What is PFIC (Passive Foreign Investment Company)?

How it works

The PFIC regime targets US persons investing in non-US corporations whose primary activity is passive investment. A foreign corporation is a PFIC if it satisfies either:

• Income test: 75% or more of gross income is passive (dividends, interest, royalties, annuities, gains from passive assets).
• Asset test: 50% or more of average assets produce, or are held to produce, passive income.

The tests are run annually, not at acquisition — a corporation can be a PFIC one year and not the next. Once PFIC, always PFIC for that shareholder unless cleansed via §1298(b) "purging" elections.

Common PFICs:

• Non-US mutual funds (UCITS, SICAV, OEIC, Canadian mutual funds).
• Non-US ETFs.
• Non-US listed investment companies, REITs, business development companies.
• Holding companies with passive portfolios.
• Insurance companies that fail the active-insurance carve-out.

The three tax regimes

A US person holding a PFIC interest faces one of three taxation regimes:

1. Default — §1291 excess-distribution regime

If no election is made, gain on disposition and "excess distributions" (current-year distributions exceeding 125% of average prior 3-year distributions) are taxed under a deferred-tax-plus-interest mechanism:

• Excess distribution allocated rateably across the holding period.
• Allocations to prior years taxed at the highest ordinary income rate in each year (up to 37% federal).
• Interest charge added on the deferred tax — significant on long-held positions.

Effective rate often exceeds 50% on long-held positions. Punitive by design.

2. Qualified Electing Fund (QEF) election

US shareholder elects to treat the PFIC as a flow-through. The PFIC must provide an Annual Information Statement with the shareholder's pro-rata share of ordinary earnings and net capital gain. US shareholder reports those amounts annually on Form 8621, taxed at ordinary income / capital gain rates. No deferral, no interest charge — but requires the PFIC's cooperation in providing QEF statements (most retail foreign mutual funds don't).

Election must be made in the first year of PFIC status for the shareholder, or via a complex "purge" election later.

3. Mark-to-Market (MTM) election

Available only for PFICs with publicly traded shares. Shareholder treats annual unrealised gain as ordinary income (annual mark-to-market valuation), losses deductible up to prior MTM gains. Cleaner than the §1291 regime but requires regular publicly traded status.

Examples

• US citizen invests in a French SICAV. SICAV is a PFIC. Default §1291 regime applies if no QEF election (and SICAVs typically don't provide QEF statements). Annual Form 8621 required. On disposition years later, gain hit with §1291 interest-charge regime — effective rate often exceeds 50%.
• US founder owns shares in a UK Ltd holding company with no operating business — just a portfolio of UK rental properties and investments. UK Ltd fails the income / asset test → PFIC. Founder's shares in the UK Ltd are PFIC interests subject to the same Form 8621 filing and §1291 regime, even though it's a closely-held private company.

Common mistakes

• Buying foreign mutual funds without realising they're PFICs. US expats opening brokerage accounts in their country of residence routinely buy local mutual funds — every one is a PFIC, every one needs Form 8621, default §1291 applies.
• Missing the first-year QEF election window. QEF must be made in the first year of PFIC ownership, or the shareholder must file complex purging elections later. Late QEF is much harder.
• Forgetting the CFC overlap. A CFC that is also a PFIC is generally taxed under the CFC rules (Subpart F, GILTI) rather than PFIC for US shareholders — but careful analysis is needed because the CFC overlap rules have edges.
• Skipping Form 8621 because nothing was distributed. Annual filing is required regardless. Failure keeps the statute of limitations open on the entire return.