Foreign mutual funds, ETFs and wealth products on a US return

Is my foreign mutual fund, ETF or bank wealth product a PFIC?

A fund can be a passive foreign investment company (PFIC) only if it is a foreign corporation for US tax purposes. It is a PFIC if at least 75% of its gross income is passive income or at least 50% of its assets, measured under the tax rules, produce or are held to produce passive income. Foreign mutual funds and ETFs organized as corporations often meet a test, but the product name and the exchange where it trades do not decide the issue (IRS: Form 8621 instructions).

Read the prospectus and account contract before classifying the holding. A bank's “wealth product” might give you shares in a foreign company, an interest in a trust or partnership, a debt claim against the bank, or direct ownership of investments. The PFIC tests apply to stock in a foreign corporation, including some stock owned indirectly. A fund called a trust or partnership abroad can still be a corporation for US tax purposes: an investment trust whose manager can vary its holdings is a business entity, and a foreign eligible entity whose owners all have limited liability defaults to corporate status unless it elects otherwise (26 CFR 301.7701-4(c); 26 CFR 301.7701-3(b)). A wrapper or a bank statement calling something a “fund” does not establish its US tax form.

If the documents show a deposit, debt claim or direct investment rather than PFIC shares, see Foreign income on a US return for the ordinary income and sale rules.

The US fund rules can also apply to a foreign operating company that meets a PFIC test. If you own a company abroad that holds investments, the controlled foreign corporation rules may overlap; see US owners of foreign companies (IRS: Form 8621 instructions).

Which holdings abroad are usually not PFICs?

A foreign account location alone does not turn its contents into PFICs. Directly held bank deposits, bonds, and shares in a US corporation are not stock of a foreign corporation. A foreign operating company may be outside the PFIC rules if it has never met a PFIC test during your holding period. If it met a test earlier, the rules can continue for your shares even after its business changes (IRS: Form 8621 instructions, former PFIC).

Do not assume a foreign listed share is safe because it is not called a fund, or assume a US listed share is safe because it trades in the US. Look at the issuer's legal residence and financial statements. An individual holding the fund only through a US IRA or another covered US tax-exempt plan generally is not treated as its PFIC shareholder. That rule does not settle the treatment of an RRSP or TFSA; see Canadian registered accounts (IRS: Form 8621 instructions, indirect shareholder).

Who needs to file Form 8621, and is there a small-holding exception?

Generally, a US person files a separate Form 8621 for each PFIC when required to report an excess distribution, a sale gain, an election, annual QEF or mark-to-market income, or annual ownership information. Attach it to the US return by that return's due date, including extensions. If no income tax return is required, the instructions give a separate filing address.

The limits apply to the combined value of relevant PFIC holdings on the last day of the tax year, including QEF and mark-to-market stock, not separately to each fund. This is relief from the annual information requirement for a default-rule fund, not an exemption from PFIC tax or from another reason to file Form 8621 (26 CFR 1.1298-1(c)(2); IRS: Form 8621 instructions). A separate exception may cover a default-rule fund held indirectly through another PFIC if that indirect stock is worth $5,000 or less and there is no excess distribution or disposition gain. Identify every layer of ownership before using either exception (26 CFR 1.1298-1(c)(2)).

How is a PFIC taxed if I make no election?

Without a valid QEF or mark-to-market election, a PFIC is generally a section 1291 fund. A disposition gain is treated as an excess distribution; selling, transferring or pledging the shares as loan collateral can be a disposition (IRS: Form 8621 instructions, line 15f). A distribution is excess only to the extent it exceeds 125% of the adjusted average distributions for the preceding three tax years, or the shorter preceding holding period. An earlier excess distribution counts toward that average only to the extent taxed as current-year income. A distribution in the first holding year is not excess, but if that year had no payout, the next year's first payout is entirely excess. A disposition gain can be excess even in the first holding year. Distributions must be annualized when shares are not held for the full year (26 U.S.C. 1291(b)).

The excess is spread over the days you held the stock. The part allocated to the current year and any pre-PFIC years is ordinary income. Amounts assigned to earlier PFIC years produce a separate tax and interest charge. A nonexcess distribution follows the ordinary corporate distribution rules, generally as a dividend to the extent of earnings and profits. A dividend from a corporation that was a PFIC in the payout year or preceding year is generally not a qualified dividend (IRS: Publication 550). The entire sale gain goes through the excess-distribution calculation even if the holding was long term. A sale loss does not reduce section 1291 gains, but may be recognized under other loss rules (IRS: Form 8621 instructions, Part V).

What do the QEF and mark-to-market elections change, and when can I make them?

Both elections can replace the default treatment for future income, but each has entry conditions and an annual tax cost. The US shareholder makes the election in Part II of Form 8621 by the due date of their return, including extensions, for the first year it applies; only the first US person in an ownership chain may make the QEF election. A later election can leave earlier default-rule years to resolve (IRS: Form 8621 instructions, Part II).

A QEF election made in the first PFIC year in your holding period can avoid unpedigreed-QEF treatment. If it starts later, making the QEF election alone does not erase earlier PFIC years. The US shareholder may make a deemed sale election, or a deemed dividend election if the PFIC is also a CFC, to clear that history. Those elections are due with the original return, including extensions, for the QEF's first year, or on an amended return filed within three years of the original due date (IRS: Form 8621 instructions, Elections D and E). A retroactive QEF election is available only under narrow protective-statement or IRS-consent procedures. A mark-to-market election generally continues for later years unless revoked or terminated under the regulations (IRS: Form 8621 instructions). Check whether the annual statement exists and whether the stock meets either marketable-stock route before choosing an election (26 CFR 1.1296-2). An election that creates tax on undistributed income needs a review of the full holding history. These are federal rules; check your state's treatment of the fund and election separately.

What if I bought the fund before I became a US resident?

If you still own a foreign fund after becoming a US tax resident, check its PFIC status and whether Form 8621 is required for your first US-person tax year. Buying it before residency is not an exemption and generally does not reset its sale basis (IRS: Form 8621 instructions). The default PFIC calculation uses the actual holding period, including days before you were a US person. For QEF purposes, the final regulation disregards pre-residency days when deciding which holding years were PFIC years for you. A QEF election effective for your first applicable PFIC year may therefore be timely even if you bought the fund earlier. That rule does not by itself settle the default section 1291 allocation; Form 8621 allocates excess distributions across the holding period and treats pre-PFIC days differently from earlier PFIC years (IRS: Form 8621 instructions, Part V).

There is a narrow mark-to-market transition rule for an individual who becomes a US person while already owning eligible stock. For mark-to-market calculations, the opening basis in the first US-person tax year is the greater of its fair market value or adjusted basis on the first day of that year. The regulation says this basis rule applies solely for mark-to-market purposes; it does not rewrite the ordinary sale basis (26 CFR 1.1296-1(d)(5)). A dual resident who claims treaty nonresidence and timely files Form 1040-NR or a dual-status Form 1040, as applicable, with Form 8833 is excused from annual Form 8621 reporting for that nonresident period (26 CFR 1.1298-1(c)(5)). For the residency return itself, see First year as a US tax resident.

How do I report a sale or a distribution in US dollars?

First classify the holding and any election, then work out the fund income in US dollars. With no election, use Part V of Form 8621 for distributions and sale gains; purchase lots with different holding periods can need separate calculations. Report nonexcess dividends as dividend income, the current-year or pre-PFIC share of an excess distribution as other income, and the separate tax and interest on the return (IRS: Form 8621 instructions, Part V).

With a QEF election, report annual earnings in Part III and adjust the stock's basis for previously taxed earnings and later distributions. If the election applied since your first PFIC year, a sale follows ordinary stock-sale rules using that adjusted basis. If it started later without a purging election, Part V still applies to distributions and gains. With a mark-to-market election, report annual changes and sales in Part IV using the basis adjusted for earlier marks; sale gains are ordinary income and losses depend on prior unreversed inclusions. The first election year may also require Part V (IRS: Form 8621 instructions, Parts III–V; 26 CFR 1.1296-1).

For foreign-currency distributions, the current Form 8621 instructions require the excess distribution to be calculated in one currency. If all relevant distributions are in the same foreign currency, calculate the excess in that currency, then translate its allocated parts at the spot rate on each distribution date. Otherwise, calculate in US dollars using the distribution-date spot rates. Report the result in US dollars. Convert a purchase cost and sale proceeds separately using the appropriate transaction-date rates; do not simply convert the foreign-currency profit at the sale-date rate (IRS: foreign currency guidance).

Keep the trade confirmations, distribution history, exchange rates, year-end values, the fund's annual statements and exchange listing, and the date you became a US person. For an excess distribution, split creditable foreign tax in Part V, line 16d. Tax allocated to an earlier PFIC year can only reduce that year's added tax, with no carryover; see Foreign income on a US return for general credit rules (IRS: Form 8621 instructions, line 16d).

What if I never filed Form 8621 in past years?

First determine which years required a form. A small default-rule holding with no excess distribution or gain may have qualified for the annual-information exception, while a sale, election or larger aggregate holding can change the answer. Reconstruct fund-by-fund purchase dates, costs, distributions, sales, year-end values and prior returns before amending anything (IRS: Form 8621 instructions; 26 CFR 1.1298-1).

If a required Form 8621 was omitted, the assessment period for tax on the affected return can stay open until the information is supplied and the statutory period then runs. Under section 6501(c)(8), the extension is limited to items related to the failure only if it was due to reasonable cause and not willful neglect. Review transfers and pledges as well as sales when checking past years (IRS: Form 8621 instructions, line 15f). Late elections have separate rules; filing a form now does not automatically make a past QEF or mark-to-market election effective. For missed-year filing steps while living in the US, see Catching up on missed foreign reporting. If you live in Canada and missed US returns too, see Catching up on missed US returns.

Example

Illustrative amounts in US dollars. An individual bought one foreign corporate fund for $10,000 at the start of Year 1, received $100 in each of Years 1–3, then received $200 and sold it for $14,000 on the last day of Year 4. Assume it was a PFIC throughout, all payouts were dividends, and no election applied. Year 1's $100 is not excess. Years 2 and 3 each compare $100 with a $125 threshold, so neither payout is excess. The prior three-year average in Year 4 is $100; 125% is $125. Of the $200 payout, $75 is excess and $125 is nonexcess. The $4,000 sale gain is a separate excess distribution. Part V allocates each excess amount across the holding days; tax and interest depend on the actual dates (IRS: Form 8621 instructions, Part V; 26 U.S.C. 1291(b)).

Different for you?

• Your funds sit in foreign accounts: Foreign account reporting covers FBAR and Form 8938, which are separate from Form 8621.
• Your fund sits inside an RRSP, TFSA or other Canadian registered account: see Canadian registered accounts on a US return.
• You live in Canada and file a US return: see Americans living in Canada for the wider cross-border return.
• You own a bank contract, trust or insurance product, or need to choose a late election: the legal form and history need cross-border tax review.
• You missed Forms 8621 while living in the US: see Catching up on missed foreign reporting. If you live in Canada and missed US returns, see Catching up on missed US returns.