What is a PFIC?
A PFIC (passive foreign investment company) is a foreign (non-US) corporation that meets either an income or asset test.
- The income test is met if 75% or more of the foreign corporation’s gross income for its taxable year is passive income.
- The asset test is met if at least 50% of the assets held by the foreign corporation during the taxable year are assets that produce passive income or that are held for the production of passive income.
A PFIC is not your account in a foreign country with a bank or financial advisor- but each investment inside of the account may be a PFIC.
What is passive income?
For PFIC purposes passive income is defined in IRC 954(c) which lists dividends, interest, royalties, annuities, capital gains, foreign currency gain, gain on commodity transactions and the like.
Common types of PFICs
- Foreign Mutual Funds- The most common types of passive foreign investment companies are non-US mutual funds. This does not include US mutual funds that own foreign investments. It does include mutual funds based outside the US that own US investment and also foreign mutual funds that are denominated in US currency.
- Exchange Traded Funds- many ETFs are also PFICs. Even though they may be set up as Unit Trusts- the IRS often considers them to be foreign corporations through a series of tests found in IRC 7701. Many iShares ETFs are PFICs, even when purchased in a US based account.
- Foreign Real Estate Investment Trusts (REITs)
- Foreign Holding Companies set up as corporations
- Société d’investissement à capital fix-(SICAF)
- Société d’investissement à capital variable (SIVAC)
- Privately owned foreign corporations that meet the asset or income test – there are special rules for Controlled Foreign Corporations that are also Passive Foreign Investment Companies.
How do I know if I own any PFICs?
Research- and it isn’t always easy.
- Pretty much all foreign mutual funds are PFICs.
- Look at the International Securities Identification Number (ISIN) – a 12 digit alpha-numeric code that uniquely identifies a security. The first 2 numbers are the country code.
- Prospectus or Statement of Additional Information may indicate the investment is a PFIC.
- Google search “Name of Investment PFIC” – often this will bring up information.
When is PFIC income taxed?
The taxpayer can choose between current taxation of real and/or phantom income or defer taxation which will be subject to higher rates of taxation and interest charges.
If you live in the United States your home state may not tax PFIC income in the same year or the same way as the IRS
What do I have to file?
Passive foreign investment companies are reported as part of your Form 1040 Individual Tax Return on Form 8621. You would file a separate Form 8621 for each PFIC.
When am I required to file Form 8621?
Form 8621 is required every year when you own a PFIC for which a Mark to Market or QEF election is in place. You are also required to file Form 8621 for any sales of or distributions from a PFIC during the year.
What is an Excess Distribution?
Excess distributions only occur in regard to IRC 1291 stock (no Mark to Market or QEF election in place). Distributions received during the year may be all, part or not an excess distribution. The portion of the current year distribution that exceeds 125% of the average distributions received over the previous 3 years. All gain from the sale of a PFIC is considered an excess distribution.
What is an Unreversed Inclusion?
Unreversed inclusions is the gain that has been included in taxable income under the Mark to Market election in years before the current year. This number is the amount of loss that a shareholder can take in a year that the value of the PFIC has gone down due to investment performance or fluctuations of the currency exchange rates. Since the M2M election includes unrealized gain into income each year- this is the IRS allowing unrealized losses but only up to the amount of gain previously recognized.
Unreversed inclusions are tracked per share and basis will have to be adjusted down if a loss is taken on the return.
What is an Annualized Distribution?
A number used in the calculation of non-excess distributions for purposes of §1291 taxation. A non-excess distribution is the total of all distributions received during a tax year that does not exceed 125% of the average of distributions received in the prior 3 years. The phrase “all distributions” means literally that- even if the shareholder did not receive the distribution because they were not the owner. You are allowed to include distributions they would have received if they had owned it all year. This allows for a larger non-excess distribution in the earliest years of ownership.