporations must use the fair market value for this determination.
  • Look-thru Rule: In assessing whether a foreign corporation is a PFIC, it is considered to directly own its proportional share of the assets and directly receive its proportional share of the income of any corporation where it owns at least 25% of the stock by value.
  • CFC Overlap Rule: U.S. shareholders owning 10% or more of a CFC that is also a PFIC, and who include in their income their pro rata share of subpart F income, are generally not subject to PFIC regulations for the same stock during the qualified portion of their holding period. This exception does not extend to option holders. Further details are provided in section 1297(d).

It’s important to note that even if a foreign corporation is not considered a PFIC with respect to a shareholder under section 1297(d), the attribution rules of section 1298(a)(2)(B) still apply.

Common examples of investments that might be classified as PFICs include, but are not limited to:

  • Foreign mutual funds
  • International ETFs (Exchange-Traded Funds)
  • Foreign pension plans that are invested in mutual funds
  • Certain types of insurance policies with cash value components

Understanding whether your foreign investments qualify as PFICs is crucial because of the stringent reporting requirements and the potentially high tax rates and penalties for non-compliance.

Who Needs to File Form 8621?

Form 8621, “Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund,” must be filed by US taxpayers who:

  • Directly own shares in a PFIC,
  • Indirectly own shares through an entity such as a trust or partnership, or
  • Are beneficiaries of a trust or estate that owns PFIC shares.

Filing Criteria

U.S. persons who are direct or indirect shareholders of a PFIC must file Form 8621 for each tax year if any of the following five circumstances apply:

  1. Receiving Distributions: They receive certain direct or indirect distributions from a PFIC.
  2. Recognizing Gains: They recognize gains on a direct or indirect disposition of PFIC stock.
  3. Reporting for QEF or Mark-to-Market Elections: They are reporting information with respect to a Qualified Electing Fund (QEF) or a section 1296 mark-to-market election.
  4. Making Elections: They are making an election reportable in Part II of the form.
  5. Required Annual Reporting: They are required to file an annual report pursuant to section 1298(f).

A separate Form 8621 must be filed for each PFIC in which the person holds stock directly or indirectly. This includes filing for each PFIC in a chain of ownership.

Understanding Section 1298(f) Reporting Requirements

Purpose of the Requirement: Section 1298(f) of the Internal Revenue Code requires U.S. persons to report their interests in PFICs annually to ensure transparency and compliance with U.S. tax laws. This reporting helps the IRS track the flow of income and gains from foreign investments that might otherwise be taxed favorably under foreign jurisdictions but are subject to different tax treatment in the United States.

What Needs to Be Reported: The annual report requires detailed information about the PFIC, including but not limited to:

  • The name, address, and tax identification number (if any) of the PFIC.
  • The number of shares the U.S. person holds directly or indirectly.
  • The value of the PFIC shares at the beginning and end of the tax year.
  • Any distributions received from the PFIC during the tax year.
  • Any gains realized on the disposition of PFIC shares.
  • Information on elections made by the shareholder regarding how to treat the PFIC income, such as making a Qualified Electing Fund (QEF) election or a Mark-to-Market (MTM) election.

Filing Form 8621: To comply with section 1298(f), U.S. persons must complete and file Form 8621 for each PFIC in which they hold shares. This form serves as the annual report and must be filed with the shareholder’s federal income tax return for the year.

Consequences of Non-Compliance: Failing to file the required annual report can result in significant penalties, including the imposition of fines and interest on any underpaid taxes related to the PFIC shares. Additionally, non-compliance may extend the statute of limitations for the IRS to audit a taxpayer’s returns, potentially opening up earlier tax years to scrutiny.

Exceptions and Exemptions: There are certain exceptions to the filing requirement under section 1298(f), such as when a U.S. person holds PFIC shares through a tax-exempt organization or account. However, these exceptions are narrowly defined, and taxpayers should carefully review the regulations or consult with a tax professional to determine if they apply.

The annual reporting requirement under section 1298(f) is a critical compliance obligation for U.S. persons with PFIC investments. It ensures that the U.S. government has visibility into foreign investments that could affect a taxpayer’s U.S. tax liability, and it helps enforce the complex tax rules applicable to PFICs. Given the complexity of PFIC regulations, U.S. shareholders are encouraged to seek professional tax advice to ensure they meet their reporting obligations accurately and completely.

What is a Qualified Electing Fund (QEF) Election?

A PFIC becomes a QEF for a U.S. shareholder who opts to treat it as such under section 1295(b) and meets the criteria outlined in section 1295(a)(2). This election allows shareholders to include their pro-rata share of the QEF’s ordinary earnings and net capital gains in their gross income annually, transforming potentially punitive tax treatment into a more manageable form.

How Does Electing a PFIC as a QEF Affect U.S. Shareholders’ Taxes?

  • Shareholders must report their share of the QEF’s earnings as ordinary income and capital gains.
  • An option exists to defer tax on undistributed QEF earnings until the QEF election ends.
  • Shareholders missing the QEF election in the first year can opt for a deemed sale or dividend election, turning the PFIC into a pedigreed QEF and avoiding the harsher tax treatment of unpedigreed QEFs.
  • Basis adjustments are made for earnings included in income and distributions received, ensuring taxes are not paid on the same earnings more than once.

Understanding the Section 1291 Fund: What Are the Tax Implications?

PFICs not elected as a QEF or marked to market fall under Section 1291, imposing strict rules on excess distributions and gains from the sale or disposition of PFIC shares.

Tax Implications:

  • Excess distributions, defined as amounts exceeding 125% of the average distributions over the three preceding years, are taxed under a punitive regime, with portions allocated to different periods of the shareholder’s holding period being treated differently.
  • The tax treatment bifurcates the excess distribution into ordinary income for pre-PFIC years and subjects the remainder to a separate tax and interest charge.

How Does the Mark‐to-Market Election Work for PFIC Shareholders?

For PFICs with “marketable stock,” shareholders may opt for the Mark‐to-Market election under section 1296, adjusting their tax obligations based on the stock’s fair market value changes.

Key Points:

  • Marketable stock includes shares traded on recognized securities exchanges or foreign exchanges meeting specific criteria.
  • Electing shareholders report annual income or loss based on the stock’s value change, with basis adjustments ensuring correct tax treatment over time.

What Are the Strategic Considerations for PFIC Shareholders Making Elections?

  • The QEF Election is often beneficial for those seeking to avoid the deferred tax and interest charge mechanism of Section 1291 funds by recognizing income annually.
  • The mark‐to-market election simplifies tax reporting for shareholders of PFICs with regularly traded stocks, aligning tax obligations more closely with actual economic gains and losses.
  • Making informed elections requires understanding the specific attributes of your PFIC investments and how they align with your broader tax strategy.

In conclusion, U.S. shareholders of PFICs face complex decisions that can significantly impact their tax liabilities. Whether opting for a QEF Election, navigating the rules of a Section 1291 Fund, or choosing the Mark-to-Market Election, it’s crucial to understand the implications of each choice.

How to File Form 8621?

Filing Form 8621, the tax form dedicated to reporting income from Passive Foreign Investment Companies, requires careful attention to detail to accurately navigate the reporting requirements and potential tax implications. Here’s a step-by-step guide to help you through the process:

  1. Gather Your Information: Start by compiling all necessary details about your investments in foreign entities, including the name, address, and tax identification number of the PFIC, the number of shares you own, and any distributions or gains realized during the tax year.
  2. Understand the Instructions for Form 8621: The IRS provides specific instructions for completing Form 8621. These instructions cover various scenarios, including reporting for QEF or Mark-to-Market Elections, making elections, and required annual reporting.
  3. Complete the Form: Fill out Form 8621 according to the instructions, ensuring you accurately report your pro-rata share of earnings, distributions, and any elections you’re making for the tax year.
  4. File the Form: Form 8621 can be filed electronically or by mail, depending on your preference and the specific requirements of your entire tax return. Ensure that it’s submitted to the correct IRS address or through the appropriate electronic filing system.
  5. Consult With a Professional: Given the complexities associated with PFICs and Form 8621, seeking advice from a tax professional experienced in expat taxes and foreign investments is advisable. This can help ensure that you’re accurately reporting information and calculating your tax liability related to PFICs.

By following these steps and leveraging professional support, you can navigate the filing of Form 8621 with confidence, ensuring compliance with U.S. tax regulations while managing your foreign investments effectively.

At 1040 Abroad, we understand the intricacies involved in managing investment income from international corporations and are dedicated to streamlining this process for our clients. We charge a flat fee of $200 for filing Form 8621, which covers the meticulous preparation required to accurately report your foreign assets and ensure compliance with U.S. tax laws.

In certain circumstances, particularly when dealing with a no-computation Form 8621, this form is included in the regular filing of your entire tax return at no additional cost. Recognizing the challenges that come with understanding the excess distribution regime and other PFIC-related regulations, we offer free tax advice via email. Don’t hesitate to contact us if you have any questions regarding PFICs, the purposes of Form 8621, or any other concerns related to your foreign investments.


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